Ailing firms face tough bankruptcy changes

Looming changes in corporate bankruptcy law could create a rush to the courthouse by ailing companies in search of easier treatment.

Starting Oct. 17, new deadlines and creditor protections in the law will make bankruptcy reorganizations harder and more expensive for companies seeking protection under Chapter 11.

The changes are part of the Bankruptcy Abuse and Consumer Protection Act signed into law in April. New restrictions on personal bankruptcies grabbed the attention then, but bankruptcy experts say new rules designed to prevent foot-dragging and financial abuse in corporate bankruptcies could have widespread impact.

In general, says Boston bankruptcy lawyer Jon Schneider, “there’s probably going to be a raft of filings in September to avoid this new law.”

Under the new rules, fewer companies that go into Chapter 11 will ever come out, experts say.

“Taken together, these changes will doom some companies to fail in Chapter 11,” says New York lawyer D.J. Baker of Skadden Arps, who is representing supermarket chain Winn-Dixie in its reorganization.

Bankruptcy lawyer James Sprayregen of Kirkland & Ellis in Chicago predicts the new rules will make it harder for companies to raise enough financing in bankruptcy. “I think there will be more liquidations,” he says.

Key changes under the new rules:

• Management exclusivity. Companies entering Chapter 11 will have just 18 months of exclusivity, meaning management alone has the right to present a plan for operating a reorganized company outside bankruptcy.

Now, bankruptcy judges can extend exclusivity almost indefinitely, blocking creditors and outside investors from presenting alternate plans to the court.

The change is huge. United Airlines, for example, has been in bankruptcy reorganization 31 months. Its management still has the exclusive right to file a reorganization plan after repeated extensions by a Chicago bankruptcy judge.

A tighter deadline — and possibly a quicker return on investments — could spark more outside financial interest in restructured companies, some say.

Sometimes a reorganization plan from a fresh perspective “is a good thing,” says Jonathan Rosenthal of investment bank Saybrook Capital.

• Retention bonuses. Firms won’t be allowed to pay officers retention bonuses to keep them from quitting, without evidence of actual job offers.

“It will drive good managers away from bad businesses,” Sprayregen says.

• Store closings. As a protection for landlords, companies will have just 210 days — about seven months — to decide which leased office or store locations to keep open or to close. Now, a bankruptcy judge can repeatedly extend the deadline if there is good cause.

“The risk is that a large retailer or chain going into Chapter 11 must make quick decisions” about hundreds of locations, “and they may not be the best decisions,” says Mitchell Cohen of Gordon Brothers Group, a consultant to Kmart during its reorganization.

• Utility deposits. Utilities will have the right to charge companies big security deposits for electricity and other critical needs while in Chapter 11.