Holding Back Bankruptcy

By Robert J. Grossman May 1, 2003

HR Magazine, May 2003The very survival of a troubled company approaching - or in - bankruptcy can depend on how well HR gathers information, trims costs, retains key people and communicates with stakeholders.

Frank Filipovitz has been living an HR executive’s worst nightmare. For the past three years he has waged a losing battle to save jobs for thousands of workers as his company struggled for survival under bankruptcy protection. At his desk in the suburban Cleveland headquarters of LTV Corp., Filipovitz, vice president for HR and a 23-year company veteran, somberly fields questions from former employees and tries to settle benefits claims. He has been striving to preserve paychecks and benefits for LTV’s 11,000 steelworkers and health coverage for its more than 40,000 retirees and their family members.

In the 1990s, LTV gambled on a growth strategy of borrowing heavily to add two business units to its core business of manufacturing steel. Then the bottom fell out of the steel market. International competition, labor commitments and mounting debt plastered the company with red ink, sending Filipovitz and other senior managers scrambling to plug gaping holes in the dike. “I was working 20 hours a day, seven days a week,” he recalls. “There was anger and frustration everywhere.”

As bad as things were in the early days of the crisis, however, Filipovitz was hopeful that targeted retrenchments of hourly and salaried employees would help the enterprise stay afloat. When the cuts didn’t stanch the bleeding, and with creditors growing impatient, the company, with $6.1 billion in assets, was forced to consider more drastic action: Chapter 11 bankruptcy. In what was the largest U.S. public bankruptcy in 2000, LTV received court authorization to freeze its creditors in place, regroup and come up with a new plan to pump life into the company.

Chapter 11 No Easy Way Out

It seems a day doesn’t go by without another major company entering Chapter 11 bankruptcy—a federally protected legal status offering some financial breathing room while a company tries to stabilize its operations and survive as a going concern. Enron, United Airlines, WorldCom, US Airways and Kmart are among the household names struggling to salvage their business after filing for bankruptcy protection.

For human resource managers in financially troubled companies, working to avoid bankruptcy, operating during it and attempting to emerge from it will challenge every skill and HR function to the utmost.

While the goal is to emerge from bankruptcy with a healthy company, Chapter 11 is too often the beginning of the end, according to Lynn LoPucki, a law professor at the University of California, Los Angeles, and a leading authority who has maintained a database of filings since 1980. Of the companies in his database that filed Chapter 11 petitions in 2000, 20 percent went in with the intention of selling off business assets and folding. The remaining 80 percent followed the Chapter 11 reorganizing process, planning on emerging leaner and with less debt within a year or so. Twenty-seven percent of these optimists failed to make it and had to liquidate. In the end, only 53 percent of the companies that filed actually emerged from bankruptcy. And even those survivors face daunting odds. “Twenty to 30 percent of the survivors will fail in the first three to five years,” LoPucki says.

John Rizzardi, who specializes in smaller bankruptcies—companies with sales between $500,000 and $20 million and fewer than 100 employees—as chair of the creditors’ rights and bankruptcy practice group at Cairncross & Hemplemann in Seattle, says only 10 percent to 15 percent of filings result in reorganizations. He estimates that only 2 percent of these companies last more than three years.

Companies that do regroup and emerge from Chapter 11 usually are forced to toss substantial numbers of workers overboard to stay afloat. For example, LoPucki says, 98 companies that emerged from bankruptcy from 1991 to 1996 shed 31 percent of their jobs—a total of 265,000. The number increased as companies failed down the road. Top leadership—CEOs, COOs and the like—did not fare well either. About 90 percent of the time, the bosses at the helm when Chapter 11 began were history when the company emerged.

Far from a moratorium on expenses, bankruptcy brings its own new costs. Even with streamlined procedures that allow quicker, pre-packaged Chapter 11s and cut the average time “in” from about a year to six months, hundreds of companies in financial distress can’t afford the tab. Administrative costs make it prohibitive. Under bankruptcy laws, a company must pay legal bills and consulting fees not only for itself but also for all the creditor committees and other entities tied to the process. The costs for big companies can be millions of dollars, says Brent Longnecker, president of Resources Consulting Group in Houston, whose bankruptcy clients include Williams Communications Group, with $5.9 billion in assets (the 10th-largest bankruptcy in 2002) and $3.4 billion Kaiser Aluminum & Chemical Corp. “The company is paying investment bankers, accountants, auditors, consultants, turnaround specialists … all at a time when cash is key.”

