Zicklin Insights

Faculty Insights

Restructuring America’s Plans
By Nizan Geslevich Packin
(originally published in Forbes

Before entering academia in 2013, I spent six years working as an associate in the Financial Restructuring Group of a major U.S. law firm—Skadden, Arps, Slate, Meagher & Flom LLP.  In those years, I focused most of my time working on the bankruptcies resulting from the 2008 financial crisis, which economists now say will be dwarfed by those of the novel coronavirus-led financial crisis.

In my time at the firm, I learned how to assess a company’s likelihood of successfully navigating the financial restructuring process. Often, it boiled down to the type of bankruptcy that was being filed. There are three types of bankruptcies: (1) the prepackaged bankruptcy, aka “the prepack”; (2) the prearranged (or pre-negotiated) bankruptcy; and (3) the “free fall” bankruptcy.  In the first type, the prepack, a company prepares a plan to financially reorganize in cooperation with its creditors. The company’s shareholders vote on the plan before the filing, and the prepackaged plan kicks in once the company files for Chapter 11. Because the work is done in advance, the prepack typically results in a shorter turnaround time. In the second type, the prearranged bankruptcy, a company “prearranges” by negotiating with its creditors in advance to try to reach consensus on an out-of-court restructuring, but does not actually vote and approve the package before filing for Chapter 11 as in the prepack.  In the third type, the “free fall” bankruptcy, a company is forced to go bankrupt without a game plan as to how, when and in what shape, if at all, it will come out of bankruptcy. Much of the uncertainty is the result of the company starting to negotiate with its creditors only after it has filed for bankruptcy and had an emergency first day hearing.  As a result, a free fall bankruptcy typically takes much longer and also is more expensive.

It feels like the U.S. is now almost in a free fall bankruptcy, of sort. To be clear, the government is not bankrupt, but the concepts of pre-planning, pre-negotiating, or just ignoring an impending crisis are the same. The government saw the writing on the wall, but decided to ignore the problem. Rather than preplanning or pre-negotiating, the government just waited to see what would happen. And that is how free-fall bankruptcies can be born.

The public-health aspect of this pandemic was clearly not thought out and planned for in advance. Even as the pandemic started to unfold, our leaders told us, “everything will be fine.” Many of us heard about the testimony of Dr. Rick Bright earlier this week, the former director of the Biomedical Advanced Research and Development Authority, which is the federal public-health agency that handles the development of vaccines that protect Americans from pandemics such as the novel coronavirus. Bright has previously stated, according to the New York Times, that he was fired last month for resisting the White House’s attempt to use hydroxychloroquine – the malaria drug – as a COVID-19 treatment. This week, he testified in Congress as a whistleblower that his coronavirus warnings were ignored. He also said that he is concerned about what he describes as the government’s lack of plan for dealing with the public health crisis.

Bright testified that it is unlikely that a safe and effective vaccine would be ready within the 12-to-18-months as suggested by the federal government. Not less concerning, he cautioned that even if a vaccine were developed in that time frame, the country cannot make the vaccine universally available because it lacks sufficient supplies or a plan in place to procure them. And he voiced concern that the country isn’t ready to distribute the limited-supply of vaccinations in a “fair and equitable” way. “We don’t have a single point of leadership for this response,” Bright said, “and we don’t have a master plan for this response.” This is a tragedy, because as Bright explained to Congress, the government’s inaction has cost lives. And it will continue to cost lives, particularly those of historically discriminated populations who already suffer from economic bias.

The economic aspect of the current crisis also was not thought through before taking action. Simply put, the plan is being drawn up and negotiated on the fly. Unfortunately, those with money and power had (and continue to have) their influence on the plan. And most Americans who are truly suffering don’t have a seat at the table.  Thus far, complaints have been made about how the administration picked favorites, in terms of which industries and business it prioritized. Likewise, the stimulus plan was executed in a discriminatory way. FinTech companies were initially excluded from participating in the Paycheck Protection Program (PPP), under which banks were at the center of distributing loans to small businesses, and did so in ways that maximized their profit rather than the public welfare. So while the SBA was required to process the loans on a first-come, first-served basis, the lenders were not. As a result, small businesses with women-owners and minority-owners, as well as peripheral area-based small businesses, found themselves facing more barriers in getting loans. Banks also froze or seized the funds from government relief checks to repay bank debt, before consumers that really needed those funds got them.

Additionally, the PPP is a stimulus, but not a survival plan for small business, and makes it challenging for businesses involved in a bankruptcy case to get PPP funds, which in many ways is counterintuitive, according to courts and scholars. Likewise, certain PPP parameters hurt various types of businesses. For example, many heavy cash-flow businesses, which rely on consistent revenues and high occupancy rates to maintain their payrolls, like restaurants, are not operational now. But, in order to have the PPP loans forgiven, they must still spend 75% of the funds on payroll and 25% on fixed expenses, within eight weeks, which makes no sense with no customers or regular business expenses.

All of this is especially devastating because financially struggling consumers already lost more in this pandemic. Nearly 40% of U.S. households making less than $40,000 per year suffered at least one job loss during March, in comparison to 19% of households making between $40,000 and $100,000, and 13% of households making more than $100,000 per year. As Fed chair Jerome Powell explained, the U.S. is in the middle of the “biggest shock our economy has felt in modern times” and potentially facing an “extended period” of weakness. Powell pled for additional fiscal support as the crisis unfolds. Although it would be costly, Powell argued that such fiscal support is worth it if it helps the country “avoid long-term economic damage and leaves us with a stronger recovery.” In stark contrast, President Trump was less sure about needing more economic stimulus, saying “I don’t know it depends,” when asked about the plan.  

One thing is for sure—a wave of bankruptcies is headed the courts’ way. That wave is coming whether or not there is more stimulus. Commentators are already planning how to ease the burden on swamped bankruptcy courts, and streamline bankruptcy to get the process done rapidly and inexpensively. Bankruptcy is important – Chapter 11 complements the stimulus policies for large entities (however, discharging debts, which is consumer bankruptcy law’s main goal, is probably not what many consumers currently need). The alternative is to delay bankruptcy long enough so that harsh decisions could be made in an economic environment that offers more certainty and predictability.

The U.S. had the advantage of being hit a bit later than other countries by the coronavirus. That extra time could have and should have given the country the ability to avoid a free fall scenario, by preplanning, prearranging and prenegotiating whatever it could to address the impending public health and economic crises. It could have even given the U.S. the “priceless chance to copy best practices and avoid the mistakes of others.”

The way the U.S. addressed this crisis was clearly not prepacked. Nor was it prenegotiated. Instead, it has been a total free fall approach.   Lives were lost because the government did not purchase needed medical supplies, refused to ramp up production of PPE, and failed to instruct earlier about social distancing. Livelihoods were lost because the government did not devise a policy framework to better mitigate the economic impact of COVID-19.  But all is not lost. We can still try to carefully design an effective public-health and economic plan, and coordinate ways to strengthen the global economic response to COVID-19.  Such plans will also serve us well in addressing the health, economic and mental crises if and when we are hit by second waves of the virus outbreak. And, much like financial restructuring lawyers do, we should use lessons learned in other places and cases, to coordinate policies to fight the virus while successfully reopening our economy and supporting its speedy recovery.