The upside of bankruptcy

Long Island Business News, Jun 20, 2008 by Bernadette Starzee

Declaring bankruptcy can allow a company to wipe the slate clean, reorganize and start over. But when one company declares bankruptcy, it creates opportunities for competitors, as well, who might acquire the bankrupt company's customers, employees, proprietary information or even the company itself.

With the sluggish economy, bankruptcy filings are up nationally. According to the American Bankruptcy Institute, there were 8,713 business filings in the United States for Q1 2008, up 38.7 percent from the 6,280 filings during Q1 2007. Long Island is part of the Eastern District of New York. Business filings in this district fell slightly in that span, from 92 to 88, the American Bankruptcy Institute said, with Chapter 7 filings (liquidation) outnumbering Chapter 11 filings (reorganization) by nearly three to one.

"Bankruptcies have been down on Long Island, but we're anticipating a surge in activity with the slowing of the economy," said Ronald J. Eagar, a senior partner with Grassi & Co. CPAs, a Lake Success-based accounting and business advisory firm.

To the victor go the spoils

"Acquiring a company in bankruptcy can be a very nice situation for a competitor," said Howard Fielstein, a partner in Margolin Winer & Evens, a public accounting and business advisory firm in Garden City and New York City. Fielstein heads up the firm's Litigation Consulting, Valuation and Bankruptcy Services Group. "The bankrupt company may have something specific that the competitor wants - such as a market niche, a product, a process of producing goods or intellectual capital - which under normal circumstances would be difficult to acquire." And, typically, these assets can be had for less - often significantly less - than their fair market value, and in many cases free of all liens.

Sometimes, companies enter into bankruptcy to facilitate a sale. When Fortunoff, the Westbury-based home furnishings and jewelry retailer, filed for bankruptcy under Chapter 11 earlier this year, it became more attractive to NRDC Equity Partners, owners of New York-based department store Lord & Taylor, which proceeded to purchase Fortunoff.

"Fortunoff was a highly respected operation that attracted a certain class of clientele that complements Lord & Taylor's business," Eagar said. "The purchase allows Lord & Taylor to capture that marketplace." At the time of the purchase, Lord & Taylor said its plans included selling upscale merchandise under the Fortunoff brand name in Lord & Taylor stores, and possibly expanding Fortunoff nationally.

Amid a marketplace flooded with competition, Linens Holding Co., the Clifton, N.J.-based holding company for housewares retailer Linens 'n Things, filed for bankruptcy protection under Chapter 11 in May and began shuttering underperforming stores in an attempt to cut costs. "The jury is still out on which way it will go," Fielstein said, adding that the retailer's prime store locations, often with favorable leases, may be an attractive lure for competitors.

"The reason a company goes bankrupt is principally that it runs out of capital," said Mark Meinberg, managing partner of Feldman, Meinberg & Co., a Syosset-based accounting firm. "It could be because sales are down, the business took a bad turn or that expenses weren't managed well." A competitor might be able to step in and make it work. "Maybe the competitor has customers that would buy a product that the bankrupt company's customers were not buying," Meinberg said.

"Sometimes, a change in leadership is what's needed to turn things around," Fielstein said. "The old ways may be too ingrained, and you can't get rid of the old ways without getting rid of the old framework."

While companies are in the process of reorganizing under bankruptcy, it's an uncertain time for their employees, customers and suppliers, who may be lured by the relative security of switching to a competitor.

"In industries where there are only two or three major players, and one of them goes bankrupt, it changes the whole complexion of the marketplace, opening the door for the other companies to increase margins and profits," Eagar said.

Managing adversity

"We tell our clients who declare bankruptcy that they can expect their competitors will help spread the word to customers, and try to convince them to use them instead," said Robert L. Pryor, a partner in the Westbury-based bankruptcy law firm Pryor & Mandelup. "There's a period of insecurity when the debtor first files, when it's particularly vulnerable. The longer a company functions in Chapter 11, people will begin to see it's business as usual, and they will become less concerned that the debtor won't survive."

For example, Pryor's firm handled the filing for a Long Island hotel that reorganized under Chapter 11.

"At first, everyone was nervous about the rooms they booked - about whether they would be honored," Pryor said. "But the longer it went on, people became less concerned." However, it took a longer time for the hotel to reclaim its convention business, Pryor added, noting that different aspects of a business can be affected differently by a bankruptcy filing.