The US bankruptcy code requires a court to determine that a debtor’s plan will pave the way toward a financially healthy outcome. The uptick in recent “Chapter 22" filings suggests companies may be avoiding needed cuts and business changes, or that shifting economic conditions can quickly upend a plan once deemed “feasible.”
Dania Beach, Fla.-based Spirit filed its second bankruptcy Aug. 29 in the US Bankruptcy Court for the Southern District of New York, just 190 days after its previous plan approval.
The low-cost carrier eliminated about $800 million in debt in its first case but didn’t sell assets or shrink its leased fleet—steps it now plans to take while scaling back in certain markets.
“That is one of the quickest failures in a large public company bankruptcy since 1980,” said Lynn LoPucki, a University of Florida Levin College of Law professor.
Feasibility doesn’t guarantee success. Judges consider whether a plan appears realistic based on projections, proposed changes, and creditor support, and they generally don’t seek an independent review of the financial projections.
The standard doesn’t explicitly say that “another Chapter 11 case won’t happen,” said James Sprayregen, Hilco Global vice chairman and founder of Kirkland & Ellis LLP’s restructuring group.
“It doesn’t say that you need an optimal capital structure,” he added. “And if everybody’s on board, the judge won’t say, ‘I’m not going to give you the chance to come out quickly because I want you to chop a lot more wood and do a complete operational restructuring.’”
Second Round
Most modern Chapter 11 debtors want to get out of bankruptcy quickly, so they focus on restructuring their balance sheets, according to Stephen J. Lubben, a Seton Hall University School of Law professor.
“Chapter 11 has lots of tools for a more substantial restructuring, but they are rarely used in many of the modern ‘quick rinse’ cases,” he said.
Spirit’s first bankruptcy cost it about $33.4 million in professional fees, according to court records. Top executives also collected $6.3 million in retention bonuses ahead of the second filing.
The airline’s initial Chapter 11 exit in 114 days was significantly shorter than the industry average of more than 500 days, said Stuart Hatcher, chief economist for aviation data firm IBA Group.
“Realistically, it didn’t make any sense to me as to why it emerged back in March,” Hatcher said.
Too often, companies fail to make enough deep changes in their rush to exit bankruptcy, said Stephanie Wickouski, managing director of restructuring advisory firm Pivot > Group. That can lead to repeat filings, and when those happen within a year of the first, it often leads to liquidation, she said.
Spirit entered its first bankruptcy with a deal in place to move quickly. While that minimizes business disruption and fees, it often leaves a “suboptimal capital structure,” Sprayregen said.
“Pre-arranged bankruptcies have a lot of good to them because they get you in and out quickly, damage the business the least, and spend the least in professional fees,” he said. “By definition, you don’t do all the hard work you would in a slower-moving bankruptcy.”
Spirit’s initial restructuring estimates were optimistic, said Josh Clark, a senior director of leveraged finance at Fitch Group. Even without the default notice from its largest lessor, AerCap, that triggered the second bankruptcy, Spirit appeared to be on track to trip a liquidity covenant that could have forced a filing, he said.
Market conditions squeezed Spirit’s margins, including persistent domestic overcapacity, slack demand from price-sensitive leisure travelers, and fare pressure from carriers, Clark said.
Feasibility
Spirit’s first feasibility projections found a new restructuring unlikely, but included caveats and disclaimers about accuracy and the ability to achieve the projected results.
The bankruptcy system relies heavily on expert opinions with inherent biases, said Edward Altman, professor emeritus at NYU’s Stern Business School.
While there are more objective methods for evaluating a company’s long-term viability, he said, those are often overlooked.
That feasibility standard effectively forces judges to act as “seers about the future,” said Robert M. Lawless, a bankruptcy professor at the University of Illinois College of Law. “When all the parties are on board with a reorganization plan, it is difficult for the judge to impose their prediction over everyone else’s.”
Chapter 22
Several airlines, including Continental, US Airways, Pan Am, Midway Airlines, and Trans World Airlines, filed repeat bankruptcies. Some eventually liquidated, while others were acquired.
But Spirit’s back-to-back bankruptcies in less than a year make it an outlier.
Occasionally, repeat filings can strengthen airlines. Continental and US Airways improved after second filings, said Henry H. Harteveldt, president of Atmosphere Research Group.
“There is a lot of surprise that Spirit didn’t take a more thorough approach to its financial reorganization when it went through bankruptcy the first time,” Harteveldt said.
Outlook
LoPucki’s research shows that eight out of 10 companies that filed bankruptcy a second time within five years liquidated within another 5.2 years.
“There is probably little chance that Spirit Airlines is going to survive the next five years,” LoPucki said.
The second bankruptcy may make it easier to sell assets such as aircraft or reject leases, without pursuing a more complex merger.
Spirit recently engaged in talks with Frontier after rejecting the company’s earlier merger offer. JetBlue’s $3.8 billion deal failed last year.
“Mergers are complex, and even a merger of two similar airlines like Frontier and Spirit does consume a lot of management’s attention and could be an unwanted distraction,” Harteveldt said. “Acquiring the assets is simpler.”
Still, a merger isn’t “out of the question,” Sprayregen said. “I would keep an eye open for something happening along those lines.”
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