Douglas raises essentially three points:
1. The intuitive qualm: If these deals are so good, why aren't the case placers taking the deals for themselves?
First, we don't know that the case placers aren't. To confirm a plan of reorganization, a debtor must file a disclosure statement -- typically 200-300 pages in length -- that explains, among other things, who will own and control the reorganized company. To sell in a section 363 sale, requires almost no disclosure at all. The debtor presents a witness or two who say they have investigated the alternatives and the proposed sale is best. In the sale transcripts I read, the sale proponents neither identified the ultimate parties in interest nor negated the possibility that it might have been themselves.
In Polaroid, for example, Bank One Equity formed the buyer, OEP, with investors not publicly identified. Because OEP insiders made the unusual decision to take reorganized Polaroid public about year after their purchase, we know that Polaroid's top managers joined OEP after the sale and received millions of dollars worth of stock in OEP. We have no way of knowing the degree to which the case placers were on both sides of the deals in the other sale cases we studied. If I were a bankruptcy judge, I would have asked. But if I were a judge and I had asked, that probably would have been the last big 363 sale case filed in my court.
Second, while our sample included no cases in which managers or DIP lenders openly bought their companies, such cases are frequently reported elsewhere. Third, case placers may prefer a massively inefficient sale because the small amount they can steal from such a sale is still larger than the amount they can steal from a reorganization. Consider, for example, the analogy of a corporate purchasing agent taken a bribe of a few thousand dollars in return for a contract worth millions. Corruption's horrendous potential for inefficiency is one of the reasons we try to eliminate it.
2. The publicly traded reorganizing companies in our comparison group may have been stronger than non-publicly traded reorganizing companies, thus exaggerating reorganization recoveries.
Douglas may well be right about this. No valuation data are available for the non-publicly traded reorganizing companies, so we can only guess at whether they produce more value.
Douglas' guess is that "the most heathy and most transparent remain public." My guess is that the investors who take companies private in connection with bankruptcy take the good ones for themselves and leave the bad ones for the public investors. The factual basis for my guess is that the five-year rate of refiling for public companies emerging from bankruptcy seems to be substantially higher than the corresponding rate for private companies emerging from bankruptcy.
3. The sold firms may have been weaker than the reorganized firms.
The sold firms were in fact weaker than the reorganized firms, as indicated by lower EBITDA. But we controlled for that weakness. In our regression analysis, the difference in EBITDAs explained less than half as much of the difference in recoveries as did the sale-reorganization choice. The sold firms were also more likely to be telecoms. But controlling for that difference B and every other difference for which we had data B the choice between sale and reorganization remained highly significant. Of course, there can always be some other lurking variable.
Because illiquidity and supposed inability to reorganize are often cited as the reason for low sale prices, we searched the sale transcripts for evidence of those phenomena. Much to our surprise, we found a claim of inability to reorganize in only 13 of 25 sale cases (52%). Even more surprising, those claims were not correlated with low sale prices. We also found no correlation between the cash-to-asset ratios and the sale price-to-assets ratios of the sold firms. Firms in stronger cash positions prior to filing did not sell for higher prices.
The issue Douglas does not address is the disastrous competition among the bankruptcy courts for big cases. Our 363 sale study is just one of many that suggest that the courts' unseemly competition has produced a race to the bottom.
Douglas' proposed solution is that "bankruptcy judges [should] be vigilant before approving [sales.]" But I do not see how they can be. The case placers can choose their court. Why should case placers subject themselves to vigilant courts when such courts might prevent the case placers from doing what they want to do? When the regulators are in competition, vigilance on the part of a regulator can do no more than drive the cases elsewhere.