Chapter 11: Strategic advantage and social anathema?

Chapter 11" Strategic Advantage and Social Anathema?

Brad Johnson B. R. Baliga

John D. Blair

ABSTRACT. The United States is at a crossroad in its treatment of Chapter 11 of the Bankruptcy Code, which deals with reorganization of "bankrupt" organizations. It is vital that the issues surrounding the debate be properly framed. This paper attempts to do just that by reviewing the evolution of bankruptcy law, assessing the impact of Chapter 11 leniency on societal stakeholders, considering bankruptcy as a strategic option, and addressing the ethical and societal issues that arise from the use of Chapter 11 to avoid massive litigation or to abrogate labor contracts. Serious threats to the underlying fibers of the American system of enterprise are exposed and an assessment of these threats is offered.

In the increasingly intense race for profitabili ty - and of ten survival - in today 's corporate arena, pressure for innovative strategies compels strategists to exercise any and every legal opt ion they have for their companies ' long run benefit.

Brad Johnson is a consultant with FLR Health Resources, Dallas, Texas. His recent research has addressed health care strategic management, societal consequences of health care systems changes, and competitiveness of NFP organizations.

B. R. Baliga is Assistant Professor in Business Policy and International Business at the College of Business Administration at Texas Tech University. He has written two books on Strategies of Multinational Corporations and several articles, whichhave appeared in Strategic Management Journal and Journal of International Business Studies.

John D. Blair is Associate Professor of Management at the College of Bussiness Administration at Texas Tech University. He is also Associate Professor of Health Organization and Management at the School of Medicine at Texas Tech University. He has written two coauthored books: The All-Volunteer Force: A Study of Ideology in the Military (University of Michican Press, i977) and Leadership on the Future Battlefield (Pergamon Press, 1984).

Meeting this head on is the voice of the public, expressing its consternat ion over the business communi ty ' s assertiveness in redefining the competitive nature and societal role of the American business sector. In no other situation is this conflict so clear as in the case o f business reorganization, as established under the reorganization chapter of the Bankruptcy Law. Here, several profitable companies are employing Chapter 11 to protect themselves, claiming imminent bankruptcy, from lawsuits and contracts that damage their competitiveness. While legal, such actions are of a questionable ethical nature.

This paper a t tempts to help frame the societal, ethical, and strategic sides o f bankruptcy laws. We start by looking at the evolution of bankruptcy laws.

The evolution of bankruptcy law 1

In its earliest forms the bankruptcy laws, from which the contemporary U.S. laws derive, were far from conciliatory. Indeed, prior to the adop- t ion of early Roman laws, the debtor who could not pay "was either killed, made a slave, imprisoned or exiled" (Ross, 1974). Evolving bankruptcy law in Italian society existed not to relieve the debtor, but to aid creditors in collect- ing their claims.

After spreading throughout Europe, these roots of bankruptcy law were transplanted to England by Henry VIII in 1543 (Riesenfeld, 1974). With time, provisions allowing debtors adjudged "hones t" to avoid imprisonment were devised, though most debtors were still severely punished and were subject to destruction of their benches or trading places - banca rotta in

Journal o f Business Ethics 5 (1986) 51--61. @ 1986 by D. Reidel Publishing Company.

52 Brad Johnson et al.

Italian law or banquerote in French law, hence the English "bankrupt" (Radin, 1940). English Bankruptcy law, while restricting many harsh penalties such as debtor dissection and detention of deceased debtors, still employed types of debtor imprisonment (May, 1912). It was this package of laws that was imported by the framers of the U.S. Constitution and the Bank- ruptcy Act of 1800 (Statutes at Large, 1800).

Only toward the end of the nineteenth cen- tury did modern protection enter the bankruptcy law, ushered in by the fourth Bankruptcy Act, passed by Congress in 1898 (Kansas Law Review, 1983). As revised by numerous amend- ments and the Chandler Act in 1938, the newer bankruptcy law provided for reorganizations, as well as liquidations, so that the

"honest but unfortunate debtor who surrrenders for distribution the property which he owns at the time of bankruptcy... [is given] a new opportunity in life and a clear field for the future effort, unham- pered by the pressure and discouragement of pre- existing debt" (Act of June 22, 1938; Local Loan Co. v. Hunt; emphasis added).

