WorldCom Inc.'s Bankruptcy Case
With Lynn LoPucki
UCLA Law Professor
Tuesday, July 23, 2002; 12:30 p.m. EDT

Telecommunications firm WorldCom Inc. filed for the largest bankruptcy protection case in U.S. history. According to chief executive John W. Sidgmore, "the company has enough money to operate and maintain the payroll for its 60,000 workers for at least a year."

"The parent company of Arlington-based MCI Group listed in its petition assets of $107 billion, making its collapse almost twice the size of Enron Corp.'s, whose December bankruptcy filing was the largest at that point. WorldCom did not have enough cash to pay interest on its more than $30 billion of debt. Last week the company missed a $74 million interest payment." Read the full story, WorldCom Files Record Bankruptcy Case (Post, July 22).

Lynn M. LoPucki, bankruptcy expert and professor of law at UCLA School of Law, discusses WorldCom Inc.'s bankruptcy case.

Recently, bankruptcy expert LoPucki and statistician Joseph W. Doherty released a study, "The Failure of Public Company Bankruptcies in Delaware and New York Revisited" (PDF file), on companies failing to reorganize after filing for bankruptcy. "At 31%, New York’s failure rate was better than Delaware’s 54%, but still significantly worse than the 14% average failure rate for all other U.S Bankruptcy Courts combined. Delaware and New York’s high failure rates are crucial, the researchers say, because today over 75% of large pubic companies filing bankruptcy – including Enron – choose one of the two."

Below is a transcript.

Editor's Note: Washingtonpost.com moderators retain editorial control over Live Online discussions and choose the most relevant questions for guests and hosts; guests and hosts can decline to answer questions.

College Park, Md.: I am pretty sure that this is not going to be of general interest, but I was intrigued by the pdf file of your forthcoming study of Delaware bankruptcies. In that study, I am not sure whether you are using the correct metric for success. To figure out whether a bankruptcy proceeding has been successful you need to keep track of all the bankrupt firms' assets and examine how they are disposed of during the proceedings --- see for example the study of bankruptcies using census data by Maksimovic and Phillips in the 1998 Journal of Finnace.

Lynn M. LoPucki and Joseph W. Doherty: In our study, we focused on the success or failure of the company that emerged from bankruptcy. If assets were sold during the bankrutpcy case, we did not try to evaluated that process. The difficulty with trying to second guess on the "success" of a sale of assets is that we have no reliable basis on which to value the asset and hence no reliable way to determine whether it was sold for a "successful" price.

Ashburn, Va.: Explain the vendor to company relationship and which vendors are paid first under Chapter 11. During the decision process what is taken into consideration?

Thanks

Lynn M. LoPucki and Joseph W. Doherty: Generally, the answer is that debts owing to vendors for post-filing debts have administrative expense priority -- the same priority as the lawyers who work on the case. They will almost invariably be paid. Debts owing for pre-filing deliveries have a lower priority and less chance of being paid. But in the Worldcom case, as in other recent cases, the debtor petitioned the court to be allowed to pay all vendors in the ordinary course of business. This is a great deal for the vendors.

Arlington, Va.: What are the chances those employees laid off will receive the severance packages they were promised? Who determines that - the bankruptcy judge?

Lynn M. LoPucki and Joseph W. Doherty: Employee benefits have priority up to about $4650 per employee. Those amounts will be paid. But we are assuming that the employees have a contract for those severance packages. If not, they will be paid only if Worldcom decides to pay them - and the bankruptcy judge approves.

Washington, D.C.: As a former Worldcom employee, I am still doggedly holding onto some Worldcom stock. How will this filing affect the stock holders?

Lynn M. LoPucki and Joseph W. Doherty: Stockholders are likely to get little or nothing from the Worldcom bankruptcy. The stock was selling at eight cents a share yesterday. At that price, it might be worth holding on, just to see if something unexpected happens. The best thing would be if shareholders organize and participate in the case. In that event, shareholders would at least get something.

Washington, D.C.: Why do companies fail to reorganize under Ch. 11?

Lynn M. LoPucki and Joseph W. Doherty: About 85 to 90 percent of the large, public companies that attemp to reorganize under chapter 11 succeed in getting a plan confirmed by the court. They "emerge" from bankruptcy. The others run out of cash and as a result close the business. Those firms are liquidated, under chapter 11 or chapter 7.

