How to decide whether to declare bankruptcy

Marc Merklin, managing partner, Brouse McDowell

Marc Merklin, managing partner, Brouse McDowell

Although it’s best used as a last resort, filing for Chapter 11 bankruptcy can offer struggling businesses a chance to restructure debt and emerge as successful entities, says Marc Merklin, managing partner at Brouse McDowell.

“Chapter 11 is a tool and not an end in and of itself,” he says. “Businesses that go into it without knowing what they want to accomplish often flounder and fail because it’s an expensive process. The longer it goes on, the greater the risks and costs. Companies that succeed have a specific goal and accomplish it as quickly as possible.”

Smart Business spoke with Merklin about alternatives to bankruptcy and how to best utilize the Chapter 11 process, should it prove necessary.

Are there options short of bankruptcy that should be considered first?

A workout is the best option because bankruptcy is expensive and risky. Try individual negotiations with the lender or creditors. Often with the lender there can be workout or forbearance agreements. They can be difficult to negotiate and disruptive to cash flow as lenders often add fees and expenses, as well as interest rate increases. Still, it’s usually desirable to attempt to work that out before seeking Chapter 11 protection. Most lenders understand that Chapter 11 will not only delay the exercise of their remedies and cost additional funds, but also carry risks such as ‘cramdown,’ which means forcing creditors to accept a plan they oppose.

Even if you have multiple creditors, you can negotiate with a group of them through an out-of-court settlement, whereby you give creditors notes for past due obligations and then amortize them. That can be difficult depending on the number of creditors.

What are the differences between Chapter 7 and Chapter 11 bankruptcy filings?

Chapter 7 is liquidation, so there is a trustee appointed and the business is almost never sold as a going concern. Even if you’re going to sell the business or liquidate it, it’s often better to do it under Chapter 11 because the company can still manage itself rather than being liquidated by someone who has no knowledge of the industry or business.

The goal under Chapter 11 is to restructure and emerge. In the past five years, more Chapter 11 filings have been sales as going concerns rather than true reorganizations. In a sale as a going concern, assets go to a buyer who will operate them as the business but under new ownership and a new structure free of claims and debts. In a restructuring, the company largely emerges the same even if there is a new investor or new ownership.

What are the benefits of filing Chapter 11 bankruptcy?

One is cramdown — the ability to force a payment plan when creditors are not willing to agree to a payment plan on their own.

The other is the ability to reject burdensome contracts that are causing huge losses. You can go into bankruptcy and reject that contract, convert it to a claim that you pay under a plan and not be bound by the contract. For example, if you’re selling to a customer at a huge loss and they’re holding you to that contract, you can reject that contract. They’re going to have a claim, but it would be an unsecured claim under bankruptcy and might be paid at 10 cents on the dollar. The company is then freed from the requirement of producing those goods at a loss and can generate positive revenue going forward.

But while Chapter 11 can be a very useful tool, it’s not the most desirable process because of the cost of accountant and attorneys’ fees, as well as the risk for existing owners and equity holders in the company. Under the absolute priority rule in bankruptcy code, equity holders or owners fall last in line. They cannot retain their equity ownership without contributing new value to essentially ‘pay’ for those equity interests after confirmation of the Chapter 11 plan.

Marc Merklin is a managing partner at Brouse McDowell. Reach him at (330) 535-5711 or [email protected]

Insights Legal Affairs is brought to you by Brouse McDowell


Overseas Shipholding may file for bankruptcy

NEW YORK, Mon Oct 22, 2012 – Debbt-laden Overseas Shipholding Group Inc , the world’s No. 2 independent tanker operator by fleet size, said it was evaluating options including filing for bankruptcy protection and may have to restate results for at least three years.

Shares of the company, which had estimated debt obligations of $2.24 billion as of June 30, fell as much as 66 percent to a life low of $1.02 on Monday morning.

The stock lost more than a third of its value last week on speculation that talks with lenders had stalled.

Shares of Nordic American Tanker Ltd., Teekay Tankers Ltd., DHT Holdings Inc. and Top Ships Inc. were down between 3 and 8 percent.

Financial statements for at least the three years ended December 2011 should no longer be relied on, Overseas Shipholding said in a regulatory filing on Monday.

Overseas Shipholding said it was reviewing a tax issue arising from the fact that while the company is domiciled in the United States, it has substantial international operations.

Allen Andreas, a director and member of the audit committee, resigned on September 27 over disagreements with the board in reviewing the tax issue, the company said in a filing.

The company had yet to determine if it would need to restate its results for the years in question.