The more complex and contentious the process, the more it costs. Enron estimates its costs will top out at $700 million.

Step One Is Avoiding Bankruptcy

Long before a company slides into Chapter 11, there are hints of financial distress. “The tom-toms usually are beating well in advance; the process doesn’t come up and bite you overnight,” says Dick Randazzo, senior vice president of HR for Federal-Mogul Corp., a bankrupt auto parts maker in Southfield, Mich.

In some cases, companies accurately trace their red ink to bloated payrolls—benefits, pensions and salaries. For others, LoPucki says, those human capital costs are a smokescreen obscuring a history of poor management, risky investments and excessive borrowing. Of 592 major bankruptcies that LoPucki has studied, only five—less than 1 percent—were caused by unmanageable pension commitments. “Pension and benefits problems are ancillary to the underlying causes of bankruptcy,” he observes.

Ultimately, companies face bankruptcy for various reasons, says Randazzo. “Bethlehem Steel filed because it couldn’t afford its pension and retiree medical costs. Kmart and Sunbeam went under because their core businesses had become unprofitable. Kaiser and Federal-Mogul filed because of potential asbestos liability.”

Most bankruptcies occur because the company takes on too much debt—either through a takeover or too-rapid growth, LoPucki says. “Then, instead of going into bankruptcy, they cut back essential spending on the business. So by the time they hit bankruptcy, they’re going in with a bad business, and that’s usually fatal.”

Integrated Health Services, a long-term-care provider based in Sparks, Md., is an example. “We grew too fast at the peak of our industry’s development, peaking at 100,000 employees and 425 facilities,” says Jeanne Phillips, senior vice president of HR and risk management. “We were leveraged to the hilt and crippled by the government’s change in reimbursement policy. Then the bottom fell out.” Integrated, now a company with $2 billion in annual revenue—down from $5.4 billion when it filed—plans to emerge from Chapter 11 later this year with 180 facilities and 40,000 workers.

Companies on the brink invariably task HR with finding a big chunk of the savings they need to survive while keeping remaining workers on the job and motivated. Among early cost-cutting options, says David L. Wolfe, a principal in Gardner Carton & Douglas’s HR practice in Chicago, is switching from a defined benefit pension plan to a more modest defined contribution arrangement.

You also can consider eliminating promises of retirement medical coverage for current employees, except those nearing retirement. But employment attorneys advise against appearing mean-spirited. In a legal challenge, courts tend to look askance at employers who take away any contractually promised benefits of retirees and near-retirees, in that order.

Look also for ways to consolidate health care providers while maintaining comparable benefits. Benefits professionals such as Arthur Cohen, CEO of Benefits Analysts in Glencoe, Ill., say there is a lot of “fat” in unexamined health care plans. “It’s not unusual to find ways to save 20 percent and, since most plans are month-to-month, it’s possible to change quickly,” he says.

At LTV the charge was “Go to the bone,” Filipovitz recalls. “All of the senior executives came together to discuss survival strategies. Each area was asked to take steps to cut expenses—purchasing, sales and marketing, operations, HR. We were charged with putting plans in place to take costs to the lowest level while continuing sales and operations. I looked at it from a headcount- and employment-cost standpoint, examining wages, benefits and retiree benefits.”

Timothy Czmiel of Magna Partners LLC in Oakbrook, Ill., who has engineered more than 200 turnarounds, says before filing is the time to seek outside help—lawyers, consultants, turnaround pros. “The biggest mistake senior management makes is to think it can handle the situation themselves. Most executives can function well in an environment when the company is doing fine. Typically 90 percent of their decisions are accurate and proper. When a company begins to experience operational and financial stress, it’s just the opposite. Now they’re 90 percent inaccurate. Sometimes you have to operate and cut off a foot to save a patient. But their personal relationships limit their ability to do what has to be done.”

The earlier HR meets with lawyers and turnaround experts the better. Bankruptcy lawyer Rizzardi moves quickly to make an independent legal and business assessment. “I want a full financial snapshot—payroll, all benefits, vacation policies, accrued vacation rights, whether you’re a party to any collective bargaining agreements, or party to any employee lawsuits. And I want to know about senior executives’ contracts. Do they include noncompete or nondisclosure clauses? Finally, I want HR’s take on the managers’ capabilities.”

Tough Decisions

When harvesting the low-hanging fruit isn’t enough, HR faces more difficult choices—cutting staff, cutting benefits, changing work rules or a combination of such actions.