Growing criticism of the bankruptcy system during the 1960's led the Congress to create the Federal Commission on the Bankruptcy Laws of the United States to study and recommend revisions of the 1898 Act (Public Law 91-354). The need for reform was voiced by this body which pointed to costly and nonsubsequential litigation, nonuniformity in application of the law, and the rising volume of consumer bankruptcy since World War II (Trost, et aI., 1978). The nonuniformity problem addressed here reflects the impact of numerous state laws on bankruptcy. Ultimately, the Commission recommended a complete revision of the bankruptcy system and of the substantive law. The result was the adoption by Congress of the Federal Bankruptcy Reform Act of 1978 (the Bankruptcy Code - see Public Law 95-598).

The Reform Act made substantial progress toward improving the efficiency and effective- ness of the process. Included in the changes were a consolidation of reorganization provisions under the current Chapter 11, which stands as one of the four operative chapters of the Bank-

ruptcy Code along with Chapter 7 (liquidation), Chapter 13 (for individuals with regular incomes), and Chapter 15 (for municipalities) (Riesenfeld, 1975). Businesses can generally file under Chapter 7, Chapter 13, or Chapter 11, where appropriate. The appositeness of filing under Chapter 11 is of primary concern here; however, before proceeding with a closer look at Chapter 11 and subsequent actions taken regarding reorganization it is necessary to take note of one further change brought about by the Reform Act.

Under the Reform Act, the former referees in bankruptcy were given greater judicial status. Suffice it to point out that these referees were given Article I (of the Constitution) status and Article III powers. [Article I judges are appointed for fourteen years with no salary stability guarantees; Article III judges are appointed for life by the President, as confirmed by the Senate, and are guaranteed no salary cuts.] In 1982, the Supreme Court ruled the Reform Act unconstitutional and only in late June of 1984 following numerous delays and interim actions, did Congress compose a new, and controversial, arrangement of judicial powers for the Bankruptcy Code. The new system gives (Article III) Federal District Judges oversight over bankruptcy court rulings, while maintaining Article I status for bankruptcy judges. Reaction has been quick and harsh, as many have questioned the constitutionality of the new arrangement, as well as the potentially burdensome impact it could have on the court system (Dahl, 1984).

The importance of this debate over the constitutionality of the new bill lies in the inclusion of several Chapter 11 alterations included in the bill that could have a serious impact on "questionable" Chapter 11 filings and thus on its use as a strategic option by corporations. Most importantly, as we shall see subsequently, the societal redefinition of Chapter 11 in terms of the ethics underlying its usage currently hangs in the balance.

Chapter 11 and its evolution

Chapter 11 exists to allow rehabilitation, not

Strategic Advantage and Social Anathema 53

liquidation, of the estate of a debtor. Petition for reorganization can be filed by either debtor or creditors. A filing under Chapter 11 allows the business to maintain operations while constraining the property of the debtor. The stay grants the debtor time to examine his situation and hopefully choose a positive course of action for the business out from under the pressures that caused the initial filing (Riesen- feld, 1975).

The key to Chapter 11 is the reorganization plan under which the bankruptcy court dis- charges the debtor and assures the business' continued existence. As further operations are expected, the debtor usually retains possession of the estate's assets and makes payments to creditors pursuant to the reorganization plan. The plan is deemed acceptable when a majority of the creditors who hold two-thirds of the claims and two-thirds o f voting stockholder interest approve the plan. It must then be confirmed by the court, which considers the interest of the non-approving creditors or shareholders (u.s.c., 1982).

For a debtor to file under Chapter 11 he must simply be willing to be adjudged bankrupt, i.e. that his company is unable to meet present or future claims against it. For a creditor to file against a debtor, the creditor must allege that the debtor is not paying his debts as they come due or that within 120 days prior to the petition a custodian was appointed or took possession of essentially all of the debtor's property (U.S.C., 1982).

Chapter 11 assumes that a business that is allowed to step back and reconfigure its operations, without ongoing creditor pressure, will be of more value to the society than would be the bundle of assets distributed among its creditors in liquidation. This opportunity for a clean break with past problems, coupled with equal, if incomplete, reimbursement to creditors, has been generally accepted and applauded as a fair refuge for the honest debtor. With this in mind, we can turn to recent actions that have put Chapter 11 on the bestseller list.

