Bankruptcy or Bailout?

There are a series of axioms that every turnaround professional knows well: “our company is too big to fail,” “better times are coming very soon, and we aren’t really in trouble anyway,” “we just need a little more money to get past our problems,” “if our company is allowed to fail, the entire industry/system will be destroyed,” “if you allow us to fail, all our jobs will be lost and a ruinous liquidation will be the inevitable result,” “just give us a little more time so that we can execute our plan to fix things in our company.”

These axioms are always trotted out like old fairytales whenever a company gets into trouble. They are put forward as excuses by existing management to avoid restructuring or bankruptcy. These managers are committed to put forward any smoke screen to cling to their positions and perks despite having mismanaged their companies’ affairs and allowing them to become troubled in the first place. Oddly, even the directors of these companies, who are charged with overseeing the affairs of the troubled entity, usually stand right beside management and join in the denial syndrome to pretend that all will be well if only management is left alone to get on with business.

What is often forgotten when observing troubled company management is that commercial entities never get pressured about their performance unless it is sub-par. Additionally, they cannot get pressured about sub-par performance in a vacuum. Unless the group bringing pressure about performance has a hook to allow it to bring this pressure forward, it is effectively powerless to affect the company. Such hooks come in many forms. Typical hooks arise because of covenant defaults, payment defaults and, in the rarest of cases, poor equity performance (rare because this requires the group complaining about performance to have committed substantial capital to control enough outstanding equity for its voice to carry any weight at all).

Troubled companies inevitably rail against the concept of restructuring or undergoing a bankruptcy, voluntary or otherwise, largely because the restructuring/bankruptcy process subjects their activities to a level of scrutiny they never have to deal with outside of this process. It is therefore not surprising that corporate chieftains rail endlessly against the thought of being forced to operate under the cool light of court and/or creditor supervision.

What is surprising is that in our current environment we see our legislators and our federal administrators parroting these same worn and endlessly recycled myths to try to help keep seriously troubled sectors of our economy out of the restructuring/bankruptcy process.

The automotive sector is a classic case in point. After decades of mismanagement, the heads of General Motors Corp., Chrysler LLC and Ford Motor Co. are united in pushing one alleged truth - forcing their companies into bankruptcy will destroy industry and capitalism as we know and love it - to prevent being forced to restructure in bankruptcy.

Indeed, the federal government’s legislative and executive branches went to great lengths in late 2008 to avoid bankruptcies in the automotive industry. They chose instead to provide taxpayer funds to these companies without any of the protections which are afforded to providers of capital in a bankruptcy context. The entire country was treated to a vision of legislators explaining from their committee rooms that a bankruptcy filing for any or all the automotive companies would inevitably lead to the loss of more than 1 million jobs and the destruction of the automotive companies and their suppliers. They based these comments largely on two factors for which they could not and did not provide substantiation: no one will buy cars from a bankrupt automotive company because (a) they cannot provide viable warranties in a bankruptcy situation and (b) you can’t trust a product made by a bankrupt company to be safe.

In part, these arguments were sponsored by management and by the head of the UAW. The latter’s interest in avoiding bankruptcy proceedings is directly linked to his institutional need to maintain contracts in existence which have made these companies uncompetitive walking dinosaurs. The problems he needs to hide from real scrutiny are inflexible work rules and pension systems which were baked into these companies’ operating costs in a different era when profit margins were substantially more robust.

As an alternative to allowing the automotive companies to seek court protection for their reorganizations, we were subjected to a parade of car and union executives on Capitol Hill and talking heads on television arguing for the infusion of bailout funds outside of the bankruptcy process. These pundits argued for an out-of-court bailout despite the fact that the funds to be infused by taxpayers would be subject to no controls at all and the taxpayers would get no lien protection against the loss of their money. Indeed, the only requirement ultimately attached to the infusion of these funds is that, before these companies can get more money or relief from having to pay back what they already have received, they must demonstrate that they are “viable.” No definition of viability was created as the government agreed to infuse these funds. We are now three months down the road and will shortly be back looking at the need for additional funding of these companies with no real control over what they have done or ability to recover the taxpayer money that has already been spent.

The travesty of the situation is that the very legislators who espoused and created this ad hoc system for infusing and monitoring cash given to automotive companies are part of the legislative tradition in this country that created the carefully crafted bankruptcy laws which have a 100 plus year history of providing a legal and economic framework in which troubled companies can find their feet or, if that is no longer possible, a decent and orderly burial. Our Bankruptcy Code dates back, in its original emanation, to the origins of this country. It has evolved over the years to provide a safe, secure and transparent way to restructure companies who have lost their way. Hugely complex problems, matching or exceeding those facing the automotive industry, have been effectively dealt with over the years. Fears that no one would fly a bankrupt airline (how could consumers trust these companies’ maintenance programs?), fears that private aircraft manufacturers could not effectively provide warranty protection to buyers of general aviation aircraft (Piper), a need to restructure excessively burdensome labor contracts to allow companies to maintain sufficient cash flow to use as working capital to restructure their operations (United Air Lines), have been dealt with in bankruptcy.

None of these issues was any less intractable than what faces the automotive companies today, and the bankruptcy system was designed by the legislature and industry professionals to provide a safe mechanism to resolve issues relating to all constituencies in a failing company - labor, management, suppliers, capital providers, secured and unsecured participants alike. It does not favor selected constituencies, which is what the bailout program passed by the House and Senate blatantly does to the exclusion of other vital constituencies.

The concept that, as a country, we are so afraid of the sky falling on our heads during this economic crisis that our political leaders are running around like chickens with their heads cut off and listening to the craven and self-serving fear mongers who ruined the automotive companies in the first place is either worthy of being a skit on “The Daily Show” or evidence of a total loss of balance in Washington. As these companies come back to the feeding trough again this spring, we should not allow them to push for more taxpayer bailout funds, subject to no or minimal supervision and protection for taxpayers and the other constituents of these companies. We must recognize that we have an excellent system in place, created by Congress, operated by hundreds of talented and qualified jurists and professionals and allow them to do for this country and these companies what the bankruptcy regime embodies - provide a fresh start for ailing companies within an organized system.

Anthony Schnelling is a managing director and founding member of Bridge Associates LLC in New York. He can be reached at

Date published: Apr 13, 2009


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