Bankruptcy affects companies that don't have the cash to pay their debts, but it doesn't have to be a kiss of death.

21st May 2001







DEFINITION: Bankruptcy affects companies that don't have the cash to pay their debts, but it doesn't have to be a kiss of death. In Chapter 7 bankruptcy, a company goes out of business, sells its assets and pays off creditors under the direction of a court-appointed trustee. In Chapter 11 bankruptcy, the company remains in operation and tries to reorganize or liquidate its assets.

Before Unifi Communications filed for Chapter 11 bankruptcy in January 1999, the account management team knew the company was in distress. Open positions at the Burlington, Mass.-based telecommunications firm weren't being filled, and Friday afternoon barbecues were a distant memory. "We're looking for another round of funding" was the oft-spoken phrase heard in the halls during the company's Chapter 11 proceedings.

Unifi's business model was centered around quick delivery of secured faxes. But when the Internet emerged, Unifi was sent packing.

"We gave as much advance notice as we knew," says Tricia Forrester, who was a human resources benefits specialist at Unifi during the bankruptcy. "We didn't know whether last-minute deals would go through, but once we knew the company had decided to dissolve, we let employees know."

Glimmer of Hope

But before employees hear the "B" word and start scrambling for the door, they should realize that facing Chapter 11 isn't the worst place to be. Unlike Chapter 7, there's some hope under Chapter 11.

If a bank, venture capital firm or other lender thinks a company has enough staying power to make an injection of money worthwhile, it provides what's known as debtor-in-possession (DIP) financing. These lenders are at the top of the list come payback time. DIP financing is what many struggling dot-coms are vying for today.

"Think of Chapter 11 as a game of tennis in which the corporation has a right to serve," says Harvard Business School professor Stuart Gilson. "In the game of bankruptcy, management gets to serve the ball until it gets it over the net.

"[U.S. bankruptcy laws] operate under the presumption that a company is worth more alive than dead and that if you can give that company some breathing room, sometimes it will turn around," Gilson adds.

In Chapter 11 proceedings, a company's management has 120 days to come up with a solution for resolving its debt. (During this time, there's often a change in management.) Creditors then have 60 days to either vote in favor of the plan or send management back to come up with a new approach.

But high-tech companies face an unpredictable set of circumstances when it comes to seeking cash injections: Their primary assets can walk right out the door.

In more traditional markets, companies filing for bankruptcy can list equipment and products as their assets. But when an idea-based outfit like a high-tech company is forced to shut its doors, payback gets a little more complicated.

"For those companies who have people with ideas, creditors seeking recovery in a typical software high-tech distress situation may find trouble creating value out of assets," says Jeff Spiers, a bankruptcy attorney at the Houston office of Andrews & Kurth LLP. "The reason being, assets are imbedded in people's brains. And indentured servitude went out with the Emancipation Proclamation."

When London-based fashion Web site folded last summer, it faced the same problems that companies such as Santa Monica, Calif.-based Inc. face right now: how to capitalize on intangible assets. sold its software and intellectual property, but at a price greatly reduced from its development costs. Most of the information was in the brains of its software developers.

Waltham, Mass.-based Inc. tried to address this problem during its liquidation last summer by attempting to sell its customer list, one of its few tangible assets. But that resulted in a battle with the Federal Trade Commission, which accused Toysmart of violating its privacy policy. In that policy, Toysmart assured customers that it wouldn't share their personal information with third parties.

"For high-tech companies, Chapter 7 is more common than Chapter 11 because your value tends to walk out the door," says Gilson. And "when that value leaves, there's less available to support reorganization," he explains.

Still Playing

Even companies that don't produce a high-tech product have to be concerned about their tech-minded employees.

In February, Loews Cineplex Entertainment Corp. in New York filed for Chapter 11 bankruptcy protection and announced it would close 23 theatres in Canada. The company had already closed 164 screens at 34 locations between March and November 1999.

However, it's still business as usual for the IT department, according to Mindy Tucker, vice president of strategic planning at Loews.

"During our Chapter 11, we continue to pay our employees and they continue to have the same benefits they've always had," she says. "The employees that are being impacted the most are those in the theaters that are closing."

Although IT employees might find comfort in the fact that their skills are in demand, morale is bound to waver as they watch co-workers get laid off. It takes faith and loyalty to continue working for a company as its stock price nose-dives - especially if employee compensation packages include stock options.

When a company is paying back its creditors during a Chapter 11 bankruptcy case, organizations that are typically paid back first include banks, other lenders and insurance companies. Those administering the bankruptcy proceedings come next, with stockholders (including employees) last in line.

Employees are given priority when it comes to wage compensation. Bankruptcy laws allot $4,300 per employee for anything earned within 90 days of a firm's bankruptcy.

Employees of companies that are facing bankruptcy also need to think about health insurance, 401(k) distributions and life insurance. "Once a company stops sponsoring [insurance plans], it usually lets employees know right away," says Unifi's Forrester. "No company wants to drop a bomb like that."

Copyright © 2001 Computerworld Inc