New interpretations of bankruptcy

Reviewing a few popular cases involving innovative uses of the bankruptcy law will help to frame the strategic, ethical, and societal issues surrounding Chapter 11. One set of cases deals with protection against plaintiffs, the other with protection from expensive labor contracts.

Following the lead of UNR Industries, Inc., a former manufacturer of asbestos insulation, Manville Corporation filed under Chapter 11 in August, 1982. It claimed not that the company had failed financially, but that it was faced with future asbestos-related lawsuits that would cost anywhere from $ 2 billion to $10 billion, provid- ing a major current operations threat to the company (Marbach and Copeland, 1982; Gini, 1984). This filing, by a Fortune 500 company that earned about $60 million in 1983 with a net worth greater than $1 billion, shocked both the financial and legal communities, as well as Manville's creditors and litigants. The filing freed Manville from the onslaught of injury claims against it by people who had worked with or had been exposed to Manville's asbestos products over the past forty years, and it froze all pending suits while allowing Manville to maintain its quite profitable operations. In addressing the action, a regretful and even angry John McKinney (Manville's Chairman) asserted that the board could see no other option for the long-term existence of Manville, (New York Times, 1982) thus implicitly acknowledging the primacy of shareholder claims over those of other stakeholders.

The Manville case is much more involved than stated here. Government noncooperation, insurance company disputes, and even unusual settlements protecting what many see as the wrong parties, are all scenes in this drama (Taylor & Dahl, 1984). Our focus, however, is rightly limited to the dispute over whether Man- ville, and similarly positioned UNR, should be allowed to seek protection for "reorganization" under the bankruptcy code, and whether such actions are ethical.

Before attempting to answer this question, we need to broaden it by addressing the other major debate - that focusing on the use o'f Chapter 11


to break labor contracts. Leading examples here include Wilson Food Corp. and Continental Air- lines, though perhaps the most crucial to date is that of Bildisco and Bildisco, a New Jersey window and door wholesaler that filed under Chapter 11 and requested cancellation of its contract with the Teamsters' Union. In 1981, a Federal Appeals Court granted this request, asserting that a company could, under the bankruptcy provisions, break "burdensome" labor contracts even though they would not provide for the imminent collapse of the company (Martin, 1983). The decision was then ushered to the Supreme Court by the Teamsters.

Meanwhile, in April 1983, Wilson Foods filed under Chapter 11, and subsequently announced termination of its collective bargaining agreement. Wilson cut wages by almost half, claiming it "didn't have any alternative," and that its labor costs were much higher than those of its competitors (Business Week, 1983). The move to reject the labor contract in 1983 followed an agreement by Wilson union workers in 1981 to accept a four-year wage freeze, Wilson's move basically forced workers in a company worth more than $ 60 million, who had earlier shown a willingness to work with management, to bear the burden of management's inability to compete.

In September of that same year, Texas Air Corporation's subsidiary Continental Airlines Corp. filed Chapter 11, laid off 65% of its workers, and abrogated its labor contracts. Con- tinental began flying again within the week with low fares and a curtailed flight schedule. Ironical- ly, while cutting wages virtually in half, company official asserted that they were not in a cash crunch (Burrough, et al., 1983).

In late February of 1984 the Supreme Court handed down a 9 - 0 ruling allowing Bildisco's abrogation of its labor contract under Chapter 11. The finding supported the earlier conclusion that imminent collapse did not need to be proven, but rather that the contract was unduly burdensome. Businesses have been directed to also show that they have made "reasonable" (left largely unspecified) attempts to secure concessions from employees. The Court also ruled that businesses may break union contracts

upon filing for bankruptcy, even before any organization plan has been considered by the bankruptcy court (Time, 1984).

Responses by Congress

The Congressional debate over bankruptcy judge powers provided an opportunity to reconsider the intent of Chapter 11. In late June 1984, Congress settled on changes addressing both of these issues. As noted earlier, debate continues over the controversial bankruptcy judge power issue. The labor contract abrogation dispute was dealt with by ruling that businesses must offer unions their proposals before moving to any bankruptcy reorganization stage. Furthermore, judges were admonished to consider reorganization schemes' impacts on all stakeholders involved. It is suggested that this change will eliminate strong-arm moves like those of Wilson and Continental (Business Week, 1984). Indeed, the bill's labor provision would counter the unanimous Bildisco decision itself, as it estab- lishes much stronger protections for labor by focusing on jobs that would be lost were the contract revisions suggested by management not accepted (Miller & Langerman, 1984). It is important to note, however, that the extent of negotiations that are to be undertaken is not specified and it is essentially up to the presiding judge to determine if these are adequate or not. The revisions further assume that management will act in good faith - a questionable assump- tion in light of events that have recently transpired.

