Recent government bailouts of private businesses have generated debate about whether the time-honored institution of bankruptcy is the appropriate mechanism for dealing with big business insolvency. Naysayers of the TARP bailouts contend that rescued businesses are candidates for bankruptcy and that bolstering them with public funds not only fails to address underlying problems but erodes the purpose and uniform application of federal bankruptcy law.

Whose losses are these?

One of the basic tenets of a free market is that a corporation’s shareholders and lower priority debt holders enjoy the profits when a business is up and bear the losses when it is down. This notion is consistent with both liquidations and reorganizations in bankruptcy, but it is at direct odds with bailouts funded by taxpayers. The bottom-line effect of the bailouts is to substitute reductions in the disposable income of taxpayers for reductions in the disposable income of shareholders and non-insured debt holders of distressed businesses.

Toss those, keep these.  Who decides?

Should deciding which private companies deserve to be bailed out and which do not be the job of the government? Is bankruptcy (or its banking counterpart, FDIC receivership) really a viable option for some businesses but not others? To be sure, WaMu, Wachovia, and IndyMac have cycled their way through the FDIC, and Lehman is wending its way through bankruptcy. But the roster of companies rescued from the bankruptcy ringer by TARP payments (http://www.opensecrets.org/news/2009/02/tarp-recipients-paid-out-114-m.html) is much more impressive: Citigroup, AIG, JP Morgan Chase, Wells Fargo, GM, Goldman Sachs, Morgan Stanley, American Express, Chrysler, and on and on.

Looking back on bankruptcy

The bailout trend is new and disturbing, but just how “time-honored” is the practice of corporate restructuring in bankruptcy? Bankruptcy law, or some variation thereof, has existed since the days of the Roman Empire. Our modern bankruptcy law has its origins in British bankruptcy statutes dating back to the sixteenth century, but bankruptcy in the form of corporate reorganization is a relatively new phenomenon.

Once a prison, now a sanctuary

Bankruptcy today is generally a voluntary proceeding initiated by the debtor, although it can also be an involuntary proceeding brought by creditors. Early bankruptcies were always involuntary and often resulted in the imprisonment of the delinquent debtor. Today, bankruptcy today can mean the liquidation of a business and the closing of its doors, or the sophisticated restructuring of debt and the continuation of business. Early bankruptcy always involved the liquidation of a debtor. Early bankruptcy was more an “inglorious end” than the “fresh start” we associate with bankruptcy today.

Individual United States colonies adopted various versions of British bankruptcy law. Although imprisonment often remained an option, along the way some debtor-friendly modifications such as property exemptions were added. Section 8, Article I of the Constitution authorized Congress to establish uniform laws on the subject of bankruptcy, but uniformity was slow in coming.

It was not until the enactment of the Bankruptcy Act of 1898 that modern bankruptcy law began to evolve in earnest. Slowly the law began to focus on the rehabilitation of over-extended debtors and the creation of equitable compromises for different classes of creditors. The Chandler Act of 1938 created specific bankruptcy proceedings to allow public and privately-held companies to reorganize instead of liquidating their assets. With that, bankruptcy was on its way to becoming a survival tool instead of a death sentence.

Businesses opt for user-friendly update

The Bankruptcy Reform Act of 1978 made it significantly easier for businesses and consumers to reorganize rather than simply liquidate debts. As modern bankruptcy practice began to take shape in the 1980s, corporate reorganizations moved out of the shadows and into the light. Before that time, major corporations generally did not opt for bankruptcy.

As recently as the 1970s, major corporate bankruptcy was still an oddity. The only two well-known corporate bankruptcies in the 1970s were Penn Central Transportation Corporation in 1970, and W.T. Grant Company in 1975. But beginning with the 1978 Act, bankruptcy became a legitimate option for sophisticated corporations in need of financial overhauls.

Giving legislative history its due

Somewhere in the last 30 years, corporate bankruptcy became a household phrase and a socially acceptable choice for insolvent businesses. Thirty years does not a “time-honored” institution make. But the prioritization of debts in a bankruptcy reorganization has a long and convoluted legal history that should not be ignored.