Arlington, Va.: What factors have you found in your research that contribute to a successful emergence from bankruptcy? Do you see any of those items so far in the WorldCom case?

Lynn M. LoPucki and Joseph W. Doherty: The most important factor is the court in which they filed. Worldcom chose the New York bankruptcy court, which is not as bad as the Delaware court, but much worse than the average of all other courts in the US. This suggests that Worldcom will confirm a plan, but will have a substanial chance -- 20 to 30 percent -- of being back in bankruptcy within five years after it emerges.

Falls Church, Va.: Based on your research of bankruptcy filings made in New York, what are the prospects for WorldCom? What key hurdles does it face?

Lynn M. LoPucki and Joseph W. Doherty: The key hurdle is to fix the business. Worldcom was lying about its income and that covered the fact that it was actually losing money. We don't know how much. Confirmation of a plan that reduces the amount of debt will improve the income statement, but we don't know yet how much improvement is needed. The new auditors, KPMG, are still working on the books.

Menlo Park, Calif.: The Justice Department, through the office of the United States Trustee, has requested the bankruptcy court to appoint an independent examiner for Worldcom.

Since there's evidence of fraud, the court has the option to kick out current management. Will Worldcom still be permitted to operate as a debtor-in-possession, or will the Justice Department move in and impose a trustee?

Lynn M. LoPucki and Joseph W. Doherty: Enron solved exactly the same problem by hiring a "turnaround manager" as a sort of CEO for the company. That was sufficient to molify the creditors who were seeking a trustee. If the pressure builds against Sidgmore, we think Worldcom will hire a new CEO from outside the company.

Bowie, Md.: Please help me understand the math. The article says the company has $107 billion in assets and $30 billion in debt. What does the other $77 billion represent that it doesn't add up to anything?

washingtonpost.com: WorldCom Fights on 2 Fronts (Post, July 23)

Lynn M. LoPucki and Joseph W. Doherty: Great question! Actually the debt is about 41 to 44 billion dollars. Worldcom asserts that the assets are worth $107 billion dollars, and repeated this in the bankruptcy filing. Some analysts put the value at $15 billion or lower. The price at which the stock is trading suggests a value less than the amount of the debt. So that difference between debt and asset value may be negative, not positive. If necessary, the court may determine the actual value of the assets which the plan comes up for confirmation at the end of the case.

Washington, D.C.: How close to disruption of operations was WorldCom before the $2 billion loan?

My suspicion is that, since the discovery of the $3.9 billion misreporting was a surprise to many, the current loan is actually just a winding-down grant. This unusual type of funding would be needed to assure that vital customers (like the Defense Department) would not experience service disruption while WorldCom assets are sold off.

Lynn M. LoPucki and Joseph W. Doherty: Worldcom claimed that it was virtually out of cash immediately before it received the first funds from the debtor-in-possession financing. We know nothing to the contrary. (You are right in thinking that if Worldcom runs out of cash, service will be suspended.)

There is nothing "unusual" about the debtor-in-possession financing in this case. Nearly every debtor gets this kind of loan to enable it to stay in business. The bank are making the loan because the loan has a very high priority. As long as the assets of Worldcom are worth more than about 3 billion, the banks will be repaid -- regardless of what happens to the company.

Vienna, Va.: When a public company files for bankrupcy protection, what changes are made to CEO/officer/director compensation packages?

Lynn M. LoPucki and Joseph W. Doherty: That depends on the circumstances. But recently the pattern has been that the executives vote themselves "retention bonuses" to compensate themselves for the "risk" of remaining with the company. We would not be surprised if that happens in Worldcom.

Bethesda, Md.: Could you talk for a moment about the different chapters that you can file and what is the significance of Chapter 11 as oppose to Chapter 7?

Lynn M. LoPucki and Joseph W. Doherty: In Chapter 7, a disinterested trustee is appointed to liquidate the firm. In Chapter 11, the management remains in control and either attempts to reorganized the firm (keep it going) or liquidates it. As you might guess, nearly all large public companies choose to file under Chapter 11. The cases "convert" to Chapter 7 only if the business fails.

