Bankruptcy: An Emerging Corporate Strategy

By Tavakolian, Hamid | SAM Advanced Management Journal, Spring 1995 | Go to article overview

Bankruptcy: An Emerging Corporate Strategy


Tavakolian, Hamid, SAM Advanced Management Journal


Introduction

The origin of bankruptcy dates back to the laws of the Roman Empire, which were instrumental in the formation of both English and American laws (Galligan, 1991). However, it was not until 1898 that the United States enacted bankruptcy laws. Later, the Chandler Act of 1938 was added to incorporate reorganization into existing bankruptcy laws, and this critical domain was expanded by the 1978 Bankruptcy Reform Act. Finally, Congress passed the Bankruptcy Amendments and Federal Judgeship Act in 1984 to address weaknesses in the 1978 Act.

Historically, bankruptcy was viewed as a sign of organizational and managerial failure. However, these stigmas are melting away as more and more companies file for bankruptcy (Barr, 1992). Furthermore, bankruptcy is becoming accepted as a corporate turnaround strategy, and the managers of these companies are no longer perceived as business failures. Rather, they may be regarded as shrewd business strategists.

Prior to 1978, bankruptcy was available only to financially insolvent companies. However, the 1978 modifications made it possible for solvent companies to take advantage of this legal maneuver as a step in their turnaround strategies (Much, 1979). Consequently, the increasing acceptance of bankruptcy the business world coupled with the less stringent criteria in qualifying for bankruptcy protection have made bankruptcy a viable strategy for executives searching for new approaches to the challenges of their turbulent environments. In recent times, an unprecedented number of companies have implemented this strategy as evidenced by the 290% increase in the number of Chapter 11 petitions filed (7,828 in 1981 to 22,495 in 1991, as shown in Figure 1) (Bankruptcy Findings, 1993).

Bankruptcy is no longer primarily limited to small or start-up companies, but is increasingly used by large, powerful corporations as well. For instance, after a $10.3 billion judgment was awarded against Texaco, the petroleum giant sought protection under federal bankruptcy laws in order to buy time and negotiate a better settlement with Pennzoil (Much, 1987; Thompson et al, 1987). Subsequently, Texaco was able to settle with Pennzoil at a reduced payment of $3 billion. Ultimately, in April of 1988, Texaco emerged from bankruptcy and is currently expanding its market share (Coleman, 1990; Smart, 1993).

Other large corporations have taken advantage of bankruptcy protection on more than one occasion. In September of 1983, Continental, the nation's fifth largest airline, sought the protection of federal bankruptcy court to revoke its costly labor union contracts (Good Law, 1983). After filing, Continental declared its collective bargaining agreement void, and established new, competitive salary levels. While this decision was difficult and unpopular, it was necessary for survival. This strategy was a major factor in Continental's successful emergence from bankruptcy in September of 1986. In December of 1990, however, a cash-starved Continental filed its second bankruptcy petition in less than eight years in an attempt to hold its creditors at bay while renegotiating its huge debt. In April of 1993, Continental successfully emerged from two and half years of protection (This Time, 1993).

Reorganization Under Chapter 11

Seeking shelter under the umbrella of the federal bankruptcy court has become an increasingly common corporate strategy in recent years. Under Chapter 11, bankruptcy is not necessarily the end of the company; rather it can be the beginning of a bright future (Atlas, 1992). Companies such as Texaco, Manville, Wheeling-Pittsburgh Steel, Storage Technology, and UNR Industries have sought protection under Chapter 11. They reorganized and not only survived but came out as strong, viable organizations.

Cases such as Texaco, Wilson Foods, Continental, and others are some examples of solvent corporations using Chapter 11 to stave off potential financial disasters. …

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