Global Hunter Securities suspended coverage on Overseas Shipholding on Monday, saying it could no longer rely on the company’s financial statements, and noting that there was no clarity on the specifics of the tax issue.

How to determine if your business really needs to file bankruptcy

Lewis Landau, Senior counsel, Dykema Gossett PLLCYour business has been slapped with a lawsuit, and in a panic, you run to see a bankruptcy lawyer.
Is declaring bankruptcy really the best course of action? In some cases, this can be true. But in most instances, it may be time to step back and consider other options, says Lewis Landau, senior counsel at Dykema Gossett LLP.
“I have found that by the time the debtor arrives at a bankruptcy lawyer’s office, there is an extreme bias in favor of pulling the bankruptcy trigger,” Landau says. “It’s almost as if the gravity pull of just going to a bankruptcy lawyer means you’re ready to do it. However, bankruptcy is just one of several tools available to a debtor.”
Smart Business spoke with Landau about how to determine the difference between needing to declare bankruptcy and simply wanting to declare it.

What is the difference between needing to file and wanting to file?

Have-to-file cases are ones in which there is an immediate loss of control of something, such as a pending eviction, forthcoming foreclosure, or a bank account has been levied up and has already lost money. Control has been lost — or is imminently going to be lost — and the debtor needs to take action through the help of the bankruptcy process today to regain control. In those instances you generally will have to file.
Those are the easy calls. However, most cases are not have-to-files, they are want-to-files, when people feel the need to do something to cure their problems.
If there is nothing that elicits the immediate loss of assets, the attorney should ask what is creating the pressure, why are you here and why are you contemplating bankruptcy?
The answer is generally a lawsuit. The sheriff has come and scared the owner by handing over papers. They panic and wind up in a bankruptcy lawyer’s office the next day because, having been served, they feel that they have to do something immediately.
However, lawsuits take a very long time to resolve; in Los Angeles, it generally takes a year. So you have to measure the cost of allowing the lawsuit process to continue. Even though you ultimately may wind up with a bad judgment, it could be smarter to let that timeline string out. You eventually could settle that case, and the problem is resolved.
Some of the hardest advice a bankruptcy lawyer gives is to not file when someone wants to do so. Your first reaction upon hearing that may be that the lawyer doesn’t know what he or she is talking about, but there may be a better alternative.

How can cost deter you from declaring bankruptcy?

To go into bankruptcy, you have to be able to afford it. Chapter 11 bankruptcy is a very expensive process. Much like you wouldn’t want to drive to Las Vegas from Los Angeles on half a tank of gas because getting stuck in the desert is never good, you don’t want to get involved in a bankruptcy case and not be able to finish the process because of the cost. At a minimum, figure $50,000 to re-organize, and the sky is really the limit.
Another concern is that the moment you file, a whole host of new people and agencies are involved in your life who weren’t before, such as the U.S. Department of Justice’s Trustee Program and its trustee offices, the court and the creditors, who have a large stake and influence in a debtor’s future. There are degrees of loss of control that happen by filing that may not happen if you don’t file, and those need to be measured and balanced.

What else should a business owner be thinking about when considering filing?

A business cannot operate in the red in bankruptcy.
A company may go into bankruptcy and have a few months of losses before going back into the black, and that’s OK if a debtor can show the low point of a seasonal business or orders that will create a profit in the future.
The reason why accrual of losses in bankruptcy is especially treacherous is that post-bankruptcy debt — to the extent that it is unpaid — receives administrative expense priority, which means it’s the top priority at the same level as unpaid legal fees.
The day before bankruptcy, if credit is extended to a business without collateral, it is general unsecured debt. That same credit extended the day after bankruptcy is top priority and entitled to be repaid in full, immediately, in order to exit the bankruptcy. General unsecured debt, on the other hand, generally gets paid back over years, or not at all.
If too much post-bankruptcy debt is accrued and unpaid, the ship can’t sail to its goal. It gets top heavy and falls over because the organization can’t pay its debts to get out of bankruptcy.
The process is a partnership between the bankruptcy lawyer and the business. The lawyer can do a lot to make it work but can’t do anything without a profitable business. Bankruptcy attorneys fundamentally take that profit component, drop it to the bottom line and make deals with creditors to split that. And if there is no profit, the attorney has nothing to work with.
If you have a bias toward filing, you will always be able to find a bankruptcy attorney to file for you. However, if an experienced bankruptcy attorney who knows the system and who understands the adverse consequences advises against it, it may be prudent to heed that advice.