You can maintain your workforce and squeeze costs by cutting pay or reducing benefits, but the downside is higher attrition and lower productivity. Or you can cut staff while maintaining wages and benefits. Layoffs, however, send a warning signal that the company is failing.

HR should quietly review any labor contracts and their notice requirements for those contracts in which unilateral layoffs are possible. If you have 100 employees or more, keep in mind the 60-day notice requirement of the Worker Adjustment and Retraining Notification (WARN) Act. Generally, it applies in situations where you are contemplating closing a worksite or reducing at least a third of your workforce.

Where there’s no union, senior management, with HR’s guidance, decides the best way to pare down. “We made a consensus decision at LTV to get to the lowest possible level on the salary side, then keep the wages competitive for those who remained,” Filipovitz says. “We could have cut wages for nonunion workers, but our thought was we’d be better served by paying people.”

Whatever the company’s strategy, HR’s reputation for trust and skill at negotiating and communicating bad news is critical. “HR doesn’t function in fairyland; we don’t always deliver good news,” Randazzo says.

When That’s Not Enough

If cost cuts and new business strategies fail to stabilize a company’s finances, HR and other senior managers must move quickly to master the details of a bankruptcy filing, says Phillips of Integrated Health Services. “Our senior management team made it a priority to understand the rudiments of the process as we were getting ready to file. Then we put together an education packet and customized it for our vendors, our employees and residents.”

“If you don’t learn, you and your employees could pay the price,” says Randazzo. “We spent a lot of time talking to lawyers, educating ourselves on what Chapter 11 is about and what’s likely to happen. We benchmarked, talking to HR people in other companies who had been through it.”

Planning for a Chapter 11 filing is like preparing for a sneak attack. Before the rank-and-file hear the news, contingency plans should be in place. HR should examine unfunded liabilities such as vacation accruals, deferred compensation and bonuses. The goal is “to avoid putting the worker in harm’s way after filing,” Randazzo says. The reason: After a filing, an employee who is still owed deferred compensation moves to the back of the line with other unsecured creditors. Before it filed in October 2001, Federal-Mogul canceled its deferred compensation plan and paid it out in advance.

When the day comes, lawyers for the company submit a petition to bankruptcy court, seeking approval for a “First Day Order,” which can run 30 pages. It asks the court to authorize management to stay in charge as “debtor in possession” and to empower the company to honor commitments necessary to continue operating. For HR, those include salaries, benefits, severance pay and the like.

With the court’s agreement, all other debts are suspended pending approval of a workout plan that must be blessed by the creditors and the court prior to emergence from bankruptcy. Creditors are divided into categories—secured creditors, who have first dibs on company assets, followed in priority by unsecured creditors. Secured creditors have a lien on property of the company as security for a debt. Unsecured creditors are owed money but have no liens on company property.

The trustee appoints creditor committees that have the right to sign off on all funding requests not in the ordinary course of business. “Bonus plans, salary increases, retention plans—first you take them to management and your board of directors, then to the creditors. If they object, then [they go] to the judge. HR deals with making the company compensation case to the committees and in court,” Randazzo says.

“You have to make sure you have a sound rationale for whatever you do because there’s a lot of oversight,” agrees Jerrold Glass, senior vice president for employee relations at US Airways in Arlington, Va. “Since all actions are public, you also have to satisfy the court of public opinion, which includes your own employees.”

Filing for reorganization changes other rules, too. Potentially, it’s open season on health plans, pensions and employment contracts. Now the company can revisit labor commitments and propose changes unilaterally. Subject to procedural rules requiring consultation and good-faith bargaining, any contracts—employment, union, pension—can be changed or voided. Unions that don’t like what’s happening have the right to strike. Conflicts or disagreements between the parties are resolved by the court.

Now, although consensus is preferable, it’s not required. “No contract is sacred if you follow the right procedures,” says Rizzardi.

Pulling out from defined benefit pension commitments is an example. The Pension Benefit Guaranty Corp. (PBGC) insures future pension payouts, although not at full value for top-earning personnel. But before a company can pass the buck on its pension obligations, it must work with the PBGC to try to rescue the plan.

