'Bankrupt' no longer means out of business

Once upon a time, American corporations tried to avoid bankruptcy court - a sure sign of failure in a success-driven society.

Now, in a remarkable cultural shift, bankruptcy no longer means being ostracized by customers, partners, and financial backers.

Some large companies, such as those in the airline industry, have declared bankruptcy two or three times before either closing down altogether or becoming successful. Oil industry giant Texaco filed for bankruptcy, and that hardly stopped anyone from buying their gasoline.

Macy's continued to have its annual Thanksgiving Day parade, even when it was in bankruptcy.

"In the last two decades, Americans have learned to fly on airplanes, buy from retailers, eat in restaurants, and go about their lives doing business with companies in bankruptcy," says Elizabeth Warren, a professor at Harvard Law School in Cambridge, Mass. "That changes the calculus ... for a company to file in Chapter 11."

The latest high-profile company to look at the math is energy giant Enron, which teeters on the edge of bankruptcy with huge debts and the burden of high-risk deals gone awry.

But if bankruptcy has become a more common - and culturally acceptable - road to recovery in recent years, it remains a far from certain one for deeply troubled firms such as Enron.

If the Houston-based company files for bankruptcy under Chapter 11 as expected, it would try to obtain financing to continue operations under the watch of creditors, says says Ken Klee, a UCLA professor and one of the principal draftsmen of the modern bankruptcy code.

Enron is not alone. According to New Generation Research, a record 250 public companies have filed for bankruptcy so far this year. This includes such well known names as Chiquita, Bethlehem Steel, and chemical firm W.R. Grace & Co.

But in a broader sense - including private companies such as hair salons and pet stores - the statistics are not so grim. In the second quarter of this year, bankruptcy filings in US District courts stood at 40,100 companies, at a seasonally adjusted annual rate. In midst of the 1991 recession, 72,200 companies were filing for bankruptcy.

"I think corporate balance sheets are stronger than they were 10 years ago," says Mark Zandi, chief economist of the Economy.com, an economic website.

He notes that companies are currently using less of their cash flow to service their debt, and bankers have become more creative in working through problems. But often a rise in bankruptcies lags behind the economy's trajectory. "This suggests we may see a significant rise in filings, but not as high as the last recession," Mr. Zandi says.

Through the 1970s, filing for bankruptcy usually was the end of the road for a company. Trustees sold off the assets to satisfy creditors. But in the late 70s, Congress rewrote the laws, and more companies began to survive the process - and to emerge with greatly reduced debt burdens.

"People realized filing was not such a big deal," says Christopher McHugh, research director for New Generation, which publishes bankruptcydata.com, a website.

One of the classic examples of how the public adapted is Federated Department Stores, which went into bankruptcy in January 1990. The company, with department-store chains around the US, was saddled with debt. When the company filed, it was the largest non-oil bankruptcy in history.

"There was no understanding on the part of the media or the public what a Chapter 11 bankruptcy filing meant," recalls Carol Sanger, vice president for external affairs at the Cincinnati firm. "Our challenge was to educate people immediately that this did not mean that our stores would be shuttered and we would be going out of business."

During the bankruptcy, Federated continued to get bank loans, called "debtor in possession" financing. This allowed the company to continue to pay vendors. Within 25 months, it emerged from bankruptcy.

"That's what bankruptcy is best at: handling financial mistakes. It doesn't solve operating mistakes," says Jeffrey Morris of the University of Dayton School of Law.

Texaco, known to most Americans for its gasoline stations, also used bankruptcy to solve a tricky financial problem. In 1985, it lost a court case to rival Pennzoil and was faced with an $11 billion judgement. The company declared bankruptcy and ultimately settled the suit for $3 billion. "They used bankruptcy to streamline their operations and make dramatic improvements in their business," says Mr. Klee.

In fact, some companies, such as the airline TWA and the supermarket Grand Union have been in bankruptcy multiple times before being bought up by rivals. "The probability of any company filing for bankruptcy is very small," says Mr. McHugh, "but if a company has filed once, it has a 6 to 10 percent chance of filing a second time."

But many of these are large companies. Smaller companies have a problem, since Chapter 11 is time-consuming and incurs big costs. "In smaller cases, creditors are afraid of having money lost, and there is not an active participation by creditors' committees," says Paul Asofsky, a Houston-based partner in Weil, Gotshal & Manges. Instead, the small firms may be liquidated.

Though companies may emerge from bankruptcy, the news is not so good for the executives who drove the ship on the rocks. "The CEO is almost always replaced, and they do not find comparable employment somewhere else," says Prof. Warren. "There's a very real price to pay for management."