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Strategic Bankruptcy

University of California Press

In December 1986, I spent many days sitting through hearings in a lower Manhattan bankruptcy court. The courtroom was filled with scores of lawyers and financial experts discussing capitalization rates, valuation ratios, depreciation values, and other technical financial measurements. As I sat listening to the estimates of the worth of the asbestos manufacturer Johns-Manville, I thought about the man sitting right next to me on the wooden court bench. He was having difficulty breathing through an oxygen mask. On that day at the federal courthouse, he was the only visible reminder of what these technical proceedings were all about. He was dying of asbestosis.

Later I asked him what he thought about the bankruptcy proceeding. He told me: "I'm not sure I really understood all those numbers. I just hope we [asbestos victims] finally get something before we die. We've been through so much. I guess they [Manville managers] had no other choice [than declaring bankruptcy]." The bankruptcy court would later decide his fate and the fate of others injured by Manville's asbestos products.

In June 1983, Continental Airlines' senior vice president for flight operations jotted down some notes during a meeting at which the airline's labor troubles were discussed: "I don't believe we can get these [labor] concessions on a voluntary, persuasive basis. We must get an [an] awfully big stick…. Most effective stick might be Chapter 11" (court

testimony, In re Continental Airlines, 3 Bankr. L. Rep. [CCH] [Bankr. S.D. Tex. 1984], and Murphy 1986, 223).

Three months later, Continental declared bankruptcy and abrogated its labor contracts with its unions. Continental's CEO, Frank Lorenzo, began referring to the company as "the new Continental" and to any employee working for the firm after its bankruptcy as a "founding employee" (see Continental Airlines, annual report, 1983). One of the "founding employees" at "the new Continental" found his salary immediately reduced from $45,000 to $30,000 (New York Times [hereafter cited as NYT ], September 24, 1984, D 1), and a ticket agent came to work after the Chapter 11 filing and found that her hourly wage had been cut from $10 to $7.50 per hour (NYT, September 6, 1985, D 2).

Employees wondered how the company could violate labor law without penalty. Union officials complained bitterly that Lorenzo had unilaterally broken legally negotiated contracts. But pro-management observers countered that Lorenzo simply had no choice—he responded to a set of financial conditions beyond his control. Lorenzo was later hailed by Fortune magazine as one of America's "most fascinating business people" (January 5, 1987, 72) and as "an imaginative entrepreneur" (February 17, 1986, 72).

In 1984, a Texas jury ruled that Texaco had illegally interfered with Pennzoil's agreement to acquire Getty Oil. The jury awarded Pennzoil $10.53 billion in damages, the largest court award in history. Texaco refused to pay the award, despite the fact that it had $35 billion in assets and approximately $13 billion in equity. Instead, Texaco declared bankruptcy. Pennzoil charged that Texaco was using bankruptcy to force Pennzoil to accept a lower award. As Time magazine reported at the time, "the U.S. was faced with the spectacle of a healthy corporation sheltering under laws ostensibly intended for the weak and the ailing" (Time, April 27, 1988). The Texas jury probably wondered why it had spent so many days in the courtroom listening to testimony if its decision could be rendered ineffective through a bankruptcy filing.

What is happening in bankruptcy court? We usually think of bankruptcy as something bad—a place that managers try to avoid. Scores of popular books with titles like Turnaround: Avoid Bankruptcy and Revitalize Your Company (Freiermuth 1989) counsel managers on how to steer clear of what is depicted as the ultimate business disaster. According to popular belief, bankruptcy occurs when management's plans go sour. As Freiermuth puts it: "Texaco, Bank of America, LTV, A. H. Robins, … mere mention of the names of corporate giants … evokes a certain image of what can happen to a business when the best-laid plans do not develop as expected" (1989, introduction).

But is this true? Do managers avoid bankruptcy and only accept it when all options are exhausted? Is bankruptcy always an anathema to "good business"? In this book, I shall show that profound changes have occurred in our economic, political, legal, and organizational landscape. Bankruptcy has become a strategic, political device used by large corporations and commercial creditors. Recent cases suggest that firms are beginning to view bankruptcy, not as something to be avoided, but as another weapon in the corporate arsenal.

Consider some recent bankruptcies. Manville declared bankruptcy to resolve the liability problem created by its harmful asbestos products, despite the fact that it had over $2 billion in assets. A. H. Robins, notwithstanding apparent financial vigor, entered Chapter 11 to create a payment scheme for women injured by its Dalkon Shield intrauterine device. Continental Airlines and Eastern Air Lines, both led by Frank Lorenzo, coupled bankruptcy filings with the abrogation of all of their labor contracts. Texaco, one of the nation's most profitable oil companies, entered bankruptcy to reduce a court-imposed damage award. LTV, a major steel producer, tried to shift the obligation of providing pension funds to retirees to the federal government through bankruptcy. Numerous smaller companies have declared bankruptcy to avoid cleaning up toxic waste sites. These cases

challenge the notion that bankruptcy is contrary to "good business." Instead, it appears that corporations or creditors invoke bankruptcy to achieve a variety of organizational or political goals. Moreover, the usual arbiters of economic health—banks, large insurance companies, bond-rating agencies, and investment bankers—increasingly share the view that bankruptcy is legitimate business strategy.

In this book, I analyze three of the largest of these cases: Manville, Continental, and Texaco. I plan to show that each firm filed for bankruptcy only to accomplish a financial or political objective that it had tried unsuccessfully to achieve through more routine processes. All parties to these cases recognized and operated on the assumption that this limited objective was all that was being pursued. Liquidation of the firm was thus not considered a serious option.

You will see that these companies spent incredible resources and public relations efforts to show their customers and suppliers that they were not "really bankrupt." Perhaps they were more right than we realized. I shall illustrate through these examples that companies can "manufacture" or "construct" a claim to bankrupt status through creative accounting, interpreting the terms liability and assets in novel ways, separating company assets from those of a subsidiary, or shifting assets from one corporate entity to another. I argue that terms such as asset, liability, insolvent, and bankrupt are far from concrete and objective but instead are subjective and open to competing interpretations.

Oddly, academic...