Objections concerning political impropriety and socialism aside, it may be that government bailouts are efficient and even judicious in a time of economic crisis. But at a minimum, when the injection of equity capital comes from the public sector, the bankruptcy blueprint for prioritization of claims should be observed. To some degree, the offensiveness of taxpayer subsidies would be ameliorated if shareholders and lower priority debt holders were pushed out of the game until the corporation’s assets are sufficient to cover its other liabilities.

Mike Tyson

The former world heavyweight  once had an estimated worth of $300 million. But with an incredibly lavish lifestyle — including pet tigers, a custom-built Bentley, and a removable glass roof on his mansion — his wealth quickly vanished. He filed for bankruptcy in 2003.

Rapper M.C. Hammer

Rapper M.C. Hammer reportedly spent more than $33 million in two years. When he filed for bankruptcy in 1996, he claimed to be about $14 million in debt.

Dorothy Hamill

The 1976 world figure-skating champion who bought the Ice Capades faced tough competition from Disney’s World on Ice. Hamill’s marriage collapsed, and she was forced to sell the Ice Capades at a loss and declare bankruptcy in 1996.

Francis Ford Coppola

Although the acclaimed movie director won five Academy Awards in the 1970s, he was less fortunate in the 1980s. Three big box-office flops — Rumblefish, The Outsiders and One from the Heart — forced him to seek protection from creditors under Chapter 11.  He filed for bankruptcy in 1990 while shooting The Godfather III.

Kim Basinger

In the early 1990s, the Oscar-winning actress was ordered to pay Main Line Pictures about $8 million for backing out of the movie Boxing Helena. The ruling forced her to sell Braselton, Georgia — a town she bought as an investment — at a loss of about $19 million. She filed bankruptcy in 1993.

Anna Nicole Smith

In 1996 the Playboy Playmate  was ordered to pay $830,000 to a former employee who accused her of sexual harassment. Although Smith was battling for a cut of the billion-dollar estate of her deceased husband, oil tycoon J. Howard Marshall, she filed for bankruptcy.

Burt Reynolds

After his highly publicized divorce from Loni Anderson in 1993, the actor sank deeply into debt, owing an estimated $10 million. He declared bankruptcy in 1996.

Don Johnson

The Miami Vice star  filed for bankruptcy in 1994 to protect his $20 million Colorado ranch from creditors. Johnson managed to get his finances in order, pay off his debts, and emerge from Chapter 11 still owning his ranch.

Gary Coleman

Citing years of financial mismanagement, the former child star filed bankruptcy in 1999. At the time he said, “This is the last step in 10 years of steps to mitigate and eliminate the dead weight of the past.”

Sister companies Anderson Homes and Vanguard Homes — the latest residential real estate companies in the Triangle to succumb to the housing downturn — filed on Monday for Chapter 11 bankruptcy protection, according to an article today in the Triangle Business Journal.

In its bankruptcy documents, Anderson Homes, based in Cary, claims $17.2 million in assets, $13.7 million in liabilities, and 100 to 199 creditors. Vanguard, based in Raleigh, claims $11.1 million in assets, $9.9 million in liabilities, and 50 to 99 creditors.

Dave Servoss, president of Anderson and Vanguard, says the companies ran into the same problems as other home builders: Houses just aren’t selling. “Most of our money’s in the ground,” Servoss says.

Layoffs give builders hope

Anderson Homes has been in business since 1980, building thousands of houses across the North Carolina region known as the Triangle. Vanguard was established in 2006 as an offshoot of Anderson Homes. The companies now employ 13 people, down from a peak of 66, Servoss says. The cuts were part of what Servoss called “a massive overhead reduction program” that he hopes will help put the company in better shape when it emerges from bankruptcy.

The latest in a string of home-builder bankruptcies

Several Triangle home builders and development companies have filed bankruptcy since the start of the housing downturn. The most recent was Vardis Homes of Apex, which filed a Chapter 7 liquidation just last week. Also included are of the region’s most notable names, such as MacGregor Development and St. Lawrence Homes. Many companies related to the business, such as construction and site-preparation firms, also have gone out of business or filed for Chapter 11.

The troubled companies face declining sales in both new and existing housing markets in the Triangle, although the Triangle markets have fared better than most across the country, with home prices remaining relatively steady.