When the employer seeks a “distress termination,” it has the burden of demonstrating to the PBGC that it can’t continue to pay accrued retirement costs. If both sides agree, the distress termination will be granted by the court as part of the reorganization. If the PBGC does not agree, it can take the issue to the bankruptcy judge for resolution. “The law requires you to fully honor the plan till you prove you need to cut your contributions or terminate,” says Barbara Cronin, principal in Gardner Carton and Douglas’s HR practice in Chicago. “The PBGC wants to get as much from you as it can, so it’s possible to negotiate a reduction” in the employer’s contributions to the plan or to spread out contributions over more time.

Terminating a plan and turning over obligations for its future commitments to the PBGC demoralizes employees and retirees and usually penalizes top earners because the PBGC retiree payouts are capped, currently at $3,665 per month for a worker who retires at age 65.

Similarly, the company can step back from health benefit commitments both to workers and retirees. Following notice requirements of the Health Insurance Portability and Accountability Act, co-payments can be increased or plans eliminated outright. Unlike pensions covered by the PBGC, there is no government safety net for those who lose benefits.

Retention and Communication Plans

During Chapter 11, a key strategic thrust is finding ways to hold on to key personnel. “When a company gets in trouble, people get nervous, and your competitors get excited,” consultant Longnecker says. “The sharks start swimming around the chum, going for the good people.”

In addition to staff specialists such as lawyers and turnaround experts, seasoned managers are essential to continuing operations. “I worked with our executive team to map out a strategy that would let us identify [retention] criteria and what we would propose as tools to wed them to the company,” Filipovitz says. “We had to petition the court and say, ‘There are X number of people that we need to be sure are here.’ In analyzing, we separated them into three categories: people who were important to us in the short run, those important in the short and long run, and people who were good but who we were willing to risk losing.”

Filipovitz’s HR team led a process that identified 80 key people to retain from among 2,000. Then he formulated a retention program costing $6 million and gained creditor and court approval to implement it. (For information on how to implement retention bonuses, see “Staying Power.”)

US Airways, in contrast, opted not to offer its top executives bonuses or enhanced severance. “We wanted them to stay because they believed in what we were trying to accomplish,” Glass says. Attrition at the middle-manager level has been a problem as US Airways has taken actions to stay in business, but all 30 members of the executive team that came in to lead the turnaround are still in place.

At Integrated Health Services, Phillips’ retention plan included “pay to stay” arrangements, severance and bonus packages for managers and other essential personnel. Creditors approved it without comment. “They understand that they can best protect their assets by preserving key management,” she says.

Still, experts such as Donald Biskin, partner at the Heidrick & Struggles executive recruitment firm in Great Falls, Va., warn that retaining some executives may be more trouble than they’re worth. “Massive denial is the biggest problem in financial distress cases,” he says. “The CEO and other senior managers don’t accept the need to make changes and do so quickly.”

Another critical goal besides retention is developing and implementing a communications plan once a Chapter 11 filing becomes public. Counting customers, suppliers, investors, retirees and employees, “we’d be telling our story to as many as a million people,” says Kimberly Welch, vice president of corporate communications at Federal-Mogul. “We had letters, telephone scripts, supplier lines all ready to go. A lot of the Q&A dealt with benefits. HR was critical in crafting the answers. We wanted it to be the biggest nonevent, and it was. Employees were fine; they saw the lights were on, suppliers were still delivering.”

Two Ways Out

There is no guarantee that a company will emerge from Chapter 11. No company can survive for long—even with court protection—if the business is not sound. Often, as with LTV, the Chapter 11 reorganization ends in liquidation.

After LTV entered bankruptcy, Filipovitz soldiered on. “We went through significant reductions in force, consolidated our health plans and scaled back benefits where we could.” But, in the end, no plan could stop the free-fall. Finally, with nervous creditors breathing down its back, LTV abandoned hopes for reorganization and filed for liquidation in December 2002.

Now Filipovitz’s depressing descent from HR executive with responsibility for thousands to manager without portfolio is almost over. Today, he’s a human capital manager with no one to manage—one of 37 employees waiting to turn out the lights after the company’s assets are sold off.

As US Airways struggles for life, Glass hopes for a better outcome. The airline emerged from Chapter 11 on March 31, but—citing a drop in bookings during the Iraq war—immediately imposed a 5 percent wage deferral for all employees.

“We’re trying to save as many jobs as we can in a situation where we’ve been given up for dead,” said Glass. “The situations are gut-wrenching, but you have to do it. My happiest day will be when I’m sending out recall notices, telling people they can come back to work.”

Robert J. Grossman, a contributing editor of HR Magazine, is a lawyer and a professor of management studies at Marist College in Poughkeepsie, N.Y.


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