After April''s drop in Net stocks, and streams of venture capital drying up, many dot coms have been forced to close their virtual doors. To better understand what bankruptcy, liquidation, and reorganization mean - and their implications for dot coms - I spoke with Charles Weintraub, a well-respected and experienced attorney who has specialized in Bankruptcy and Reorganization matters since being admitted to the New York State Bar in 1967. His practice is predominantly in the field of Chapter 11 and restructuring, representing debtors, although he has represented creditor committees, individual creditors, banks and secured lenders. Why might a dot com seek protection under the bankruptcy laws?
The primary reason is to obtain a stay (that is, a halt, a stop or a delay) from lawsuits, prevent termination of leases, and/ or prevent the cancellation of profitable contracts.
What is meant by protection?
"Protection" in the confines of the Bankruptcy Code means, in effect, a stay of interference with the debtor''s business -- and specifically protection from the items set forth in the first answer above.
Is there still a stigma attached to a bankruptcy filing? Many entrepreneurs operate under a culture that sees "failure" as a learning experience.
The "stigma" associated with bankruptcy is normally associated with personal filings for Chapter 7. This is a liquidation of an individual''s non-exempt assets to be distributed equally among the debtor''s creditors. Investors, however, probably will not look at corporate bankruptcy as a "learning experience." But there may be legitimate reasons for failure, such as the production of superior technologies from well-established and more efficient companies that have entrenched channels of distribution.
But that would not be the case with all companies. For example, Boo.com (based in England) spent around $140,000,000 on advertising without having a product that was ready to launch! Hype without substance is not a recipe for investor compassion.
What are the options for filing, that is, what are the different "Bankruptcy Chapters?"
For dot coms, the options are either Chapter 7, which is a direct and almost immediate liquidation or Chapter 11, which is a reorganization under court supervision. "Chapters" simply refer to specific parts of the Bankruptcy Code. Chapter 11 is, for example, sometimes referred to as "a reorganization."
Is bankruptcy the right term for reorganization?
Bankruptcy is a generic term, but it is generally used to refer to liquidation proceedings (Chapter 7). When referring to reorganization, Chapter 11 is clearly the right legal term; it does not put a company out of business, but restructures a company''s debts (thus giving it the opportunity to continue and, hopefully, become successful).
Congress has been working on legislation to change the bankruptcy laws. What implications would this have for dot coms?
The revisions in the bankruptcy law presently reflect changes pertaining to personal bankruptcies. At this early stage, there would not seem to be any implications for dot coms with respect to pending legislation.
Can you provide some examples of successful and unsuccessful reorganizations?
In the traditional world, the examples of successful and unsuccessful reorganizations are legion. It''s a little too early for there to be much history in the "dot com" world. However, since the stock market plunged last March there is beginning to be quite an inventory of failed companies. Value America, an on-line retailer, for example, filled a Chapter 11 on August 22 this year.
Some prime examples of successful reorganization from the "old economy" include Texaco, Johns-Manville, and Barney''s. Unsuccessful efforts would include Alexander''s, Caldor''s and Eastern Airlines.
However, success in legal terms means "a plan of reorganization" that is confirmed by the Court. There are no statistics (to the best of my knowledge) kept on practical successes -- i.e. what happens to companies after they have legally emerged from Chapter 11.
Can "intellectual property" (such as computer code or "business practices," such as Amazon.com''s "one click purchase" or Priceline.com''s "demand collection system for committed bid buying") be assigned a value as "assets" in a bankruptcy proceeding?
The use of intellectual property, and patents as an asset of a company is subject to being valued by the courts and its administrators. Decisions are sometimes made on an individual basis; but comparison with comparable industry assets is increasing. This is also true in determining a company''s valuation.
There is a distinct and growing tendency to include these items/assets as valuable property. How, exactly, their value is derived is decidedly more art than science. Increasingly, financial projections of revenue produced by such assets are increasingly used as a measure.
An interesting wrinkle in this scenario took place in August of this year when a federal bankruptcy judge set aside a Federal Trade Commission plan which limited the ability of on-line retailer Toysmart.com to sell its database as part of its liquidation.
The issue revolved around confidentiality -- the data had been collected with the promise of confidentiality. Judge Carol Kenner said that the restriction revolved around "hypothetical rather than actual considerations." Toysmart.com had pledged not to sell its customer information to third parties, but its bankruptcy prompted concerns that this pledge would not be honored. That is, the data would simply be sold as an asset of the corporation.
The position taken by the Federal Trade Commission (FTC) was that the database could only be purchased by a similar "family" related business and that the information could not be resold without the permission of the individuals who submitted it. Notwithstanding the judges setting aside of the FTC''s objection, no sale has taken place to date in view of the fact that an actual purchaser was not obtained. Obviously, this is an area of the law that is innovative and evolving.
Is there anything special about dot coms (such as cross border operations, etc.) that should be considered or that would affect bankruptcy outcomes?
There does not seem to be anything special about dot coms that would affect their bankruptcy filings. Yet issues could arise about where specific companies do business: states; countries; jurisdictions, etc. This could potentially affect where they file their proceedings -- and whether they might benefit by filing outside the country as opposed to inside the U.S. This, importantly, could have an effect on criminal proceedings and issues related to fraud, bribery, and both recovery and valuation of assets.
How might a company''s bankruptcy filing affect stock options, future compensation, employment agreements, etc.?
All of these items are subject to change, depending on filing for either Chapter 7 or Chapter 11. Bankruptcy and Reorganization can affect stock options, future compensation, and just about all contracts. These can be re-negotiated, rejected, reissued and changed in all areas from price to performance, from conditions necessary for qualification to time for vesting.
Could bankruptcy filing lead to a change in company ownership or management or both?
Yes, any and all of these situations can change. The key factor is the position taken by creditors -- and the judgment of the courts.
How does bankruptcy affect cash flow, especially accounts receivables?
Both bankruptcy (liquidation) and reorganization have always had an initial negative effect on cash flow. However, Chapter 11 (reorganization) has the potential -- as it goes forward -- to return a company to (or, even, to exceed) pre-filing levels.
Could those with warrants, options, etc. maintain any possibility of future income if assets such as code, patents, etc. ever prove to be a bonanza to a company obtaining these in lieu of debt payment? Is there precedent for such an arrangement, or is the distribution of assets simply assigned and distributed without recourse for future compensation?
Equity participants (such as holders of warrant options and investors) often come out of Chapter 11 better than they were prior to filing for protection. There is no essential requirement that all of the assets be distributed to creditors. There is always a balancing between the creditor position and the equity position, which can vary the liquidation priorities under Chapter 7.
On the contrary, in Chapter 7 a strict order of priority is followed whereby senior debt will always be paid prior to junior debt.
With private equity tight and the IPO market treacherous -- and almost closed to many types of virtual companies -- too many entrepreneurs are faced with the decision of either liquidating their business, or trying to reorganize through the bankruptcy courts. If you are in such a situation, or want to understand the process more fully, then you would be wise to consult an experienced and qualified attorney, such as Charles Weintraub, who specializes in this area.
Don Sussis is a business advisor and investment consultant in New York. He has led many companies to a Portkey of success. He can be reached at dsussis@internet.com or dons@interested.com.
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