The Stimulus Package, Charter, and Paul Allen, – A New World for Restructuring/Bankruptcy?

Remember the old phrase: “I would rather be lucky than good”. Well this situation with Charter certainly falls into that category.

Charter’s pre-packaged bankruptcy looks like a winner for all parties. A company as large as Charter needs to have all agreements done upfront in order to ensure an orderly filing and then re-emergence. Charter’s filing also leaves Paul Allen at the top in terms of control. Companies in bankruptcy or companies about to file for bankruptcy just fell into a pile of diamonds. Talk about dumb luck or great lobbying.

The Stimulus Package now temporarily suspends taxes on debt amounts that are forgiven in 2009 and 2010. If you are a debtor you just had someone hand you either a “get out of jail free card” or “bail money”. As for Paul Allen, talk about dumb luck. This is one of those moments where someone has been “lucky rather than good”.

This new tax provision allows firms to delay paying taxes on income from debt that is forgiven until 2014. Even better for the debtors they can spread those taxes from 2014 to 2018. My concern is that the debtors typically had a huge hand in driving the company into bankruptcy so why are we rewarding stupidity?

I understand there is a bigger picture behind the stimulus package so please no political or social lectures.

Bankruptcy is a process that afflicts a variety of debtors; from owners who had no control over external circumstances to owners who simply did not know what they were doing. The distress process is an interesting way of weeding out those who got caught between a rock and a hard place and those who raced right into the rock at full clip.

In other words, I feel as if we are rewarding bad management and ownership. Of course, there are truly innocent victims in a bankruptcy. There are times, when a company simply could not reverse its course in reaction to market shifts or sudden dynamic changes brought on by technology. However, there are also times, when companies have been completely mismanaged form the get-go. The rules appear to try and make both sides of the distress process more whole than ever before – debtors and creditors.

The new rules have also changed the way certain tax assets like net operating losses are handled. Under the old rules, the company would have certain net operating losses reduced in conjunction with not having to pay taxes on debt that is wiped clean. Under the new rules, the company could save its net operating losses and pay taxes on income from forgiven debt. The fact is the net operating losses could be larger than the income from the forgiven debt. If you could defer paying taxes for up to 10 years you would defer those taxes.

One interesting twist to this tax deferral matter is an investor could simply take their windfall and not even reinvest it back into the bankrupt company. An investor could take the money saved from not having to pay taxes and invest it elsewhere. If you had from between 5 to 10 years would you reinvest that money back into the company?

However, the new rules may actually put more cash in the hands of the company and hopefully the creditors. The new rules may also facilitate a bankrupt company’s ability to emerge from bankruptcy. Secured creditors (and possibly unsecured creditors) can therefore come out with more cash under the new rules. Then again the new rules could be a disaster for American businesses in the long run.

Bankruptcy has a way of shaking out those who should not be running companies and shutting down companies that never should have been in operation. I am fearful we have simply given a group of people an “unwarranted pass”. The long term result is rewarding an incompetent manager or owner; encouraging them to make the same mistakes again. Bankruptcy forces the debtors and the creditors together to resolve the situation quickly. There are those who support a much longer process to submit the Plan of Reorganization. By extending the filing period for the Plan of Reorganization beyond 180 days, it may encourage competitive proposals from other creditors. However, having a 180 day period forces all parties to move quickly. If you get into competitive bidding for creditors the company can sit in bankruptcy for far too long. Having a company sit in bankruptcy for too long is no good for anyone.

The long term impact of the new rules may actually force apart the debtors and the existing creditors when in a bankruptcy they need to work together to emerge from bankruptcy. Keep in mind there are multiple parties in a bankruptcy. There are debtors (includes equity holders) and more importantly creditors. There are six different classes of creditors, debtors, and other parties in a bankruptcy. Among these classes are: secured creditors, financial advisors, attorneys, unsecured creditors, taxing authorities, employee claims, and shareholders.

All of these claimants have different agendas, motivations, and needs. The new rules may change the dynamics of a restructuring. We are now looking at a shifting battlefield. What are the impacts on how and when a company emerges from bankruptcy?

Getting back to Charter. Charter will not be the last telecom/infocom company to either file for bankruptcy or suffer from the recession. There are still the small independents that may have to file. There are still startup technology companies that may have to file. We are looking at hundreds of millions of dollars in private capital sitting in privately held technology companies that have either been placed into dormancy or have been shut down. The new rules can conceivably make private equity investors whole.

Charter and maybe even Nortel(TSX:NT) may become the models for bankruptcy under the new rules.

The overall impact on corporate restructuring is yet to be determined.

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