Northport, N.Y.: Why can't the government prosecute these frauds using the harsh IRS penilities? It seems to me that if corporations are cooking the books all Americans are being defrauded not just investors.

Lynn M. LoPucki and Joseph W. Doherty: If the goverment decides to prosecute executives, there is no shortage of laws under which they could do that. The present administration considers it a political issue. They are concerned about the effect prosecutions might have on the willingness of honest people to become executives. Not only are the prosecutions not occurring, the bankruptcy estates have not yet made efforts to even recover the money that several of the corrupt executives have taken from their firms. Nor has Congress repealed the unlimited homestead exemption that several are using to shield funds looted from the firms.

Washington, D.C.: Do you think the recent wave of large bankruptcies by high profile companies suspected of wrongdoing will have any effect on the chance that the presently pending bankruptcy reform legislation will pass?

Lynn M. LoPucki and Joseph W. Doherty: The bill deals largely with consumer bankruptcy so there is not much of a rational connection. We just don't know whether there will turn out to be a political connection.

Hartford, Conn.: Recent changes were made by Congress affecting an individual's ability to file bankruptcy. It's more difficult now for the family to get out of debt than before. These changes were made at the request of lobbyist for the large financial institutions like CitiGroup.
Were any similar changes made recently by Congress to a business' ability to file for bankruptcy that might impact WorldCom?

Lynn M. LoPucki and Joseph W. Doherty: We think you are referring to the pending bankruptcy bill. It has been pending for about five years and almost always on the brink of passage -- as it is now. You are correct in thinking that it would apply stringent rules against consumer debtors, but leave large firms free to do what they have been doing.

Alexandria, Va.: If Worldcom is found guilty of fraud, can any liability for that fraud be discharged in a Chapter 11?

Lynn M. LoPucki and Joseph W. Doherty: Yes. A corporation that reorganizes can discharge liability for fraud. The thinking behind the law is that the executives who committed the fraud will be thrown out of office and the shareholders who elected them will lose their investments. The firms will be owned by creditors when they emerge, and the creditors should not suffer for the wrongdoing of the executives. Executives who acted fraudulently have personal liability and that liability is generally not dischargeable in bankruptcy.

Anchorage, Alaska: How much do the lawyers, trustees, and accounts working for these entities stand to make on this bankruptcy?

Lynn M. LoPucki and Joseph W. Doherty: We estimate that the fees for this case will be between 100 million and 200 million dollars.

Knoxville, Tenn.: Gentleman, given the volume of traffic UUnet carries do you believe it in the national interest to let it go dark?

Lynn M. LoPucki and Joseph W. Doherty: No. But we would love it if there were some way to just let the spam go dark.

Ashburn, Va.: Hi, if the $2 billion is not enough during the bankruptcy, how hard is it to secure more funds? If it is not enough, then will they goto Chapter 7? I mean $2 Billion is not a whole lot considering they gave Bernie Ebbers over $400 million to cover his debt for heaven's sake!

Lynn M. LoPucki and Joseph W. Doherty: It is rare for a debtor to go through two rounds of debtor-in-possession financing, but in unusual circumstances, that might be possible. The second round of debtor in possession financing would have to be awared priority over the first.

Bethesda, Md.: If WorldCom declared bankruptcy, why does the stock price keep climbing?

Lynn M. LoPucki and Joseph W. Doherty: If you have been watching the business news over the past ten years, you must realize by now that stock prices don't move rationally. The total value of the Worldcom stock is small now, so it is relatively easy for small changes in mood to make big percentage changes in "value."

Crystal City, Va.: In response to an earlier question you said that "The most important factor is the court in which they filed. Worldcom chose the New York bankruptcy court, which is not as bad as the Delaware court, but much worse than the average of all other courts in the US." Why would Worldcom choose to file in NY given the relatively low success rate of bankruptcy filings there, when it it incorporated in many (if not all) other U.S. States?

Lynn M. LoPucki and Joseph W. Doherty: Neither the managers, the banks, or the lawyers necessarily have the long-term best interests of the company in mind. The New York or Delaware court will let them do pretty much what they want right now, and that is what is most important to them. Each participant thinks about its own interests and that thinking is often short-term thinking.