Lewis Landau is senior counsel at Dykema Gossett LLP. Reach him at (213) 457-1754 or [email protected]

Insights Legal Affairs is brought to you by Dykema Gossett LLP

Dynegy Inc. files for bankruptcy; will merge with unit

HOUSTON, Fri Jul 6, 2012 – Power producer Dynegy Inc., the parent company of Dynegy Holdings, filed for bankruptcy protection on Friday morning as part of its settlement agreement with creditors and said it will merge with its unit.
Last month, a bankruptcy court approved the company’s settlement with creditors under which Dynegy and Dynegy Holdings would be combined, with creditors holding a 99 percent equity stake in the combined company.
The settlement resolved a dispute among creditors over whether Dynegy had acted properly last September in taking $1.25 billion of coal-powered plant assets from Dynegy Holdings.
Creditors of that unit said the transfer unfairly benefited shareholders, including billionaire financier Carl Icahn and the Seneca Capital Investments LP hedge fund and Franklin Resources Inc.’s Franklin Advisers unit at their expense.
Susheel Kirpalani, a court-appointed examiner, in March called the move a “fraudulent transfer” that harmed Dynegy Holdings.
On Thursday, the court approved the reorganization plan of Dynegy Holdings which clears the way for it to seek approval from creditors.
Dynegy units that operate its coal and gas-fired businesses were not included in Friday’s Chapter 11 filing.
The company in 2001 set and then canceled plans to buy Enron Corp as the business and finances of its larger rival deteriorated quickly.
Dynegy had total assets of $11.3 billion and liabilities of $5.1 billion as of May 31.

Stockton, Calif., files bankruptcy petition; largest in U.S. history

STOCKTON, Calif., Fri Jun 29, 2012 – Stockton, Calif., became the largest city to file for bankruptcy in U.S. history on Thursday, after years of fiscal mismanagement and a housing market crash left it unable to pay its workers, pensioners and bondholders.

The filing, announced by the city of 300,000 people, followed three months of confidential talks between the city and its creditors aimed at averting bankruptcy.

“We are now a Chapter 9 debtor,” said Marc Levinson, a lawyer representing Stockton, noting he filed the city’s voluntary petition in U.S. Bankruptcy Court for the Eastern District of California in Sacramento, California as Case 12-32118.

Levinson said pleadings in support of Stockton’s eligibility for Chapter 9 bankruptcy will be filed on Friday.

“We are extremely disappointed that we have been unable to avoid bankruptcy,” Mayor Ann Johnston said in a statement. “This is what we must do to get our fiscal house in order and protect the safety and welfare of our citizens.”

The negotiations ended on Monday with Stockton failing to win enough concessions to help close its shortfall for the fiscal year starting on July 1.

“Our general fund resources are depleted, and we cannot allow the city to spiral into uncontrolled default,” City Manager Bob Deis said. “Bankruptcy stops a barrage of lawsuits and allows the city breathing room while working toward a plan of adjustment and moving Stockton forward.”

The filing of Chapter 9 bankruptcy, a rare event for the U.S. municipal issuers, was left as the only option to close a deficit of $26 million for the budget of the new fiscal year.

The budget suspends $10.2 million in debt payments and cuts employee compensation and retiree benefits by $11.2 million. About $7 million in savings would come from cutting retiree medical benefits for one year. The retiree medical benefits will be eventually eliminated.

Stockton becomes the nation’s most populous to file for Chapter 9 bankruptcy. But Jefferson County, Ala., remains the biggest in terms of debt outstanding, as it had a debt load exceeding $4 billion when it filed in 2011. Stockton has about $700 million in bond debt.

How to minimize the risk of fraudulent transfer claims when a vendor goes bankrupt

Alan Koschik, Co-Chair Commercial & Bankruptcy Practice Group, Brouse McDowell

Your parts distributor has always been reliable, offering you prices that its competitors couldn’t beat. It was a great deal for you — until the distributor went bankrupt.

You find another supplier and move on. But months — or years — later, you are called on by a bankruptcy trustee that has been appointed to oversee the bankruptcy case. The trustee says that the commodity you were purchasing was priced much lower than market rate. And because the trustee’s job is to collect funds in this case, he’s delivering you with a lawsuit to charge you with paying the difference between your below-market prices and the market rate for those years you purchased the commodity.

“Increasingly, customers of bankrupt businesses are being caught by surprise with fraudulent transfer claims asserted by bankruptcy trustees, who claim that they received a deal that was too favorable,” says Alan Koschik, co-chair of the Commercial & Bankruptcy Practice Group at Brouse McDowell. “These claims seek to renegotiate sale transactions long after they took place and create a new layer of uncertainty for certain business transactions.”

