In the musical “Cabaret,” it was the clinking, clanking sound of money — whether a mark, a yen, a buck or a pound — that made the world go round. But in a bankruptcy, the important debate that abounds for those with hands outstretched — each wanting more, more and still more — is what is left to go around.
Of course, by the time a debtor is done with the so-called reorganization, most likely there’s even less to hand out. What gives? Attorneys’ fees, accounting expenses, restructuring costs and even the costs of investment banking advice drive the tab for these distressed firms ever higher. Welcome to the high costs of bankruptcy.
Certainly it takes money to run a business. However, it takes even bigger bucks to go bankrupt. Depending on which side of the fence one is on, there are pros and cons to the skyrocketing costs.
Andrew Miller, managing director of the financial restructuring group in the Los Angeles office of investment banking firm Houlihan Lokey Howard & Zukin, notes the fee structures in bankruptcy cases have remained consistent over the years. He points out that what has changed in these large, complex cases is the increased number of creditor constituencies who, in turn, feel they should have their own set of professional advisers.
Miller notes while the fees may seem high, the fact is that the creditor groups who see fit to hire their own team of experts are really using their own money.
“Look, if they believe that they were spending money foolishly and impairing their gains, they wouldn’t be hiring the advisers. The fact that they do hire them suggests a belief that the advisers will get them a higher rate of return,” he says.
Louis J. Cappelli, chairman of Sterling National Bank, observes, “Professional fees go in tandem with the rest of the business economy. No doubt that if you employ an attorney in New York City and another one from a different state — whether South Carolina, Utah or Montana, as examples — the fees in the other state would be less than those charged by the New York firm. Much also depends on the expertise of the individual, although I don’t necessarily believe that the more you pay, the more you get.”
The bank chairman remembers a time when many of the smaller firms sought relief elsewhere so they wouldn’t have to air their dirty financial laundry before a bankruptcy court judge.
“The trend many years ago was for the smaller companies to go to their trade organization, which would help facilitate a settlement, and the firm would be reorganized in an informal way. The costs were significantly less because what happens these days is that sometimes the professional fees eat up a good deal of the estate,” he says.
Of course, he acknowledges, it is considerably much more difficult for the larger public firms to effect out-of-court settlements when there are so many creditor-interest groups with their hands outstretched.
Allan Ellinger, senior managing director of Marketing Management Group, a consulting firm with extensive reorganizational credentials, wouldn’t mind seeing more informal workouts, which he considers to be a much more efficient process.
He explains: “I think the way bankruptcies are run is so inefficient. When we get involved in a crisis situation, the first thing we do is determine whether a company can survive as a freestanding firm. It if can’t, we immediately convert it to a merger and acquisition and attempt to sell assets as a going concern to stop the bleeding. You have to focus on what’s best for the business and its creditors and shareholders.
“The informal process can be much quicker. Not all bankruptcies need to be public, and when all the creditors are onboard, you can accomplish the same thing informally. It’s also cheaper than an actual bankruptcy filing with the courts, which have gotten so expensive because of the special interest groups feeding at the trough.”
Wilbur L. Ross Jr., chairman and chief executive officer of investment firm W.L. Ross & Co., observes that the professionals vying for the restructuring work have in some situations turned the bankruptcy into a “feeding frenzy.”
Ross was the chairman of the unsecured creditors’ committee in the Burlington Industries bankruptcy. His firm bought most of the assets of Burlington.
“I think in many cases it has gotten out of hand. In some of the recent bankruptcies, the courts have authorized equity committees to look out for the interests of shareholders even though in most cases, you know that there won’t be a return to the equity holders.
“In Burlington, unsecured creditors are getting between 30 cents and 40 cents on the dollar. Yet the court let money be spent on behalf of the shareholders. That’s a waste because creditors wouldn’t be settling for 40 cents on the dollar if there was enough to pay them and the equity holders,” he says.
According to Ross, the fees can reach a very high amount, particularly when the debtor, its bankers and different creditor groups each have their own set of legal and financial advisers.
He observes: “It’s not unusual for the total professional fees to be 10 percent to 20 percent of the unsecured creditors’ total recovery. Each time a committee files papers in court, the professionals for the other committees have to file their answer, and the fees just multiply. The more constituencies you have who feel aggrieved, the bigger the market for professional expenses.”
But exactly how high can some of those fees climb?
In the case of Kmart Corp., the sky was the limit. The retailer listed $16 billion in assets on Jan. 22, 2002, the day it filed its Chapter 11 petition in a Chicago bankruptcy court. While its sheer size made it a megacase, the fast-track approach meant that the retailer was in bankruptcy proceedings for only 15 months. Yet, the tally for professional fees in the case is expected to climb to at least $140 million, or an average minimum of more than $9 million in fees billed per month.