Pending issues

As indicated above, recent revisions in the law leave unsettled the use of Chapter 11 in situations such as that faced by Manville, nor is debate concluded concerning the availability of Chapter 11 for dissolving labor contracts. Most importantly, the central questions of the philosophical basis for Chapter 11 and the role of Chapter 11 in the 1980's corporate America remain shadowed by the murky and often


ambiguous messages sent forth from various governmental decision-making bodies. It is unclear whether Chapter 11 exists now as a tool for extending the life of a good business that had some bad breaks, as a downgraded punishment for poor management, or as a strategic option for modern American businesses. These issues must be considered in the context of the social role of business as well as that of business' desire to survive or increase profitability.

The ethical issues in bankruptcy filings

Specific issues

The actions of Manville, Wilson, and Con- tinential raise a number of interesting issues concerning ethical behavior in a competitive society. Manville was able to derive significant benefits (revenues, profits, etc.) from its asbestos operations, yet it has side-stepped a major portion of the costs associated with those operations. The actions are all the more dis- turbing when one realizes that Manville's management was long aware of diseases caused by asbestos dust. Chapter 11 filing makes it extremely difficult for former employees and customers of Manville to collect damages, even though Manville remains an ongoing concern.

The Manville case is confounded by the roles of two other major parties involved in the situation-the government and Manville's insurers. The U.S. government was a major customer and it encouraged Manville to produce vast quanti- ties of asbestos in order to meet Naval needs. The question of whether it is appropriate for the government to assume that it is above the law, but not the company it contracted with, indubitably arises. Furthermore if the government, through lenient Chapter 11 interpretation, permits profitable corporations to restructure themselves to avoid costs associated with legal injury claims, it then assumes a new role in the U.S. commerce system and becomes party to ethically questionable behavior.

The role played by Manville's insurers is

equally questionable (Gini, 1984). These companies purportedly supply Manville with protection against all sorts of clams against it. A major problem in settling the Manville case has been the dispute over which insurance companies, if any, should settle the clams of litigants. Those insurers employed by Manville during the period in which the diseases were contracted claim they are no longer liable, as they no longer insure Manville. Current insurers make the opposite argument, claiming non-responsibility since the injuries were actually incurred long before they started insuring Manville.

While the legality of the stance taken by Man- ville, the U.S. government and the various insurance companies involved is not in question, such actions raise questions of what should have been the moral and ethical responses by the parties involved. One could argue that the most ethically effective (though possibly economical- ly ineffective) response would have been to work out, in conjunction with its past and current insurers a fair settlement with the litigants. Government, through the Justice Depart- ment, could have intervened to set some limit on the liability of Manville and the insurance companies while ensuring reasonableness of the settlement. Moreover, if the government was truly convinced that Manville's management was not fully aware of the danger of its asbestos operation (though this is debatable) then it could have intervened to legislate a special fund to meet claims similar to that set up to meet claims arising out of natural disasters. Such actions by the key parties involved would have fostered a perception of "concern and fairness" in the minds of the public.

The Manville case also raises some interesting issues pertaining to the ethics of free competition. In a competitive society survival of a company is deemed to be a function of its ability to compete successfully in meeting the demands of the marketplace. This is done through offering an appropriate mix of products/services at a price that customers perceive to be a good value and which enables the company to meet the expectations of its shareholders. The corporation is expected to bear the costs of such competition. It could be argued that by filing under


Chapter 11 and avoiding the full payment of associated costs Manville enjoys a "societal subsidy". As a result, Manville is in a position to compete very aggressively and cause damage to its full-cost-bearing competitors.

Continental and Wilson Foods, likewise, could utilize their reduced cost structures to move aggressively against competitors. If competition from companies such as Wilson and Continental becomes very intense, it seems logical that competitors will seek either similar restructuring protection or will adopt other strategies 2 to ensure that they Can remain competitive. Given that such maneuvering has already begun to transpire, the need clearly exists to develop mechanisms to restrain companies from employing Chapter 11 provisions for purposes of engaging in predatory competitive activities.

