The Bankruptcy Game

ACCORDING TO THE AMERICAN capitalist gospel, it is no sin to go belly up. Quite to the contrary, U.S. firms enjoy the most liberal bankruptcy laws on earth -- a privilege strengthened by a provision of the code known as Chapter 11 that holds creditors at bay while often allowing sick firms to bleed new buckets of red ink and still operate for years.

Congress added the Chapter 11 provision to the federal bankruptcy code in 1978 so companies could stay in business while working out repayment plans. But a national debate has now sprung up over whether the country would be better off if sick firms were allowed to die. Last year nearly 21,000 firms filed Chapter 11 petitions, the most since 1986. More significant, many of the new cases are mammoth, involving such familiar names as Macy's, TWA and Orion Pictures. While few large companies entered Chapter 11 before the mid-1980s, more than a dozen with assets exceeding $5 billion have taken refuge there in the past three years.

A growing body of critics charge that Chapter 11 has become a tool that wily managers can now use to stiff creditors and preserve their own jobs. Moreover, they argue, companies in Chapter 11 can take advantage of the fact that they pay no interest on part of their debt by slashing prices and wreaking havoc on their competitors. Most companies that take refuge in Chapter 11 ultimately fail anyway, critics say, leaving creditors with even fewer assets than if the firms had been liquidated in the first place. Says Sam Zell, a Chicago financier: "It isn't good for the economy to prop up cripples and hand them unfair advantages that allow them to bleed income and help destroy the healthy competition."

Horror stories are easy to find. Eastern Airlines had a net worth of more than $1 billion when it entered Chapter 11 in 1989. But there was little left for creditors by the time Eastern exhausted $400 million trying to remain aloft before it quit flying last year. Manville Corp. filed a 1982 petition solely to escape $2 billion of liability suits brought by defendants who claimed to have been harmed by the firm's asbestos products. The next year Frank Lorenzo steered Continental Airlines into bankruptcy, allegedly to break union contracts. But the tactic could not save Continental -- now minus Lorenzo -- from returning to Chapter 11 in 1990.

Alarmed by such abuses, Congress is considering reforms. The Senate Judiciary Committee has called for a blue-ribbon panel to study whether the entire 1,568-page bankruptcy code should be overhauled. The panel would also consider speedy alternatives to Chapter 11 proceedings, which last about two years on average and force companies to expend vast sums of scarce cash on legal and accounting fees.

Many experts agree that changes in Chapter 11 are sorely needed. "Nobody thought it would ever come to this," says Sam Giordano, executive director of the American Bankruptcy Institute, a clearinghouse for bankruptcy information. "The law was meant to keep people employed and allow companies to be good corporate citizens, not allow bankruptcy to be a shield for purposes for which it was never intended. Right now," Giordano says, Chapter 11 "is just a hodgepodge that's being decided on a case-by-case basis. It's probably time to revisit the law itself."