The Dallas Business Journal reported today that Idearc Inc.’s largest shareholder has issued a statement saying the company has no need to contemplate the possibility of filing for Chapter 11 bankruptcy in the future.

Idearc, headquartered at Dallas/Fort Worth International Airport, publishes telephone books and provides consumer information over the Internet. It has about 7,200 employees and 100 offices in the U.S.

Shareholder says “No”

The shareholder, Jack Corwin, sent letters to each Idearc board member and issued a public statement saying he was “shocked” to find statements in Idearc’s earnings release suggesting that the company is pursuing all strategic options and that the option of filing for Chapter 11 bankruptcy protection is on the table.

In his letter to shareholders Corwin said that other alternatives need to be pursued, including the option of Idearc paying down outstanding debt with the $510 million in cash it had on hand in late 2008. He added that failure to pursue other alternatives before deciding on a Chapter 11 bankruptcy reorganization is a breach of the Board’s fiduciary duty to shareholders.

“This comes at a time when all eyes are on corporate America to behave with the utmost fiduciary responsibility. Where alternatives may exist for companies to avoid bankruptcy it is highly unusual for a corporation to choose the route of bankruptcy at the risk of damaging [its] business and harming [its] employees and other stakeholders,” Corwin said. “The impact on local and national communities and economies is significant, to put it mildly,” he added.

Earning statement says “Maybe so”

Last week, Idearc posted a fourth-quarter loss of $77 million on sales of $709 million, and said in notes attached to the earnings statement that it is “currently considering a restructuring” under federal bankruptcy laws. Based on current forecasts and year-end results, Idearc is out of compliance with one lender’s agreement and risks being out of compliance with a second. As a result, lenders have the right to consider all the company’s debt in default and could call it due within 30 days, Idearc said.

Shareholder would be last in line for payment

In bankruptcy, shareholders such as Corwin are last in line to be paid. As of mid-February Corwin reported holding more than 8% of Idearc stock, or more than 12 million shares. Idearc shares were trading at 5.5 cents at midday on Monday.

(Image from Flickr.com)

According to the Dayton Business Journal , Blockbuster Inc.’s stock price rose 13.83 percent Monday morning to 74 cents per share. The increase came after the company received a vote of confidence from a former competitor who purchased additional stock in the company.

A Securities and Exchange Commission filing says Mark Wattles, president of Wattles Capital Management LLC and the founder of Hollywood Entertainment Corp., purchased Blockbuster shares this week, bringing his ownership to 5.7 percent of all outstanding shares of common stock.

and based on his experience

Wattles has experience in the industry. He founded Hollywood Entertainment Corp., a movie and video game rental company that became the second largest movie rental and retail chain after Blockbuster.

believes there’s no reason to file bankruptcy

In the filing Wattles expressed confidence in Blockbuster (NYSE: BBI), saying he does not believe Blockbuster has a motive to file a Chapter 11 bankruptcy reorganization. His confidence is backed by Blockbuster’s proactive cost-cutting through store closings and subleases.

The filing states: “Mr. Wattles does not believe that the issuer has a motive to reorganize under Chapter 11. In addition, regardless of likelihood of obtaining a ‘going concern’ qualification from its auditors, Mr. Wattles believes the issuer will be successful in refinancing its revolving bank line of credit, or if it cannot, that it will be able to use cash flow from operations to meet its August repayment obligations.”

without health insurance

The Buffalo Business First reported today that attorneys for a group of salaried Delphi Corp. retirees are preparing to argue an appeal from a bankruptcy court ruling of last week. On March 11 Judge Robert Drain in New York City rejected a plea from the white-collar workers that they be allowed to keep their health care and insurance benefits. Drain previously had ruled in February that the company could discontinue those benefits. The retirees, who have until April 15 to sign up for self-paid insurance, will ask for a stay to keep Judge Drain’s ruling from going into effect. Representatives of the employees’ group say they hope to take the case to the appellate court if Drain rules against them again.

according to the plan

Troy, MI-based Delphi has said that eliminating the insurance is part of its plan to restructure and emerge from the Chapter 11 bankruptcy protection it entered three-and-one-half years ago. About 15,000 salaried retirees, including several hundred who were employed at Delphi Thermal Systems in Lockport and General Motors Corp — Delphi’s former parent — are involved in the case.