Preemptive Bankruptcies May Increase

While the recession promises to send many companies into bankruptcy, some might go there on their own ahead of time, joining the universe of distressed exchanges and other measures used for coping with oncoming maturities. The preemptive bankruptcy filing is something market observers expect to see more of as companies with upcoming debt maturities file early.

A preemptive bankruptcy is best defined as a bankruptcy filing that occurs without the trigger of a missed coupon payment or other type of default. Toronto-based Nortel may be the first in a wave of preemptive bankruptcies that could increase in frequency as debt maturities approach. Nortel filed for bankruptcy Jan. 14, when it had $2 billion (C$2.4 billion) in cash. The company cited its debt burden, the current recession and the global financial crisis as factors that have compounded its financial challenges.

"Nortel may be the first in what may be a longer line of these things or longer list of companies that find themselves in similar situations," said Adam Harris, an attorney with Schulte Roth & Zabel who specializes in bankruptcies. "A lot of companies are sitting down now and doing a hard analysis. They're seeing debt maturities coming. They may be in total compliance in terms of their credit facilities, but they realize there is no market to refinance that debt."

No Double (Or Single) DIPing

The main motivator that will push companies into preemptive bankruptcy is the absence of DIP financing. "The inability to get DIP financing is the true catalyst," said Gregory Peters, an analyst with Morgan Stanley, who co-authored a report on the problem. "I've heard other things [mentioned] as factors, such as changes in bankruptcy laws, but the difficulty of getting DIP financing is really driving it more than anything else." Morgan Stanley analysts foresaw a trend in preemptive bankruptcy last year. In the report, they pointed out that fears of a lack of DIP financing would push companies without near-term maturities to file for bankruptcy. The Nortel filing could be a signal that those fears will be realized.

"There's an old joke but truism: 'You can't file bankruptcy if you're broke,'" said Michael Crames, senior restructuring counsel for the law firm Davis Polk. He added that the financing needed for bankruptcy will further push companies to file before their cash is too depleted, particularly with the absence of DIP financing.

Harris said that companies might also have a fair amount of money in an untapped revolver that could be used to help finance their bankruptcy. But if the revolver is used to pay debt maturities in advance of the bankruptcy, and the company is going to have to file anyway, it makes more sense for the company to file early and use that revolver for its bankruptcy financing needs.

The Morgan Stanley report points out that while $100 billion of bonds and loans are due to mature in 2009 and 2010, more than $100 billion will mature in 2011, about $350 billion will mature between 2012 and 2013, and another $350 billion is due in 2014. Because of these upcoming maturities and the expectation of increasing default rates and bankruptcies, the need to file before other companies is also a factor in favor of declaring bankruptcy early.

Martin Fridson, founder and CEO of Fridson Investment Advisors, says there is a push among companies to file before other companies use up resources they'll need to help reorganize. He cited a theory advocated by Professor Edward Altman at New York University that too many companies filing for bankruptcy at the same time will spread much needed restructuring players too thin.

Peters agrees. "With the expectation of so many companies filing, there is this kind of first mover advantage effect as well as far as recoveries go," he said.

Experts warn that filing for bankruptcy is still a last resort. "I have never found Chapter 11 to be a panacea," said Crames. "There are a lot of pitfalls and disadvantages and caveats that a board and management ought to be advised of. It doesn't solve everything, and it comes with host of other issues that can be quite difficult." Crames said that before a company considers bankruptcy, it should do everything in its power to forge an agreement with its debt holders, such as debt exchanges, forbearances or equity exchanges.

It's Complicated