When Chemical Banking Corp. decided to offer an $80 million "exit loan" to Harvest Foods Inc. - a company that was about to file for reorganization under Chapter 11 of the Bankruptcy Code - it set the stage for a record- breaking performance.
The Little Rock, Ark., grocery chain made a successful exit from bankruptcy a mere 16 days after filing with the court late last year, beating the previous record for fastest bankruptcy, held by In Store Advertising, by 13 days.
Aside from putting Harvest in contention for a dubious achievement award, the record also represents a significant trend in banking.
Faced with the costly delays and exorbitant fees of a traditional bankruptcy battle, more lenders and their borrowers are trying to shorten the process. They are hammering out debt restructurings out of court or, like Harvest Foods, arranging prepackaged bankruptcies in which the parties agree to a plan before filing with the court.
In fact, last week's filing by Trans World Airlines was a "prepack," as bankruptcy professionals call them. The airline's creditors agreed to submit a plan to bankruptcy court in which $500 million of debt will be forgiven and the company will emerge from bankruptcy, presumably in a better position to survive, as early as September.
"We're seeing a lot more willingness on the part of creditors to listen, rather than go to court," said Paul Luftig, principal in the Epic Group, a New York debt-restructuring consultancy.
"What you really want to do is preserve value," explained William C. Repko, the managing director of restructurings at Chemical who was called as an adviser by a Harvest bondholder that had had a long relationship with Chemical.
The key question in any restructuring, according to Mr. Repko, is what will be left after the reorganization. Often, he said, the bankruptcy process itself can significantly reduce the value of a business as a going concern - and its ability to carry debt.
"You look at a business on an unleveraged basis," he said. "It's got the opportunity to earn a certain amount of cash flow. Then you make a judgment, as you do in any lending decision. Then you calculate how much debt can get layered on and still have a good credit."
In the Harvest case, potential legal fees and delay were not the only factors weighing against a traditional bankruptcy. The company was the beneficiary of some tax breaks that would have been lost and business laws that would have been changed if the company was in bankruptcy at yearend.
That would have made it impossible for the bank to approve the $80 million loan, Mr. Repko said.
The solution was to agree in principle to the $80 million loan prior to the bankruptcy filing, but make the loan contingent on a successful restructuring before the end of the year. With the financing agreement in hand, Harvest was able to quickly arrange a settlement with its other creditors, reducing total debt from $145 million to $80 million, while raising capital for new acquisitions.
Bankers and consultants said the trend toward out-of-court and prepackaged settlements has gradually picked up steam since the mid-1980s, when bankruptcy lost the stigma it once had and became a commonplace tool for overleveraged companies.
Indeed, Mr. Repko notes that two of the seminal workouts - by International Harvester and Chrysler - were out-of-court arrangements.
Although Congress last year approved legislation to streamline proceedings for bankrupt companies with $2 million or less of liabilities and to place some limits on professional fees, "on a significant case there has been nothing legislated that would really affect the timing cost and uncertainty cost," said Mitchel H. Perkiel, a lawyer with Kay, Sholer, Fierman, Hays & Handler in New York.
When time comes to restructure debt, he said, "it still behooves management to give first and primary consideration to the out-of-court process,"
Mr. Luftig said out-of-court settlement techniques and prepackaged filings have evolved in the marketplace because Congress has failed to act. "The analogy is the health care industry," he said, pointing to the rise of health maintenance organizations following the failure of legislation that would have mandated them.
From the borrowers' perspective, an out-of-court settlement is preferable in numerous ways, Mr. Perkiel argued. "Cost is certainly a factor. And the uncertainty of the bankruptcy process has become more of concern for various parties," he said.
Filing for protection "raises a whole different array of influences that don't exist outside of bankruptcy," he added. The introduction of a judge and various official creditor committees "may result in a change in the power structure" to the detriment of current management, he pointed out.
Still, experts say bankruptcy affords certain advantages, foremost among then the automatic stay of claims, which gives the borrower some time to work out a settlement.
"There are situations where you have to" file for bankruptcy, said Antonio C. Alvarez 2d, a managing partner in the crisis management firm of Alvarez & Marsal, who has acted as chief executive officer of the Phar-Mor Inc. drug store chain during an especially contentious bankruptcy proceeding that is finally winding down this month.
"When the vendor community has lost confidence in terms of the ability of the company to pay on credit terms - and you get in a cash-on-delivery or cash-before-delivery situation - it becomes difficult to stay out of court," he said. "Once you get in, you get debtor-in-possession financing, and you start getting credit terms" that are more favorable.
Banks are willing to grant debtor-in-possession, or DIP, loans, because the bankruptcy law gives these loans seniority over other debts of the bankrupt company.
Mr. Alvarez found himself at the center of a controversy in which arbitragers who had bought bank debt in hopes of a payout accused him of milking Phar-Mor for multimillion-dollar fees.
Mr. Repko noted, however, that Phar-Mor failed in part because of fraud by the previous management, meaning that the fees paid to Alvarez to cut costs at the company and reestablish its value were "worth every penny."
"In the absence of integrity," Mr. Repko said, "there is no value."
Bankruptcy also removes pressure on the troubled company to achieve unanimous approval by creditors of its plan. In bankruptcy, the plan must be approved by a majority of the creditors representing at least two-thirds of the outstanding debt.
But consultants are developing new ways to sidestep bankruptcy court.
Geoffrey Lurie, president of GDL Group Inc. of New York, which specializes in out-of-court settlements, said he has sent forms to creditors offering to settle for a portion of the total owed - and noting that if the plan is not approved, the company will file for bankruptcy.
It is surprising how many lending officers will sign off, to avoid dragging their employers into a protracted bankruptcy proceeding, Mr. Lurie said. If enough sign off, the few holdouts can be paid off quietly, Mr. Lurie said, and the company can proceed with its reorganization.
Mike Leinwand, chief financial officer of one of Mr. Lurie's clients, Hair Club for Men, attested to the benefits of the out-of-court approach. He said creditors received 79 cents on the dollar in a recent restructuring, and that the return could have been much lower in a traditional bankruptcy.
But Mr. Leinwand added that the settlement was possible because Hair Club's debt structure was relatively simple. It had only one class of creditors - and no bank debt.
Experts say the prepackaged bankruptcy is a hybrid of the in-court and out-of-court approaches that allows resolution of more complex problems faster than a traditional filing.
Jay M. Goffman, of the law firm of O'Sullivan, Graev & Karabell is a prominent advocate of the prepackaged bankruptcy and counts Harvest Foods among his clients.
He said in order to achieve the 16-day bankruptcy, he had to persuade the court to accept an unusual procedure.
Normally, a vote of creditors is taken, then the company files a petition and asks the court to schedule a hearing 25 to 30 days later, allowing time to notify creditors of the hearing.
"We effectively adopted a new technique," Mr. Goffman said. "We asked the court to preschedule the confirmation hearing on a tentative basis before we went out for a vote. So when we went out for a vote, we also sent out a notice advising people that if we got the votes we would file Dec. 13 and confirm Dec. 29. It allowed us to shorten the period to about half what anyone had done before."
Mr. Goffman said if it is possible to persuade the court to preschedule its confirmation hearing, it should be possible to shorten the bankruptcy process even further.
"The next step is the one-day prepack," he said. "It makes sense, and I think we'll get there."
