The Impact of Giant Bankruptcy on the Average Consumer

Frederick J. Petersen

The American public has been barraged with news of accounting scandals, corporate misfeasance and the bankruptcy of corporate giants. The losses involve numbers that are not expressed in millions, but rather billions. The players include corporate behemoths, who broker the availability of energy, oil and gas, provide telephone service to a large part of the country, own most of the infrastructure for the internet and own airlines, restaurant chains, car rental companies and department stores that have appeared successful for years.

With the frequency of bad news, investing in the stock market seems as secure as buying land in Florida from a traveling salesman. You may be buying beach-front property, or may wind up in the middle of a swamp. Trust in big business is low, and the average individual is wary about which airline or telecom will next file for bankruptcy. Every publicly traded company that files is BIG news, but what does it all mean to the average individual?

Large bankruptcies are usually filed under Chapter 11 of the Bankruptcy Code. A "Chapter 11" filing typically occurs when a company can no longer pay its creditors, when a company predicts future liabilities it will not be able to pay, or when it wants to terminate a burdensome contract. Examples . . .

WorldCom filed for Chapter 11 reorganization because it had $30 billion in long term debt, for which significant interest payments would be due within weeks of its filing. Based on its annual gross income of $35 billion, it was unlikely that the company would ever be able to keep up with its debt service, a significant part of which would become due in the year after its filing.
For years, USG had been a large, stable and successful company making wall-board that was installed in buildings throughout the world. USG filed for Chapter 11, not because it was not profitable, but because of the significant costs and liability from asbestos lawsuits filed against it.
Kmart, in operating its 2,114 stores, found hundreds of its locations unprofitable. Kmart had signed numerous long term leases, which would be expensive to terminate. Kmart filed bankruptcy to terminate the leases in the unprofitable stores and focus its business on the profitable locations. Kmart has now trimmed its locations to only the most profitable stores, and merged with Sears.

Upon filing a Chapter 11, the Court imposes an "Automatic Stay." The automatic stay stops all litigation, foreclosure efforts and collection actions by creditors, yet allows the business to continue operating, subject to certain restrictions. If creditors have reasons why their foreclosure or litigation should be allowed to continue, the Bankruptcy Court can modify the automatic stay, so such actions may proceed.

Once in reorganization, committees will usually be formed of representative groups of creditors. In most cases, a committee of unsecured creditors will be the only committee. In large cases, a committee of bond-holders, tort creditors, landlords or other interested parties may be formed. The committees work as representatives of similarly situated creditors to investigate the business operations of the debtor and negotiate a plan of reorganization.

The goal of a Chapter 11 is to devise a plan of reorganization that will allow the debtor to emerge from bankruptcy and repay creditors according to the terms of the plan. A reorganization plan is a new contract which governs the terms for repayment to creditors. The plan usually proposes payment to creditors in an amount greater than if the assets of the debtor were simply liquidated and the proceeds distributed. Once proposed, the plan of reorganization is sent to all creditors to vote for or against it. If voting requirements are met, the Bankruptcy Court will normally approve the plan.

When the plan is approved, the business will operate normally, as long as the terms of the agreed plan are followed. Like all contracts, the failure to make payments as required by the plan may constitute a breach and lawsuits may be filed to enforce its terms.

The Effect of Billion Dollar Bankruptcies

The average consumer will feel the impact every time a major bankruptcy is filed. Chapter 11, despite its consequences, allows airlines to continue flying, telephone service to continue and the Internet to keep spreading information. But most importantly, Chapter 11 reorganizations set the framework for a company to emerge a stronger and more productive entity.

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