Bankruptcy, Bailout, or Bust: Early Corporate Responses to the Business and Financial Challenges of COVID-19

By Diane Lourdes Dick (Professor of Law, Seattle University School of Law)

Diane Lourdes Dick

Over the last year, publicly traded companies have provided thoughtful commentary in their public company disclosures regarding the financial decisions they have made in response to the COVID-19 crisis. Meanwhile, public and private companies have filed for bankruptcy protection, providing detailed narrative accounts of the events leading up to the filing and the various steps they have taken to stem losses and maintain the company as a going concern.

In a recent article, I use public disclosures and declarations of this sort to take a closer look at the firm-level decision-making process in response to the sudden liquidity crisis caused by the pandemic. Specifically, I analyze the recapitalization and restructuring decisions made by twelve large and mid-sized companies in the cruise, airline, health care, and consumer sectors in the spring and summer of 2020. Although the case studies are mere snapshots in time, they help to shed further light on the key factors that have influenced firm-level bankruptcy, bailout, and other recapitalization decisions.

The case studies reveal that, outside of bankruptcy, corporate managers of the profiled companies have followed a remarkably similar decision pathway. First, firms slashed costs and reduced employee headcount. Of course, many of these cuts are the natural consequence of voluntarily or involuntarily scaling back operations; in other cases, firms likely chose to make reductions of this sort because there are typically few if any legal impediments to doing so. But whether voluntary or involuntary, the choice to scale back operations generally means allocating economic burdens to employees, vendors, suppliers, and, in the case of firms that provide an essential service, the broader communities they serve.

A firm’s subsequent choices appear to be constrained by its overall financial condition and its new or existing legal commitments. For instance, companies with substantial open lines of credit were able to draw down available funds to shore up cash. Meanwhile, those with stronger balance sheets were able to obtain new debt and equity financing from the capital markets. Virtually all of the profiled companies that were eligible to receive governmental bailouts accepted the assistance—in both grant and loan form—with little apparent concern for the conditions and restrictions attached to such funds. Participation in bailout programs, in turn, constrained the firm’s choices regarding how to allocate economic burdens. For instance, the restrictions and limitations in the CARES Act were designed to delay or prevent companies from allocating economic burdens to employees and, in the case of airlines and health care facilities providing essential services, their broader communities.

The case studies suggest that to the extent these other liquidity options are available, corporate managers may view bankruptcy primarily as a legal or strategic tool rather than as a true financial restructuring option. Perhaps because of certain underlying assumptions about bankruptcy, no company seems to have weighed participation in a governmental bailout—with or without strings attached—against the option of filing for bankruptcy. Rather, these alternatives—like all of the major decisions firms make in response to a sudden liquidity crisis—appear to have been independently examined at very different points in the lifecycle of the distressed firm.

The full article is available here.

Bankruptcy’s Corporate Tax Loophole

By Diane Lourdes Dick, Seattle University School of Law

AvvoPhotoMy recent article, Bankruptcy’s Corporate Tax Loophole, 82 Fordham L. Rev. 2273 (2014), explains how corporate debtors use Chapter 11 to divert the value of tax losses and credits to a select group of stakeholders in contravention of bankruptcy’s distributional norms.

The problem stems from an ambiguity at the intersection of federal tax and bankruptcy law. Bankruptcy-specific exceptions in the tax laws transform a corporate debtor’s tax attributes into marketable property that, in many cases, gives the bankruptcy estate its intrinsic value. Yet bankruptcy law’s most vital safeguards neglect to fully take into account these tax assets, leaving them vulnerable to siphoning by dominant stakeholders who are in a position to extract excess returns.

Most notably, the debtor’s valuable tax attributes slip through the cracks of the “fair and equitable” test for contested Chapter 11 plans. The analysis requires, in pertinent part, that the court evaluate whether the plan provides each impaired and dissenting creditor with at least as much as it would have received in a hypothetical Chapter 7 liquidation. But testing a Chapter 11 plan against a hypothetical liquidation naturally omits the debtor’s tax attributes from consideration, as they would be extinguished when the liquidated debtor is subsequently dissolved. This means that the “fair and equitable” analysis ignores the very existence of what may be the debtor’s most valuable asset.

This extraordinary gap not only facilitates inequitable allocations of economic benefits and burdens in Chapter 11 but also causes a much broader, systematic misallocation of resources. I recommend statutory revisions to the federal tax and bankruptcy laws to neutralize the tax consequences of corporate restructuring decisions.

The full-length article can be found here and here.