Clearly, customers involved in the Manville and Continential situations are affected quite differently. In the case of Manville, some customers may now be litigants, suffering, uncom- pensated, or undercompensated, at the hands of the organization's maneuvering. Customers who held Continental tickets in late August of 1983 clearly suffered tremendous inconveniences from the cancellation of their "contracts" with Continental. It could, however, be argued that customers of a restructured Continental would benefit from lowered ticket prices. This benefit is likely to be transient, though, as fierce price competition could easily drive out a number of marginal airlines (including Continental) and permit the stronger ones to assume the more profitable price structures they enjoyed in the past.

Labor is a key group affected in each of these situations. For Manville, some workers of former workers are among the litigants. Their plight has been covered elsewhere. As for Wilson and Con- tinental, fairness clearly becomes an issue. No prior notification of contract cancellation was given in either situation. Contracts - explicit and specific legal agreements to exchange services for money and other benefits - were broken outright. Many in the Continental situation simply lost their jobs outright. All lost the level of reimbursements that they had bargained for and agreed to, including pensions,

insurance benefits, etc. Here the primary concern must be for the collective bargaining system in the United States. If companies are allowed to break labor contracts at will, what security exists for labor in any contract? And, for those in society gleeful that unions are taking some hard knocks at present, what precedent does this set for contracts with all suppliers ? In essence, unions are simply suppliers too. If indeed managerial actions were found to be wanting, how ethical is it for management to seek refuge under Chapter 11 provisions and make unions and other suppliers the scapegoat. Might not management need to be tossed out with the "bad contracts" or bad products that they sanctioned? A clean slate might also require a new piece of chalk.

Broader issues

What are the broader societal implications of such uses of Bankruptcy Laws by corporations? The focus of our discussion can now shift to issues of intent of the law and the role of businesses in American society. The ethics of the issue lie largely in breeches of faith with society's desires and expectations.

One might assume that Chapter 11 was designed to allow all sorts of protective maneuvers. If so, we are now moving toward something of a "strategic contracting" approach to management. Corporations would con- ceivably be allowed to opt for agreements that clearly favor their contracted partners with great down-line benefits promised in exchange for rapid transmission of the desired goods and services. Upon receiving the desired supplies, the corporation could then simply file for bankruptcy under Chapter 11, asserting that the contract is "burdensome" and it restricts their ability to compete. The implications of this are many, some quite subtle. This could easily serve as a marvelous inducement for foreign companies seeking access to U.S. markets by allowing them to establish channels of distribution and other difficult-to-develop structural arrange- ments, only to exercise their legal rights and declare bankruptcy, leaving these now available


channels open to parent or sister organizations. This might also allow for limited responsibility for foul-ups, permitting companies to say "we were wrong, and we may have known it long ago, but we can only pay society back a pittance for the benefits we reaped at its expense. Sorry." This societal subsidy may be an unintended consequence of Chapter 11.

Yet, this emphatic approach to shareholder wealth maximization - that heralded com- mandment of corporate America - seems a bit simplistic. An equally important tenet of a free enterprise philosophy is its insistence that strong performers be allowed to enjoy their rewards and that poor performers be allowed to fail. From the history of bankruptcy law it is easy to conclude that the Chapter 11 outlet was created for extending benevolence, not blessings, to corporate failures. Even with the seemingly utili- tarian approach of measuring stakeholder impacts, positive and negative, one does get the feeling that some limits on business maneuvering are necessary for the safety and welfare of the larger society.

This point again focuses us on the value of ongoing operations. Benefits to a society do exist if firms are kept alive to continue operations in a competitive society. Yet we must ask where the line is drawn separating legitimate demands for businesses to meet their obligations and the willingness to allow businesses to continue to operate despite harm to parts of society. Manville has argued that the only way litigants will realize any real compensation for their misery is through an up-front settlement and, presumably, continued operations. This stance becomes a bit questionable when we consider that the proposed settlement fails far short of meeting claims (see Dahl, 1984), and that Chap- ter 11 exists to eliminate claims, not postpone them. Of what consequence is it to litigants that Manville remains active if proposed reimbursements are insufficient and claims are dissolved? The societal issue here is whether Manville's existence is more important than the punishment of normal business failure coupled with the rightful claims of those killed or diseased by corporate operations. The ethical issue lies in Manville's clear avoidance of claims it rightfully

owes - a rejection of its responsibility as an erring citizen in society.

