The Complex Art Of The Chapter 11 Deal

A century ago, J. Pierpont Morgan expanded his empire by buy ing up once-mighty railroads ruined in a harsh economic downturn. On May 9, General Electric Co.-owned CNBC scooped up its chief cable-TV business-news rival, Chapter 11-enmeshed Financial News Network Inc.

Increasingly, other spiritual legatees ef Morgan are devouring the wards of bankruptcy court, such as American Real Estate Partners, Coleco, Liquor Barn, and Miniscribe (table). A recessionary surge in Chapter 11 filings--they were up 45%, to 4,577, in 1991's first quarter--provides plenty of pickings.

But the pickings are not very easy. Acquirers need enormous stamina and resources to brave the bankruptcy system, where judicial whims, lawyers' legerdemain, and clever politicking with touchy creditors often overcome even the best intentions. Taking over a distressed company also can be done in an out-of-court restructuring or a prepackaged bankruptcy, in which a majority of creditors agree on new ownership before the Chapter 11 filing. Trying a postfil-ing takeover, however, multiplies the pitfalls. Says Kose John, a professor at New York University's Stern School of Business: "You'll have a fight on your hands."

HEADACHES. Consider the mess at Sharon Steel Corp., whose massive $400 million debt load pulled the steel producer into Chapter 11 in 1987. The only thing squabbling creditors could agree on was ousting majority owner Victor Posner, the Miami Beach financier. Meanwhile, legal fees mounted at a $6 million yearly clip and management kept turning over.

Then along came Castle Harlan Inc., a Manhattan buyout firm willing to infuse $ 140 million in new capital into the ailing Farrell (Pa.) steelmaker, which was still a strong player in such disparate niches as golf clubs and cluster bombs. "The steel environment is tough, but we saw a specialty manufacturer that could do very well," says John K. Castle, the firm's chairman. Castle Harlan was joined by Quantum Overseas N. V., an investment fund and Sharon creditor, which agreed to satisfy its claim--$105 million face value in bonds--by acquiring Mueller Brass Co., a Sharon subsidiary, and some mineral rights.

Getting the other creditors to welcome a takeover, though, proved a challenge. Without their O. K., a company can forget about emerging from Chapter 11. Cleveland-Cliffs Inc., Sharon's iron-ore supplier, insisted it was owed $465 million, which Castle Harlan deemed vastly inflated. Eventually, the supplier settled for less than 25% of that and a 15-year contract renewal. "The ore deal was an ordeal," quips Christian L. Oberbeck, a Castle Harlan vice-president.

The road gets even harder in a hostile takeover. Sharon's management enlisted Castle Harlan. The unfriendly acquisition of Allegheny International Inc. by New York's Japonica Partners was a ripsnorter ending in management's overthrow. Executives at the Pittsburgh appliance maker had enough trouble pleasing creditors, who had repeatedly voted down reorganization plans since the 1988 filing. Then, Japonica bought a controlling amount of the debt in late 1989, which meant all future plans not involving a Japonica takeover would be dead on arrival. After much legal swordplay, management realized that Japonica could tie them up in court for years, so they gave up.

Bankruptcy takeovers of smaller companies are easier: The finances are less tangled, and the creditors are fewer. There, judges often set up a simple auction. For acquirers, says Peter S. Kaufman of restructuring advisers Gordian Group, a major risk is "that the judge may select a bid that's not the highest." This is just what happened in the auction for FNN. After several acrimonious rounds of bidding, Consumer News & Business Channel, a competing cable network owned by GE's NBC Inc. unit, won with an offer of $154 million. Bankruptcy Court Judge Francis G. Conrad denied a $167 million bid by a Dow Jones-Westinghouse Broadcasting alliance. The judge described the bid, partly conditioned on optimistic revenue growth, as "financial gymnastics."

While the number of Chapter 11 takeovers will increase, don't expect everybody to succeed. The union at strikebound Greyhound Lines Inc., which filed last June, failed to attract any buyers for the Dallas-based bus company because of its shaky prospects. Says one nontaker, Henry R. Silverman, a general partner at Blackstone Group: "The game wasn't worth the candle." After all, in the bloody arena of Chapter 11, kindness and mercy are scarce.



Appliance maker's plan to emerge from Chapter 11 rejected nine times by

creditors. Then, in August, 1990, Japonica investment partnership lays out $205 million to buy up the equity and a majority of the debt. Company renamed



Putting up $44 million, raider Carl Icahn tops two other bidders during

bankruptcy court auction in September, 1990, to buy property subsidiary of

Chapter 11-mired Integrated Resources


On May 9, cable rival Consumer News & Business Channel, backed by GE's NBC,

wins auction with $154 million bid over Dow Jones-Westinghouse combo. Final

O.K. pending antitrust challenge


Disk-drive company acquired for $46 million in April, 1990, by Maxtor, which

then becomes third-biggest data-storage maker


Stuck in Chapter 11 under owner Victor Posner, specialty steelmaker emerges in

January after $140 million buyout. New owner Castle Harlan takes steel

operations, while Quantum fund gets brass subsidiary


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