When it shed the oversight of the bankruptcy court in May, Kmart emerged with a healthier balance sheet, having wiped away nearly $8 billion in debt. In the process, however, it paid millions in retention bonuses to its top executives. At the same time, it left many others in the dust. In its restructuring, the discounter shuttered 600 stores, left 67,000 former employees without jobs or severance pay and forced its shareholders to swallow more than $6.3 billion in lost equity.
When The Warnaco Group emerged from Chapter 11 protection in February, it, too, had an improved balance sheet that was “deleveraged,” as well as leaner operations and a corresponding volume smaller than at its peak. And there was also one key personnel change — longtime ceo Linda J. Wachner was no longer with the firm.
As for reorganization costs, it didn’t matter that Warnaco is a manufacturer instead of a retailer. A bankruptcy is a bankruptcy, each one with its share of professional fees and experts.
When all was said and done, Antonio Alvarez of Alvarez & Marsal Inc., the turnaround expert hired first as chief restructuring officer and then as ceo, succeeding Wachner, received an aggregate payment including bonus and salary of $5.7 million in cash, subordinated notes and a percentage of newly issued reorganized Warnaco stock. The company said part of the payment represented a vote of approval from creditors for his role in helping to quickly move Warnaco out of Chapter 11 status.
Unfortunately for former Warnaco shareholders, they didn’t get a return on their equity stakes, either, although they were allowed to hold onto their memories.
Sometimes even former executives get included when companies about to emerge from bankruptcy dole out little somethings from the creditor pot, whether as a “thank you” gesture for sticking around until the bitter end or a gratuity check to speed them on their way.
Gene and Bob Pressman, for example, didn’t do too badly as consultants to the luxury chain they once commanded. Although no longer co-ceo’s at Barneys New York, the reorganization plan provided one-year consulting agreements that entitled the brothers to each receive $1.4 million for their respective services, which were left undefined in the reorganization plan.
Ross doesn’t expect the fees and costs associated with bankruptcies to change anytime soon.
“I don’t see it changing as long as bankruptcies are as plentiful as they are. There’s no price competition because there are so few individuals with the expertise that is required when a firm is bankrupt, and there is so much demand for their services. Right now it is a seller’s market. If we ever get to a point where there are a lot less bankruptcies, maybe we will see some price competition,” he notes.
According to Bryan Lawrence, managing director at investment bank Lazard Frères & Co., the griping about the high costs of bankruptcy is “much ado about nothing.”
He explains: “I don’t believe that the bankruptcy costs are too high at all. The perception of high costs in the American bankruptcy process has to be measured against the alternatives, which, in many other countries, has more to do with punishing the company and its management team because they failed.
“Debtor’s prison is a European concept. But here, second chances are a big part of our culture. Look at how many times [Wal-Mart founder] Sam Walton failed before he succeeded. Under the bankruptcy process in Germany, liquidation is the custom. That’s not a good answer. In America, we have a process that preserves asset values and jobs as much as possible, while reconstituting the capital structure.”
For Lawrence, the process in the U.S. is clearly superior, even if American debtors get to stay in bankruptcy longer than their overseas counterparts, and in turn incur more costs.
Lazard Frères served as financial adviser to Fruit of the Loom after it filed for bankruptcy protection in December 1999. “It stayed in for what is a typical time period, given its size,” Lawrence notes. “FTL is a strong brand, with a high-quality asset and a difficult balance sheet. Part of its problem was that it hadn’t been able to get offshore fast enough. A reorganization plan was filed in March 2001, but the brand was strong enough that Warren Buffett wanted to own it. Buffett buying it was the best solution for everyone.”
Buffett’s investment vehicle, Berkshire Hathaway, surfaced in late 2001 as a potential buyer of FTL, and in January 2002, it received bankruptcy court approval to purchase FTL for $835 million.
In what is likely to be the next post-bankruptcy successor story, John Idol, chairman and ceo of bankrupt Kasper A.S.L., says the best advice he received was to take his time and proceed slowly.
Kasper filed for Chapter 11 bankruptcy court protection on Feb. 5, 2002. It expects that by Dec. 1, it will be out of bankruptcy and have a new parent, Jones Apparel Group, which agreed to purchase the firm for $232.5 million, plus the assumption of certain liabilities.
According to Idol, “We are a fortunate model to look at. The creditors will get paid in full, the equity holders will get some money and we will still have enough to pay our lawyers and accountants. It has been an extraordinary process, a very expensive and costly process.
“When a company already is in a difficult financial position, spending millions on the different fees is just more assets taken away from the company that ultimately belong to the creditors and shareholders.”
Yet Idol believes that the costs incurred in Kasper were “very much worth it.” He adds that the creditors were also instrumental in the restructuring process because they allowed the firm the time it needed to maximize the opportunities that were available for the company.
“Too often companies are forced to get out quickly so creditors and equity holders can have a monetary piece of paper that they can go trade, but what is really needed is to get the company restructured so it doesn’t go back into a Chapter 11,” Idol says.
Too often, however, the opposite happens, exacting an even greater cost.