As for the labor (or supplier) contract issue, society must balance the benefits of ongoing operations against two types of costs: the real losses for laborers and societal implications of rapid and unexpected contract abrogation. Here, the National Labor Relations Acts seems to stand at the mercy of bankruptcy judges, though it is very difficult to assume that Chapter 11 stands superior to the NLRA, or vica versa. The gravity of individual decisions here is evident. The bankruptcy judges are faced with clear pressure to determine societal directions in terms of both of these laws, and their roles in devising and implementing solutions to the problem must be appreciated. And beyond the NLRA, should wage agreements be open to rejection by management due to their "burdensome" nature, all types of "burdensome" contracts may provide corporations the carriage to ride into Chapter 11 protection.

What we can see from this set of societal issues is that bankruptcy, as a strategic option, falls under the letter of the law. Yet the current debate in Congress and indeed throughout the country raises questions as to whether the spirit of the law stands intact. We see managers fighting with all their might to compete, as society wishes, to the best of their abilities. But we must question whether these actions violate the broader ethical expectations society places upon organizations that choose to compete in its markets.

Conclusion: the ethics of bankruptcy

And so we have before us a set of specific issues as well as a set of more general yet encumbering issues that seem to frame the question of Chap- ter 11 maneuvering as the societal level problem that it rightfully is. It is this framing of the question that we see as most vital to public deter- mination of the fate of Chapter 11.

The specific issues confronted here concern contract security (as reflected in the Wilson, Continental, and Bildisco cases) and product liability and corporate responsibility (as seen in


the UNR and Manville cases). The more general issues here, reflected in the corporate actions taken in all of these cases, concern the free market nature of our enterprise system and the spirit of the bankruptcy reorganization law. Each of these issues must be considered within the framework of the larger society, with individual stakeholder group emphasis added as appropriate. We will address these issues in turn for summary but also evaluative purposes.

Contract security

As we have noted, labor contracts appear to be in serious jeopardy given recent judicial decisions. Changes in the trend toward abrogation may be evident as reflected in recent Con- gressional moves, yet the issue itself must be considered by the society as a whole, as it continues to reassess the option of reorganization.

Labor contracts have, in recent years, borne much public criticism for their generosity to the American worker. And yet these contracts are contracts. They were agreed to and signed by both management and labor representatives, and the criticism was never over the legal obliga- tion of each side to uphold its end of the bar- gain. A dangerous threat confronts the contract process that has evolved over so many years. Loss of honor and trust in this process seems to threaten the very foundations of contractual agreements. If contracts can be broken due to high wage costs over the next few years, what security exists for the workers who, attempting to work with their employers, seek job security or educational agreements in lieu of wage concessions? These agreements would clearly burden the employer in future time periods. Can he as well break these agreements at will? And what of contracts in general? Are all suppliers now to be faced with total uncertainty as to whether they will be reimbursed for their efforts? This does not appear to be the intended outcome of Chapter 11, but it is certainly a plausible one.

Were such developments to occur, even on a limited scale, the logical outcome would be a counterattack by labor, litigants, and suppliers.

The reorganization law allows for filing by either creditor or debtor. Coalition building among creditors and preemptive strikes against debtors become very real options. If these terms smack of warfare tactics, it is because that is the mentality they reflect. Is further division between sectors of the American society what is really needed for it to become more vital? Probably not. Cooperation is a much less frightening tact. That is where the role of bankruptcy judges again becomes vital, as the opportunity is presently open for them to steer the society clear of this path to open combat. Alter- native compensation packages benefitting both labor and management, such as multi-tiered packages or profit-sharing or productivity agreements may need to be demanded by judges, forcing the two sides to behave and work together for the greater benefit of the company and the society.

And yet the problem here is not one-sided. Labor has to recognize that if it seeks to enjoy the benefits of company profitability, some risks accrue to them as well as to their managers. Sharing in gains means sharing in losses as well. Employees may well need to view their jobs as entrepreneurial efforts that may take them to victory or defeat.

