When companies going broke, Chapter 11 is their final hope

Bankruptcy used to be a dirty word.

It said failure. It brought shame. The English word comes from the Latin bancus, meaning table or bench, and ruptus, meaning broken.

"What happened is that your bench in the marketplace was broken," said attorney Jack Bury, a bankruptcy specialist with the Spokane firm of Murphy Bantz and Bury. "When you were insolvent, you couldn't do commerce at your bench."

In merry old England, debtors were hauled off to debtors' prisons. Even the son of a deceased debtor could be imprisoned, because debt, just like the family farm, was inherited.

The founders of this country, itself a place of new beginnings, wanted something different.

"They wanted people to have a chance for a fresh start," Bury said. "They didn't believe people should be burdened for life. They thought it was important enough to put in the Constitution."

These days, bankruptcy is almost commonplace - 3.6 million people and businesses filed in 1999 and 2000. Montana bankruptcies are mostly individuals and families who've spent too much on credit cards that were too easy to get or have been laid to financial waste by skyrocketing medical costs for which they were not insured.

"In a state like ours, where so many people are working in service industries and low-paying jobs, medical costs can just be catastrophic," said Dick Samson, an attorney with Christian Samson & Jones in Missoula. "That is a large cause of bankruptcy."

But bankruptcy isn't solely for individuals. A far less common kind of bankruptcy has drawn headlines lately, the version known as Chapter 11 reorganization.

"Reorganization is really a fancy word for paying debt over a longer period of time," said Bury. "Some gets paid in full, some gets paid as a percentage and some doesn't get paid."

In the past two weeks, two prominent companies have filed Chapter 11 - Ronan toolmaker Jore Corp. and the international construction firm run by Missoula's Dennis Washington, Washington Group International.

They reached that critical junction by decidedly different paths.

Washington recently bought a division of Raytheon, the giant defense contractor. That purchase involved taking on about $450 million in debt Raytheon had incurred, but Washington later discovered that the debt was much, much larger. Washington has filed suit against Raytheon, claiming it was mislead, a charge Raytheon disputes.

Regardless, the discovery left Washington strapped for cash. The company, based in Boise, announced in March it had a "liquidity crisis," and filed Chapter 11 bankruptcy on March 14.

Jore, a much smaller company, got in trouble by over-investing in its manufacturing capacity. Jore, which sells tools through Home Depot, Lowe's, Sears and other stores, wanted to break into industrial markets, and spent about $70 million upgrading its production facilities to do so. Unfortunately, the company found it difficult to break into those markets after making a huge capital expenditure.

Jore filed Chapter 11 on Tuesday.

Both companies have financing plans in place that will keep them afloat as they work through the bankruptcy process. The companies' problems are extremely different, however.

Washington's crisis is Raytheon-specific. Interestingly, bankruptcy could resolve the issue much quicker than the court case filed by Washington. It's possible that the bankruptcy judge could rule in Washington's favor in regard to Raytheon's claim as a creditor. If Washington is not liable for as much Raytheon debt as currently assumed, Washington might emerge quickly from bankruptcy.

Jore, on the other hand, has a more typical problem. It simply owes lots of money to a number of creditors. The crux of Jore's problem is whether it can produce a plan that will satisfy those creditors and still be an ongoing concern.

The odds are not good in Chapter 11.

Nationally, about two out of 10 Chapter 11 filings succeed, Bury said. In Montana, the number is closer to one in 10, Samson estimated.

One reason the failure rate is so high is that companies consider bankruptcy too late. Those companies, once they file, almost always find themselves pushed into Chapter 7 bankruptcy, which is forced liquidation.

"Chapter 11 is a very small percentage of the overall bankruptcy filings," Bury said. "Most companies that try it end up in Chapter 7 anyway. Then they're done."

The core of Chapter 11 is the company's disclosure, a sort of "how we got here and how we might get out" statement, Bury said. That disclosure is something like a stock prospectus, an effort to show investors that the project can turn a buck.

"Your creditors already are invested in you, and basically you're asking them to stay invested in you," Bury said.

In Chapter 11, the business remains in possession of its assets, but operates the business under the supervision of the court and for the benefit of the creditors. Every 30 days the business must file a complete report of income and expenses, and that report is available to creditors.

The unsecured creditors - those who stand to lose everything the company owes them - are represented by a creditors committee, which will be represented by a lawyer whose fee is also paid by the company.

"This group really makes major arguments in bankruptcy cases," Bury said. "They're really the architects of the plan."

Creditors are grouped by classes, but they're by no means equal. Nor surprisingly, attorneys and the government are in first possession.

"The government tax man is going to get paid," Bury said.

Next comes secured creditors, which are most often banks or other lending institutions. Then come unsecured creditors, most often suppliers and vendors.

Then, in the case of public companies such as Washington and Jore, come shareholders.

"The shareholder is almost always going to get nothing in a bankruptcy," said Bill Dezellem, chief investment adviser for Davidson Investment Advisors in Great Falls.

Each class of creditors has a vote in whether the debtor's plan will be approved, and each class must approve the plan by 51 percent of the creditors and by two-thirds of the debt owed.

If a class votes against a plan, the bankruptcy judge will determine whether the debtor's plan or liquidation provides the most relief to creditors.

"The judge can override the no vote if he thinks the creditors will be better off with the plan," Bury said.

For the first four months after filing, only the debtor can submit a reorganization plan, but after that any creditor can file a plan. Occasionally, competing plans will surface. If the judge turns down a debtor's plan, the debtor usually has 30 days to deal with the objections.

"You are sweating buckets there," Bury said. "If you can't work it out there, you're headed to liquidation."

"The call has to be: Is it a reasonable proposal?" said Samson. "The creditor wants the debtor to succeed because it is in each side's best interest."

Even so, most debtors don't succeed. Most are forced to sell off their assets.

But still they file, doing whatever they can do to keep the doors open and their employees at work.

"Hope springs eternal," Bury said. "That's what Chapter 11 is."

Reporter Michael Moore can be reached at 523-5252 or at mmoore@missoulian.com.

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