November 18, 2008
The Rise in Corporate Bankruptcies
Posted by Michelle Harner

In April 2008, U.S. business bankruptcy filings were up over 49% from the previous April.  That percentage has continued to increase, peaking recently with several high-profile bankruptcy cases, including Lehman Brothers, Washington Mutual and Circuit City.  During the past 90 days alone, according to filings posted on PACER, 395 chapter 11 cases were filed in the District of Delaware and 107 such cases were filed in the Southern District of New York.  (These numbers do not reflect businesses that have filed for liquidation under chapter 7 of the U.S. Bankruptcy Code.)  A similar trend is emerging in the United Kingdom, where business bankruptcies are up 26%.

    

And based on October sales numbers, the trend most likely will continue.  Retail sales were down 2.8% (4.1% from one year ago).  The breakdown shows retail sales, excluding autos, down by 2.2% and auto sales down an estimated 5.5%.  So, how will this current wave of corporate bankruptcies affect the economy?  Certainly, consumers may benefit from lower prices.  Reports suggest that retailers already are offering discounts similar to those traditionally reserved for the Friday after Thanksgiving and the few days before Christmas.  Gasoline prices also have dropped precipitously.  Of course, corporate bankruptcies are not all good news for consumers.  As Lisa Fairfax noted in a pair of informative posts last week (see here and here), unemployment is on the rise.  Corporate bankruptcies typically pose some risk of layoffs for employees, but that risk appears to be especially acute in the current wave of bankruptcies.

    

Corporate rehabilitation and the attendant preservation of jobs are important goals underlying chapter 11 bankruptcy.  A debtor needs cash flow, however, to accomplish these goals.  This fact does not change in bankruptcy.  A debtor that lacks adequate financing during the bankruptcy case or a viable business model simply cannot continue in business.  Unfortunately, many corporations that have filed for bankruptcy recently could not secure adequate debtor-in-possession financing or cannot generate sufficient revenues to sustain their business models.  Both problems stem, in part, from the current credit crunch—banks are not lending and consumers and business customers are not spending.

    

The result is an increase in corporate liquidations and resulting job losses, particularly in the chapter 11 context.  (A recent article notes that Edward Altman has predicted not only an increase in corporate bankruptcies and bond defaults, but that “the unemployment rate could peak as high as 9.5 percent.”)  Just a few examples of recent chapter 11 liquidations include Lehman Brothers, Washington Mutual, Mervyns, Whitehall Jewelers and Steve & Barry’s.  For interesting and thoughtful discussions of the pros and cons of liquidating a business under chapter 11 versus chapter 7 of the U.S. Bankruptcy Code, see Stephen Lubben’s 2007 article and a recent article by Michael Cooley posted on the TMA website, which explores the issue from a strategic perspective.

    

The trend of corporate liquidations also may be good news for market competitors.  In fact, several observers are speculating that Best Buy will benefit from Circuit City’s bankruptcy filing because it allows Best Buy to gain market share.  (Even if Circuit City does not ultimately liquidate in chapter 11, it already has announced plans to close 155 stores.)  Likewise, Wal-Mart reported third-quarter earnings of $3.14 billion and an increase in sales.  This competitive edge is somewhat the inverse of what happened during the last bankruptcy cycle, where reorganized debtors emerged from bankruptcy with trimmed down balance sheets and an edge over their non-debtor, leveraged competitors.

    

Finally, more corporate bankruptcies mean more work for bankruptcy lawyers, financial advisers, investment bankers and other professionals that work in the bankruptcy field.  For an extensive and extremely well done exploration of professional fees in bankruptcy, see Stephen Lubben’s 2007 report.  By way of example, observers predict that professionals’ fees in the Lehman Brothers’ liquidation will top $1.4 billion, plus costs of hiring experts to assist in the winddown (estimated at $200 million).  These numbers certainly prove the old saying that you can’t be broke to file bankruptcy.

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Comments (2)

1. Posted by Jake on November 18, 2008 @ 19:22 | Permalink

The Chapter 11 system is thoroughly corrupt. Congress recently confirmed the fact by hurling $700 billion at entities that ought to be in bankruptcy, thus spurning the clearly constitutional solution in favor of one of questionable merit. What an incredible vote of no confidence by the very legislative body that created Chapter 11.

Bah.



2. Posted by rentestanden hypotheek on March 3, 2009 @ 1:31 | Permalink

I really liked this report on Rise in Corporate Bankruptcies.

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