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Bankruptcy Is Giving Firms Less Chance for Survival

Harsh as it is, a bankruptcy filing has always offered a glimmer of hope for a business hobbled by debt or a downturn. A company could slim down, negotiate manageable payments to workers and suppliers and keep going, preserving jobs.

But the credit crisis has trampled on that dream. More companies that file for bankruptcy protection are shutting down, lawyers say, because they cannot obtain enough financing to operate while they reorganize.

Linens ’n Things, in bankruptcy since May, is liquidating now that creditors have refused to extend more credit. Another retailer, Mervyn’s, announced it would also liquidate, and several analysts expect the same at Circuit City, which filed for bankruptcy protection last week. On Wall Street, Lehman Brothers is being dismantled in the biggest bankruptcy ever.

So companies battling for survival have lost another lifeline. While they might have once gotten together with their creditors and worked out a plan in the common interest, they are avoiding bankruptcy court if at all possible because they know that without ready access to credit, the odds of emerging from legal proceedings are slim.

Is it any wonder that companies confronting serious problems — General Motors, for example — are reluctant to gamble?

And if a corporate bankruptcy does not offer a path to reorganization, many of the jobs at struggling companies may vanish for good. That suggests a long and painful economic downturn.

“It just further amplifies the recessionary spiral,” said Stephen F. Cooper, a restructuring expert who is advising companies trying to stay out of bankruptcy. “It will certainly have an impact on the employment — or unemployment — outlook and it will certainly have an impact on consumer spending.”

Bankruptcy protection is supposed to give a company a breather, blocking creditors while workout specialists, lawyers and managers try to figure out how to return it to profitability. In court, the bankrupt company can renegotiate loan payments and modify contracts.

Lenders to a company trying to reorganize under Chapter 11 of the Bankruptcy Code decide whether they want to bet on the company’s success once it emerges from court oversight, by offering new loans or converting their existing loans into equity. If the company emerges, there is a chance it will repay investors.

“Many companies in Chapter 11 are teetering between whether they are able to move forward with their reorganization or shut down because they can’t find additional funds,” said Mark D. Collins of Richards, Layton & Finger, which represents Linens ’n Things in its bankruptcy case.

In past, less severe downturns, Mr. Collins said, more companies faced the relatively simple problem of owing too much money. Lenders, creditors and the company’s management could work out a palatable plan, then file for bankruptcy protection and use the legal proceeding to wipe away some of the company’s debt. That is known as a “prepackaged” bankruptcy.

“But it doesn’t really work when you’ve got a much more difficult situation, where it’s a very challenging industry or when the company needs a lot of restructuring beyond just its balance sheet, such as eliminating or selling off unprofitable lines of business,” Mr. Collins said.

Reorganizing a company under those circumstances requires an investment in the company’s future, but investors now are not optimistic enough to make such bets, he continued. “People are hesitant to do a lot of significant transactions.”

Deterred by lack of credit and, in some cases, wagering on the possibility of a government bailout, corporate executives have chosen to avoid bankruptcy and delay changes that might keep businesses going, which can block a successful reorganization, said Lynn LoPucki, a law professor visiting at Harvard.

“You have a whole country full of companies and people in financial distress, all of them trying to delay dealing with their problems, all waiting to see what the government is going to do,” Mr. LoPucki said. “And that in itself may be the financial crisis.”

The pace of filing for bankruptcy protection has recently begun to pick up, but filings typically trail an economic downturn and so far the number is nowhere near levels in previous downturns. The number of corporate bankruptcies rose last year to 28,322, but that is the second-lowest number of filings since 1980, according to the American Bankruptcy Institute.

And many of the recent filings, lawyers say, are not efforts to reorganize at all.

“True reorganizations, in the spirit of the bankruptcy code, are becoming extremely rare,” said Sandra E. Mayerson, a lawyer at Holland & Knight in New York. Instead, she said, many companies file for bankruptcy protection and proceed immediately to liquidation.

Part of the problem is that in recent years, large lenders to corporations have been hedge

funds, private equity investors or other institutions. Even if these lenders wanted to extend a loan to a struggling company, they might not be able to do so because they need cash quickly, from the sale of whatever assets a bankrupt company has, to satisfy their own nervous shareholders, Ms. Mayerson said.

“Some of them don’t have it to give, their funds might be tapped out,” Ms. Mayerson said. “Some may choose not to put good money in after bad.”

Even if creditors give a struggling company more rope, they are not patient about it, and tight repayment deadlines leave scant time to turn a big company around. Shutting down a company can be done more quickly.

“A number of years ago, we had fairly long bankruptcies, where companies could come out as stand-alone enterprises,” said Joe Bondi, a managing director of Alvarez & Marsal, a turnaround and restructuring firm. Now, no one wants to hold the debt of companies whose prospects are in doubt.

“They want to get paid off,” he said, whatever amount is possible. “People are concerned that we are in a very long-term economic doldrum.”

The prospect of liquidation of enormous companies, like Detroit’s Big Three, is frightening; the collapse of one would wipe out tens of thousands of jobs. But the absence of credit poses a practical obstacle to their reorganization through bankruptcy proceedings: Who wants to extend a loan to companies with such shaky prospects?

One solution, Mr. LoPucki said, would be for the federal government to extend loans to an automaker after it filed for bankruptcy protection. In that way, under bankruptcy law the government would be first in line to be repaid, before other creditors. And vendors might be more willing to work with a company backed by a loan made or guaranteed by the government, he said.

“Otherwise, you’re just giving money to the creditors,” Mr. LoPucki said, because outside of bankruptcy proceedings, bailout funds given to the company could be paid out immediately to suppliers and other creditors. “You want to get ahead of other creditors. And you want to maintain jobs.”

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