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It's conventional wisdom for investors unfortunate enough to own a stock in a company that files for bankruptcy: Just get out. Even if you have to sell for pennies a share, that probably will be more than you'd get when the company emerges from bankruptcy, since shareholder equity is usually wiped out in the reorganization.
Yet, it doesn't always have to be that way, says Jonathan Rosenthal, head of restructuring at Saybrook Capital, a Santa Monica (Calif.) investment bank. As long as the company is not "hopelessly insolvent," shareholders can ask the bankruptcy-court judge to appoint an equity committee that sits at the negotiating table right along with creditors. Having an equity panel doesn't guarantee shareholders a better shake, but at least they have a fighting chance, he says.
Rosenthal has represented creditors as well as shareholders in many bankruptcy proceedings and is now the financial adviser to the equity committees of both Kmart (KM
) and Adelphia (ADELQ
). For a fee paid by the bankrupt company, his role is to show that the company has the financial wherewithal to compensate shareholders, as well as pay back creditors and negotiate terms of the reorganization. Shareholders need only ask the judge for appointment of an equity committee.
Rosenthal feels passionately that stock owners -- especially large institutions -- should make an effort to gain representation in more bankruptcy proceedings. Recently, he talked with with BusinessWeek Online Associate Editor Amey Stone about how investors can get a spot at the negotiating table. Here are edited excerpts from the conversation:
Q: What typically happens to shareholders in a bankruptcy proceeding?
A: Shareholders typically have no voice once companies file for bankruptcy. All the talk about corporate responsibility to shareholders is forgotten. [Such talk is] really only true in a prebankruptcy context.
When a company files for bankruptcy, the court automatically appoints an unsecured creditors committee. But if you want to have a shareholders committee, someone has to go to the judge and say, "Look, this company is not 'hopelessly insolvent.' There's a chance of recovery. We think there should be an official equity committee appointed to watch out for shareholder rights."
Once you gain official status, you have a very different standing in the courtroom. The judge will listen to you, and the company is obligated to pay for your legal and financial advisers. Most people would say shareholders have no rights, but on behalf of Kmart and Adelphia, we are standing tall.
Q: How many bankruptcy cases have shareholder committees?
A: Very few. It's not appropriate in every case. But we looked back at hundreds of bankruptcies since 1986 in excess of $500 million and found only a half a dozen equity committees total.
Q: What do you hope to accomplish on behalf of shareholders on the equity committee?
A: Basically, I try to negotiate for them the most equity that I can. There are a lot of variations on that theme. Some of the debt might be converted to equity. The old shareholders could end up owning anywhere from 0% to 100% of the equity. The bigger picture is that I think it's important for shareholders to know that they had representation and fought a good fight. If, at the end of the day, you don't get anything, at least you know you tried.
What I don't understand is how large mutual funds that are fiduciaries can so quickly walk away. Often times, it's difficult for us to rally the troops when there's a filing, and we think the company has a chance of solvency and an economic recovery for shareholders. The institutional investor community really throws up its hands and doesn't want anything to do with it.
Q: Why don't institutional investors get more involved?
A: I think it's a mindset. Traditionally, companies filed for bankruptcy because they were going to liquidate or they were hopelessly insolvent. People who are managing funds have historically experienced low returns on postbankruptcy positions, so they assume that's always the case.
But bankruptcy is no longer a sign of true insolvency or liquidation. It's often a strategic tool by management. I think there are a significant number of bankruptcies where shareholders do have an economic interest in an enterprise, and it's important to make sure they have a voice.
Q: What negotiating tools do you have at your disposal, since creditors are higher up in the capital structure of companies?
A: The biggest weapon I have for negotiating the outcome is a release of liability to the directors. That's what they want. The board of directors has a fiduciary responsibility to anyone who has an economic interest in the company. But as a practical matter, when a company files for bankruptcy, especially a big company, the protector of shareholder interests are running for cover.
My experience is, the boards of directors, especially when there's allegations of wrongdoing, very quickly and understandably start looking out for their own rear ends.
Q: Can a small shareholder petition the court to establish an equity committee?
A: Theoretically it's possible to do it on your own. Often what happens is investors contact us. We evaluate the situation to see if the company is not "hopelessly insolvent." If we think it's a good case, then we will help organize shareholders, reaching out to both institutional and individual investors, some with less than $2,000 worth of stock. The committee hires a financial adviser and a lawyer, and the fees are paid by the company.
Q: So if more equity committees are formed, that could mean more business for your firm?
A: That's true. But I also have a bigger agenda. The U.S. is a haven for foreign investment because we have a very predictable system here where there's a rule of law and courtrooms that function. It's important to send a signal to the worldwide financial community that if you invest in a company here and things go wrong, you will be treated with respect, that the system has integrity. We enjoy a certain lifestyle in the U.S. largely because of an abundance of capital. We have to jealously guard that treasure.
That's the main reason I want all investors to better understand the bankruptcy process. I'm always struck by how poorly investors understand the system. As a professional working in the system, I can tell you that it works. And to investors, I'd say that contrary to what you may think, you have a lot more rights in bankruptcy than you think you have.
Edited by Douglas Harbrecht
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