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It's no surprise that Harvard Business School professor Stuart C. Gilson gave an enthusiastic thumbs-up to the recently announced $11 billion US Airways/American Airlines merger. The deal, which came after American's parent company, AMR Corporation, declared bankruptcy in November 2011, will allow the airline to work with the court to restructure and unload a significant amount of its debt, giving an iconic company "a second bite of the apple," says Gilson. An unabashed advocate of Chapter 11 and debt restructuring, Gilson is an expert in the legal innovations and institutional changes that have revolutionized their use in practice. He contends that both serve the US economy by helping troubled companies stay viable by giving them time to find new financing, renegotiate unfavorable leases and supply contracts, or expedite processes for selling off assets. Despite these benefits, he says that Chapter 11 has suffered an image problem. "When I first started in this area, I faced challenges selling this to students," says Gilson, the Steven R. Fenster Professor of Business Administration. "Bankruptcy was seen as the study of dead or dying companies." The truth is anything but "it's about reviving companies," says Gilson, author of the 2010 book Creating Value through Corporate Restructuring: Case Studies in Bankruptcies, Buyouts, and Breakups .
cash poor can raise money. In 2001, American Airlines acquired the assets of bankrupt TWA using this approach. More recently, Section 363 sales played a key role in some of the largest and most complex bankruptcies of the financial crisis, including General Motors and Lehman Brothers.
the back of the line is unfair, but Gilson says that giving a distressed company access to new cash can increase its chances of paying back more investors overall. "It's about increasing the size of the pie available to all the firm's stakeholders," he says.
"The amount of debt that needed to be restructured posed a seemingly insurmountable challenge"
Chapter 11 gives troubled companies other valuable options for raising cash, Gilson says. While operating in Chapter 11, a company is freed from paying interest on its pre-bankruptcy debts. Section 365 of the Bankruptcy Code allows the company to reject unprofitable leases. And through so-called debtor-in-possession (DIP) financing, new lenders are given priority in the capital structure. This is a critical incentive because it spurs banks and other creditors to lend to companies in Chapter 11 by giving them senior status, effectively letting them stand in front of pre-existing creditors. (American did not need such debtor-in-possession financing. United and Delta together raised almost $3.5 billion in DIP financing in their bankruptcies.) Some argue that putting earlier investors at
boom, and the company was struggling to manage its $6 billion debt load. As the housing and mortgage market collapsed, Realogy scrapped to pay more than $600 million in annual interest. With a total debt of $6.6 billion in 2010, the company decided to restructure out of court instead of filing for Chapter 11 for several reasons, Gilson says. First, most of Realogy's operating cash flows were from franchise agreements with local real-estate agencies, and a Chapter 11 filing could have critically damaged relations with the agencies. Second, its workforce was not unionized. Finally, the appearance of "giving up" through bankruptcy could have sent a signal to Apollo's limited partnersand to its competitorsthat the firm wasn't "willing to support its less successful investments, undermining future fund-raising efforts or its ability to restructure other portfolio companies," Gilson writes. While the jury is still out on the restructuring, Gilson says Realogy is seeking opportunities to grow the business, and "operating improvements made during the restructuring have positioned the company to take full advantage of any recovery in real-estate values."