A New Page For Chapter 11?

The heads of the nation's biggest airlines have been griping for months about U. S. bankruptcy laws. And the longer such sick carriers as Trans World Airlines and Continental languish in Chapter 11, the louder those cries grow. The executives charge that the law's protections give the ailing airlines a competitive advantage by allowing them to slash fares below the cost of providing service--forcing healthier carriers to do the same or lose customers.

The Bush Administration mostly ignored the complaints. But United Airlines Inc. thinks it may soon gain a sympathetic hearing. On Jan. 6, UAL Corp. chief Stephen M. Wolf sent Bill Clinton a letter urging the President-elect to set up a commission to study the bankruptcy laws and other factors undermining U. S. air carriers. And American Airlines Inc.'s chief financial officer, Michael J. Durham, dares to hope that change might occur. "Call me a crazy optimist," he says. "At least the incoming Administration has said they see a problem and they believe it needs addressing."

The airline folks may find the bankruptcy code a convenient scapegoat. It throws the focus off their overexpansion and overleveraging. Just the same, there's a growing consensus that corporate debtors have become too powerful and that the scales must be tipped back a bit toward creditors.

NO STIGMA. That can be seen in the forces that are gearing up for a drive on Washington to revise the bankruptcy laws. It's not just airlines. Bankers, retirees, and unions also are making bankruptcy reform a top priority this year. Even bankruptcy lawyers--notable beneficiaries of the bankruptcy boom (table)--are proposing revisions to the bankruptcy code. The key target: Chapter 11, which lets companies reorganize their finances free of pressure from creditors. "The cost and delay of running a Chapter 11 are a matter of serious concern that deserves serious scrutiny by Congress and the courts," says Elizabeth Warren, a visiting bankruptcy-law professor at Harvard University Law School.

The airline industry says it's a case study of what's wrong with Chapter 11. But so are industries ranging from steel companies to wallboard makers. The healthy companies complain the law inhibits a key function of capitalism: weeding out inefficient players. "Shakeouts don't seem to occur," says Thomas C. Graham, CEO of Armco Steel Co. The companies "hang around like old soldiers and never die."

The problems are magnified by the growth of Chapter 11 filings. They hit a peak of 149 filings by public companies in 1985. But the size of the companies making the filings peaked only in 1991 and remains high (chart). In 1992, 79 companies with $53 billion in assets entered Chapter 11. Although the economy is improving, "bankruptcies will continue," says Washington lawyer Roger M. Whelan. "Whether this reflects a play-now-pay-later philosophy, it seems the attitude of Americans is bankruptcy doesn't bear the stigma it once did."

OVERCAPACITY. Chapter 11 was supposed to give financially troubled companies a second chance. But a debtor company has only a 6.5% chance of reorganizing as a going concern, says a recent study by lawyer Susan Jensen-Conklin. Large, public companies have a much higher success rate. But those that pull through are weakened by asset sales. Moreover, companies that languish in Chapter 11 can cause market distortions by keeping excess capacity on line while driving down profit margins for other companies in the same business.

The courts are partly to blame for the inefficiencies. Distracted by such issues as environmental liability, some judges are letting cases drag on. Many judges also grant the debtor corporation repeated extensions of the 120-day deadline for filing a reorganization plan. And the longer the cases go on, the less there is for creditors. Since LTV Corp. filed for Chapter 11 in 1986, the professionals advising a committee of equity holders have received about $20 million in fees. LTV's equity holders probably will collect a good deal less from the bankruptcy, says investment banker Wilbur Ross, who is advising one of the creditors' committees.

The harshest critics blast changes in the law that give debtors more clout. Before the law was amended in 1978, management lost control of a company at the time of the bankruptcy filing, and the court appointed a trustee. Now, the executives that run a company into the ground are allowed to try to save it.

Critics also blame the revised bankruptcy law for the swarms of lawyers, accountants, and investment bankers that descend on companies in Chapter 11. Under the old code, judges would award these professionals cut-rate fees based on the return to creditors. Today, professionals get paid market rates based on the services provided.

The result is often a feeding frenzy. After Zale Corp. filed for Chapter 11 last January, professional fees ran as high as $1 million a week. To prevent that, the judge in the R. H. Macy & Co. bankruptcy, filed last year, appointed a committee to keep tabs on the fees. Yet they now total about $25 million. Los Angeles bankruptcy lawyer Kenneth N. Klee says that professional fees still only average about 3% of the company's debt. Perhaps so, but every buck a lawyer or accountant gets is a buck creditors never see.

That's why legal fees are likely to be on the agenda when Congress takes up bankruptcy reform. Last year, both the House and Senate passed legislation that included a provision giving bankruptcy-court officials more control over the payouts. But the measure bogged down at the last minute.

RETIREES' RIGHTS. The fee provision is expected to be in a new bill to be introduced as early as February. As it did last year, the legislation will cast a wide net. Among the proposals: a new section for small businesses and language reversing a court ruling making it difficult for banks to recover assets. The bill also is likely to call for a commission to study the bankruptcy code. A similar commission was set up in the 1970s.

Some powerful lawmakers are pushing other changes. Senator Howard M. Metzenbaum (D-Ohio), for one, is championing the rights of retirees, who often get shortchanged in bankruptcy. He wants to require debtors who get new financing to give priority to retiree health benefits. And Representative Jack Brooks (D-Tex.) wants to add collective-bargaining obligations to that requirement. A Metzenbaum staffer vows that a bankruptcy bill won't pass without those two provisions.

Critics deplore such tinkering. "The bankruptcy code is really in danger of being eviscerated by special interests," says lawyer Sandra E. Mayerson, who represents banks that criticized Metzenbaum. Others would just as soon see Congress leave well enough alone. "In any system, you will find abuse," says bankruptcy lawyer Bruce R. Zirinsky. "But that doesn't mean the system is bad. As a matter of public policy, re-organization is better than liquidation," since it preserves jobs.

The question is, whose jobs? The law seems to have been reshaped into a lawyers' full-employment act. As long as that's the case, and as long as some companies in Chapter 11 enjoy a cost advantage over their solvent rivals, the airline industry and others will continue to holler that the bankruptcy law is killing competition, not saving it.

                                Bankruptcy Lawyers
      Firm                      in 1987    in 1992
      WEIL, GOTSHAL & MANGES       9        110
      New York
      SHEARMAN & STERLING         50         90
      New York
      SKADDEN, ARPS, SLATE,       25*        70
      New York
      MORGAN, LEWIS & BOCKIUS     25         60
      DAVIS POLK & WARDWELL       20         60
      New York
      MURPHY, WEIR & BUTLER       20         58
      San Francisco
Before it's here, it's on the Bloomberg Terminal.