Smart Business spoke with Koschik about how businesses can help protect themselves against fraudulent transfer claims.

What are fraudulent transfers and when do they most commonly occur?

Technically, a fraudulent transfer claim is a transfer of property that is made with the intent to hinder or delay a creditor, or put property beyond their reach. In typical cases, a debtor might transfer his home or savings accounts to another person, an insider such as family or a spouse.

Fraudulent transfer claims most often arise in these familiar situations: transfers to insiders, as described; so-called upstream guaranties of a corporate parent’s debt by a business that ultimately cannot pay its creditors; and leveraged buyout transactions that cause an insolvent debtor to take on too much debt while permitting former equity holders to cash out of the business.

What is surprising about the new class of fraudulent transfer claims?

The new class of claims is distinctly different from these typical cases. They do not involve insider transactions, or extraordinary transactions. The claims are being charged against customers that have engaged in day-to-day business transactions, such as simply buying a commodity a company sells.

The customer isn’t trying to defraud or hinder anyone; it simply wants to buy the product and the seller (debtor) is offering an attractive price. However, bankruptcy trustees are seeking to change the price term of regular sales transactions long after they were completed by arguing that the value paid was less than ‘reasonably equivalent.’ Litigation ensues and usually involves an expensive debate about the sufficiency of the price.

What typical business transactions could lead to fraudulent transfer claims?

Sales of commodities are the most typical sales that can trigger a fraudulent transfer claim because a bankruptcy trustee has access to pricing information. Commodities are traded in a variety of exchanges, so trustees can look up idealized prices and make comparisons to prices actually paid to the debtor, the business that went bankrupt. Then, the trustee can calculate the difference and come up with a figure that he contends the customer should have paid.

The trustee justifies this based on commodities prices, charging that the debtor would have collected X more dollars if it had charged the reported market price. Commodities are more likely to be subject to a pricing comparison and lead to a fraudulent transfer claim than, say, accounting or legal services that are typically considered unique and less likely to have a non-negotiable ‘market price.’

In case of a lawsuit, what defenses can a business raise?

These new fraudulent transfer claims can be challenged with the argument that non-insider customers that negotiate at arm’s length set their own market price and should not bear the burden of guarantying the debtor-seller’s debts to its creditors. The customer shouldn’t have to help pay the vendor’s debt just because it was offered a lower price on a commodity during a regular business transaction.

A non-insider customer’s negotiated price should be considered to be ‘reasonably equivalent value’ by definition and the trustee’s claim should fail. However, the problem is that litigation is a lengthy, costly process, and customers frequently end up paying more in a settlement.

How can businesses protect themselves against fraudulent transfer claims?

If your business purchases commodities, dig deeper when vendors offer a surprisingly low price. Why is the price so low? How long has the company been in business? Are you aware of the financial state of the vendor’s business? Is it in trouble? How much lower than market rate is this vendor charging?

While it’s prudent in business to seek out vendors with competitive prices, if a deal seems too good to be true, it just might be. That said, if you move forward with a vendor offering a price you can’t resist, engage in a futures contract or swap agreement. These transactions are common in the commodity trade, and there are safe harbor defenses built into the bankruptcy code regarding futures trading.

It’s a good idea to consult with your attorney if you engage in commodities purchases to discuss pricing and the potential risks associated with fraudulent transfer claims. Then protect your business by making decisions not based solely on cost.

Alan Koschik is co-chair of the Commercial & Bankruptcy Practice Group at Brouse McDowell. Reach him at [email protected]

Insights Legal Affairs is brought to you by Brouse McDowell

Textbook publisher Houghton Mifflin files Chapter 11 bankruptcy

BOSTON, Mon May 21, 2012 – Houghton Mifflin Harcourt Publishers Inc. filed for bankruptcy protection on Monday, after the publisher of textbooks reached an agreement with a majority of its creditors to cut about $3.1 billion of debt.

The company filed for Chapter 11 protection from creditors with the U.S. bankruptcy court in Manhattan. It said it had more than $1 billion of both assets and liabilities.

MF Global clients bash fat fees, seek quick wind-down

NEW YORK, Fri May 18, 2012 – The legal team winding down MF Global’s  bankruptcy estate, led by former FBI director Louis Freeh, estimates the fees charged by the team and other professionals have reached nearly $25 million since the bankruptcy was filed in October.

Now a customer group is planning to ask that the case be streamlined so that those professionals – especially Freeh – receive less and customers receive more.

On Friday, a coalition of former MF Global customers plans to argue in U.S. Bankruptcy Court in Manhattan that the Chapter 11 liquidation of the MF parent entity should be converted to a so-called Chapter 7, coalition leader James Koutoulas said on Wednesday.