Rockville, Md.: As a general question regarding bankruptcy...WorldCom filed, in part, because it was being killed by interest payments which the filing protects them from. Do these banks usually get their interest payments after some time? Do they get the principle back? And if not, do they write it off as a lost cause? What is their recourse if there is simply no money to be repaid? Finally, if there is a loss, does this affect their average banker in the form of higher interst payments or lower returns?

Lynn M. LoPucki and Joseph W. Doherty: Distinguish the interest payable to the banks and the interest payable to the subordinated bondholders. The banks will probably be paid in full. The subordinated bondholders will be converted to equity. The interest owing to the subordinated bondholders will not be paid.

New York, N.Y.: Why is it that companies that are known to be filing bankruptcy still have some equity value despite the fact that equity holders will likely see zero value?

Lynn M. LoPucki and Joseph W. Doherty: Becaue there is a possibility that things will turn around before a plan is confirmed. In fact, if equity merely gets a committed appointed so it can participate in the case, equity will be offered some "nusiance value" recovery. But on the whole, studies show that the equity of bankrupt companies more often declines in trading price over the course of the proceedings.

Smithfield, Va.: A question that arises from the various "Q&A's" the Post has published to help educate those, like myself, with little knowledge of bankruptcy proceedings: I've read that Worldcom's bankruptcy declarations means investors' stock will be "wiped out." Could you give me a more technical definition of what happens to shareholders? Obviously, the value is wiped out right now. I don't know if the paper's usage is casual or technical.
Also, if a company like Worldcom, which has appears to have decent assets and a committed CEO, pulls out of bankruptcy, what is the historic trend concerning its stock price? Thanks.

Lynn M. LoPucki and Joseph W. Doherty: The plan of reorganization may provide for the cancellation of the shares. Alternatively, it might provide for dilution -- the issuance of a lot of new shares that will share in ownership of the firm. The first provision may result in the shareholders getting nothing, the second in their getting only a nominal recovery -- because so many new shares are issued. As of today, nothing has happened to "wipe out" the equity.

If the emerging firm is successful the stock will see big gains, if not the stock will probably go to zero by the time of the second bankruptcy filing.

Reston, Va.: I would like to know what responsibility the company has to its employees in the way of benefits, future layoffs, etc. Is this the final flag to start looking for new work?

Lynn M. LoPucki and Joseph W. Doherty: The bankruptcy filing does nothing to either protect or threaten the current employees. Management remains in control. Often management seeks "retention bonuses" for some employees to keep them from leaving.

Gainesville, Fla.: There is currently an investigation into possible fraud on the part of WorldCom. If it is determined that certain creditors were in fact the victims of fraud, what will be thier standing in bankruptcy case? In other words, will they get paid ahead of other creditors who were not defrauded?

Lynn M. LoPucki and Joseph W. Doherty: Defrauded creditors get no special priority. Their priority is the same as other creditors of their general type.

Knoxville, Tenn.: In your words, sum up the key failure and remedy of the ENRON, Worldcom story. (For bad men to prevail it is necessary only that good men do nothing) comes to mind.

Lynn M. LoPucki and Joseph W. Doherty: Amen!

Alexandria, Va.: Wait, so let me get this straight. WorldCom employees who were laid off recently will only get severance IF they have an employment contract explicitly guaranteeing such payment? Otherwise it's up to the company and the bankruptcy judge?

Lynn M. LoPucki and Joseph W. Doherty: Exactly. Bankruptcy puts no additional obligation on the firm to take care of former employees. The firm would probably be allowed to make noncontract severance payments if it chose to do so.

College Park, Md.: Follow up question about your study --- it may be economically efficient for a banktrupt company to sells all its valuable assets in Chapter 11 to other firms that can operate them more efficiently. When the firm emerges it might then be very fragile and fail again, but it does not mean that this is not the best outcome.

Lynn M. LoPucki and Joseph W. Doherty: What you say is correct. But that is not likely the explanation for why New York and Delaware reorganized firms fail more often. We found that the Other Courts actually reorganized a larger percentage of the firms that filed in them.

