Bankruptcy Rules Thwart the Recovery
Why should management have a monopoly over restructuring proposals?
The epic financial crisis afflicting the banking industry over the past 18 months is largely the result of cratering loan and other asset values stuck on bank balance sheets. When the market for such loans stalled, banks couldn't sell them and had to take billions of dollars in writedowns.
Fearing the worst, the government pumped hundreds of billions of dollars into these institutions, with questionable long-term results. Though it is early in the rescue, the economy has shown few signs of improvement, and the bank losses continue.
Why should taxpayers foot the bill when there are trillions of dollars in private money on the sidelines in the world financial markets? Private investment is a far more appropriate agent to revive these institutions, yet little is coming in.
One reason for this is that distressed assets on bank balance sheets have artificially low values because of misguided federal bankruptcy laws. With a few changes, the banking system could enjoy a revival backed by private investment, not public funds.
The problem is that, in this bear market, the prospect of a bankruptcy puts a huge damper on investor appetite for debt securities in overleveraged companies. This includes hundreds of billions of dollars in bank and bond debt issued for leveraged buyouts.
This state of affairs could be improved by eliminating the bankruptcy rule known as the "exclusivity" period. This rule unfairly gives managements, with court approval, a monopoly in drawing up a reorganization plan for a minimum of 18 months. Generally that plan includes proposals to restructure debt, sell assets and void onerous contracts. During this period nontrade creditors, like bank debt and bond holders, languish in uncertainty as to what will happen to their investment.
The exclusivity rule mainly benefits equity holders and managements, not creditors. But why should the same management that got the company into trouble have the right to lock-up its assets for an extended period of time?
Without an exclusivity period, different classes of creditors and equity holders could immediately propose different restructuring solutions, including the sale of assets overseen by a bankruptcy court. The biggest impact of such a rule change would be that the assets of a company in Chapter 11 would be priced as though they could be sold -- in effect giving them a "mergers & acquisitions premium" -- rather than be shackled for years in a bankruptcy court.
This change would cause many distressed loan prices to rise -- bolstering the balance sheets of banks and other companies that hold these loans -- without public money. Furthermore, such a change would slash the need for expensive bankruptcy lawyers, restructuring firms, and other advisers, who can reap tens of millions of dollars in fees -- often at the expense of creditors and company treasuries.
It is one thing to apply the exclusivity rule to small businesses in the hopes that an individual who has spent his life building a business has a chance to keep it. But it is unfair that huge private-equity players can use this same rule to put into limbo billions of dollars of debt that banks lent to finance once-healthy companies.
If equity holders bet and lost, then debt holders should be able to come in quickly and salvage the company and their investment. In the long run, this would be good for companies, credit markets, employees and the communities in which companies are located.
Few are helped by the exclusivity rule, other than desperate equity holders and top managers clinging to the helm of companies that faltered on their watch. Eliminating exclusivity would not necessarily lead to more company liquidations, but it would take away the monopoly management has on formulating restructuring proposals.
It would also force managements to redouble their efforts to stay out of Chapter 11 -- which would be a good thing. Chapter 11 is often a crutch for lackluster managements. Changing the rules would put pressure on them to keep their companies healthy.
I have long argued for increased shareholder rights and last year founded United Shareholders of America to advocate strengthening those rights. In this case I argue for increased creditor rights. But the thinking behind both is identical. In both cases it allows market forces to work better, both in pricing securities and in eliminating management monopolies in company affairs.
We must allow market forces to do their job, which includes promoting the ability of the rightful owners of assets -- not just managements -- to control their fate to the maximum extent practical. The idea is to efficiently maximize the value of the assets through operational changes, restructuring or sale to third parties.
Today, troubled assets are stuck in a quagmire and will be for years unless bankruptcy laws are changed. The capitalist system is the most efficient wealth-producing machine in existence. We must strive to remove barriers that thwart this efficiency.
Mr. Icahn is chairman of Icahn Enterprises, a publicly traded diversified holding company.
Carl C. Icahn