In Chapter 11 cases, businesses or their court-appointed trustees try to restructure debt or sell assets to recover as much money as possible to pay off creditors, a process that can be drawn out. In Chapter 7, a trustee sells off assets as quickly as possible, with less involvement from professionals like lawyers, but sometimes at the expense of drawing top-shelf value.

Under bankruptcy law, administrative fees are paid ahead of other creditor claims, so Freeh’s mounting bills are siphoning money from creditors, said Koutoulas, a Chicago fund manager who had $55 million tied up in MF Global on behalf of his clients.

Freeh has released estimated fee figures but not yet formally submitted compensation requests.

LightSquared bankruptcy seen imminent: sources

RESTON, Va., Mon May 14, 2012 – LightSquared Inc., the startup telecommunications company bankrolled by hedge fund manager Philip Falcone, is expected to file for bankruptcy protection in the next hours, sources familiar with the matter said.

Falcone has until Monday at 5 p.m. EDT to reach an agreement or face a default on a $1.6 billion loan, sources said. While the parties still have a few hours left to negotiate, the sources suggested that a last minute deal is highly unlikely and that the filing is imminent.

A representative for Falcone was not available for comment.

Creditors have been negotiating to restructure LightSquared’s 96 percent ownership by Falcone’s Harbinger Capital Partners.

“The bondholders are asking for conditions they know Harbinger and Phil cannot agree to,” a source close to the situation said on Sunday.

Falcone, once one of the hedge fund industry’s biggest stars, had already been given a reprieve twice before when debt holders extended the original April 30 deadline two times.

LightSquared has been fighting for its life since February when the U.S. Federal Communications Commission said it would revoke permission provisionally granted to LightSquared to build a high-speed wireless network. Tests found that LightSquared’s systems could interfere with the Global Positioning System, critical to the military, commercial aviation, and many other industries including agriculture.

Falcone, who once managed around $26 billion for wealthy investors, has faced off against other prominent hedge fund managers who had bought the company’s debt. LightSquared creditors have included hedge fund manager David Tepper, billionaire investor Carl Icahn and hedge funds including Fortress Investment Group, Knighthead Capital Management, Redwood Capital Management and investment firm Capital Research and Management Co.

Icahn recently sold his $250 million position in the company for a profit, according to sources.

Ally hopes to end mortgage woes with ResCap bankruptcy

NEW YORK | Mon May 14, 2012 – Ally Financial Inc.’s mortgage unit on Monday filed for bankruptcy and the auto lender said it will sell some international operations to help set it on a path to repaying $12 billion in bailout money.

Ally’s mortgage unit, called Residential Capital, or ResCap, filed for bankruptcy protection in federal court in Manhattan under a plan that has the support of some of its creditors, although it was still expected to be a drawn-out and litigious process.

At the same time, Nationstar Mortgage Holdings, which is majority owned by Fortress Investment Group, struck a deal to buy substantially all the mortgage servicing and related assets from ResCap for about $2.4 billion, including debt. The deal will make Nationstar the opening bidder in an auction that will be held under bankruptcy court rules.

“The single-most important thing we can do for the U.S. taxpayer is to not put billions of dollars into this business on a going-forward basis,” Ally CEO Michael Carpenter said in an interview.

Ally, the former lending arm of General Motors Co., has been besieged in the past few years by losses at ResCap, which was once a major subprime lender and profit engine. The company has considered bankruptcy and other ways to shed ResCap since at least 2009, but has never pulled the trigger.

A bankruptcy of ResCap now will help Ally, formerly known as GMAC, focus on its main auto lending business and put together a plan to pay back U.S. taxpayers.

The U.S. Treasury Department injected $17 billion into the lender through multiple bailouts during the financial crisis and now owns nearly 74 percent of the company. Ally still owes the government about $12 billion, counting dividend payments by the lender and sale of some securities by the Treasury.

The bankruptcy filing comes as pressure increases on Ally to repay that money and problems at ResCap become increasingly unmanageable. The Obama administration is trying to show recoveries from crisis-era bailouts before the presidential election in November, and government officials are loath to let Ally become a black mark on the auto industry restructuring.

In filing for bankruptcy, ResCap would also become a rare example of a subsidiary of a bank holding company to do so. As a result, other banks with intractable mortgage problems, such as Bank of America Corp., will be closely watching how the company deals with regulators and creditors and manages the bankruptcy process.

ResCap and its advisers believe it may be one of the first times that a financial services company with retail operations such as a bank has filed for bankruptcy and been able to continue operating.