Fairfax, Va.: I'm a little confused about the Chapter 11 bankruptcy process and its underlying philosophy. My impression from news reports is that WorldCom will now pay its creditors and bondholders cents on the dollar, then re-emerge as an invigorated and debt-free company. As telecom companies are all interconnected, this means that Verizon, SBC, BellSouth, etc will have to write down millions in bad debt (for unpaid interconnection and line charges) and then have to face a debt-free, rejuvenated competitor. Where is the punishment in the bankruptcy process? And if I understand the process correctly, won't the WorldCom bankruptcy cause a rush of other telecom carriers to declare bankruptcy to rid themselves of huge debt servicing payments? Thanks for your time!

Lynn M. LoPucki and Joseph W. Doherty: A large portion of the telecoms have already filed bankruptcy. More than 41 with assets of $220 million or more each. Each of these business failures imposed losses on others.

But it is the finacial failure that imposes the loss, not the bankrutpcy filing. The bankruptcy filing merely recognizes the loss.

Acompany is just an abstraction. Punishing it does no good, particularly if the people in it are people who replaced the wrongdoers. The "punishment" in the bankruptcy system comes two ways, if at all. There may be criminal prosecutions and there may be lawsuits against the people who did the wrongful acts. So far, we have not seen much of either.

Mt. Lebanon, Pa.: Aside from the bankruptcy lawyers, of course, who typically gets first crack at the assets when a large outfit like WorldCom spirals into a death roll and thunderously crashes into a charred, jagged, unrecognizable mass? I guess you can tell I don't have any sympathy here. Thanks much. HLB

Lynn M. LoPucki and Joseph W. Doherty: The professionals will make a lot of money. The banks that do the debtor-in-possession financing will probably do well also. Finally, speculators will buy into the bonds of Worldcom and try to make some quick bucks on the turnaround. But that is not a business for amateurs!

Washington, D.C.: What typically happens to shareholders when a public company files Chapter 11? Will WorldCom's shareholders be left with any equity in the company once this is over?

Lynn M. LoPucki and Joseph W. Doherty: In a Chapter 11 case today, shareholders usually get nothing. That will probably be true in Worldcom as well, but it isn't over yet.

Bowie, Md.: Persons of the anti-business persuasion often say "reorganizing under Chapter 11" is a way of getting out of contracts, like with vendors or unions. Is that often a factor, and is it with WorldCom?

Lynn M. LoPucki and Joseph W. Doherty: We agree with that statement. Chapter 11 permits debtors to "reject" contracts and leases, thereby converting the outsider's contract rights to a damage claim that can be paid in a reduced amount. A few years ago, Sizzler Steakhouses filed a Chapter 11 case specifically to reject a number of unprofitable leases.

We don't know what contracts Worldcom might intend to reject.

Laurel, Md.: Geez, between corporate bankruptcies and credit card issuing, how much of the country's debt can be traced to Delaware?

My real question is, the recent spate of bankruptcies (other than dot-com busts) really began with the mild recession and post-attack slowdowns of 2001. If a mild recession was to start tomorrow, how many new business bankruptcies could we expect to see that wouldn't occur if the economy kept growing at 5%; and in how many of those would aggressive/creative accounting be a factor?

Lynn M. LoPucki and Joseph W. Doherty: Big firm bankruptcy filings have more than doubled in the past three years. The primary driving force is the increasing use of debt -- particular bond debt and debt arising from takeover activity. The business cycle has less effect than borrowing cycles.

Lake Placid, N.Y.: Does not the Worldcom and MCI Ch 11 expose the lack of understanding and action by the SEC with regards to the Trust Indenture Act?
Would not all be better served it this important law was turned over to the FED as most banks act 2 faced in collecting for bondholders? Usually getting to the front of the line with some high-sounding term like 'senior-indebtness' and leaving bondholders with little or nothing.

Lynn M. LoPucki and Joseph W. Doherty: Supposedly, the bondholders "agreed" to be subordinate to the banks. That deal is made on behalf of investors by the investment bank that underwrites the bonds. Many investors are probably unaware of the priority of the bonds they buy, so it isn't much of an "agreement." But you can by senior bonds in some companies.

Lynn M. LoPucki and Joseph W. Doherty: Thanks for the great questions. It has been a pleasure.

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