The essence of the issue, though, lies in recog- nizing the inherent threat and misdirection in contract abrogation moves. If a company agrees to a contract, it must honor that contract at all costs. One brick out of the dam causes a flood. The village of honest enterprise lies at the foot of the dam.

Product liability and corporate responsibility

As noted, ongoing concerns are quite valuable to American growth and development. The question is whether entrepreneurial actions that results in great damage to people throughout the society should be excused. Embodied within this question is a more direct one of whether product liability claim protection 3 is similar enough to regular creditor claim protection, based on the spirit of the bankruptcy laws, to warrant similar protection. Should companies be


allowed to sidestep the losses associated with decisions made, the benefits of which have already been enjoyed? A mistake in judgement can be forgiven under the bankruptcy laws. But when the mistake leads to loss of life and health for literally tens of thousand of people, and when the profits from those activities have already been consumed, can the company ethically walk away from those it has harmed? The ramifications are tremendous for both individuals in society and the mechanics of the society's system of enterprise.

The free enterprise system

Granted we have no "free" enterprise system. Yet the major tenets of American society emphasize competition, rewards for success, and fairness toward the unsuccessful. Winners and losers alike have provided the foundation for the progress of each succeeding generation of entre- preneurs. Chapter 11 stands as a regulatory exception to the Darwinian process of competition. Corporations are complaining more and more vociferously these days about over-regulation of their activities, and yet, if the actions of corporations are seen to abuse the regulatory supports that society offers corporations, how can the society be expected to remove other constraints it builds through regulation? Cor- porate self-control or self-governance would be ideal. An open system of success and failure and subsequent repeat attempts to succeed would be cherished. Such desires wane, however, when the society perceives its primary legal support for those repeat entrepreneurial efforts being abused. Perhaps a true free enterprise system could be established. But this would have to operate without the laws that promote business efforts, as well as those that restrict them.

This issue is not new, and it clearly is one that lies at the heart of free market philosophy. (Cavanagh, 1984, provides an excellent discussion of this debate.) Assuming, though, that we retain Chapter 11 opportunities for honest organizations, we must, as a society, decide the point at which promotion of entrepreneurship turns to societal subsidy of the nature discussed

earlier. It seems that it will be much easier for society to err on the side of restricted use of the reorganization chapter if businesses continue to act in ways which give the appearance of abusing the spirit of the law.

The spirit of the law

The evolution of bankruptcy law, especially as embodied in the 1898 laws and beyond, moves the emphasis more and more toward protecting the benefits to society flowing from ongoing operations, possibly at the expense of those to whom the businesses are obligated. With this in mind, corporations should be encouraged, from a societal and strategic point of view, to employ this potentially effective and efficient way to turn around the business and maintain their inveterate place in society. It is easy to conclude, however, that the intention of Chapter 11 is to provide a benevolent second chance to unfortunate yet honest companies that have tried everything possible to meet their obligations. It is much more difficult to surmise that any Congress or court, much less any society frozen in time, intended companies to enter or leave obligations at will - as it suited their purposes. There is a clear balancing of the value of ongoing operations against the costs of both abrogating obligations and of allowing businesses to defame the honor and commitment that is supposed to underlie their contractual and social actions. Ongoing-ness is not omnipotent. This is an ethical issue. Organizations turning their backs on either the societies who have helped them succeed or the parties with whom they have made explicit legal agreements must face the scrutiny of the society that has provided them with the opportunity to compete. And the spirit of Chapter 11 does not offer itself as a cloak for these companies, rightly naked as they stand to be judged by the societies in which they exist.

A final comment

That bankruptcy as a strategic option for cor-

60 Brad Johnson et aI.

porations is even debated reflects an important change in the way bankruptcy is viewed by the public. Bankruptcy means failure. Traditionally, there has been a negative stigma that was included in the bankruptcy package. It is precisely loss of this stigma that may be the greatest threat to the American business sector as laws and attitudes change. As more and more companies file under Chapter 11, following the lead of that innovative set making headlines and used as examples here, bankruptcy loses its punitive value. It becomes just another maneuver, something that means no more to society than diversification. This is where the real value of bankruptcy may be threatened, as the whole society is pushed into disregarding the meaning of failure. The law would thus be rendered impotent, intent would be disregarded. Instead of dumping poor management for its performance, it has the protection necessary to fail again, to remain poor, substandard, and ineffective.

It seems, then, that bankruptcy is a vital part of the free market system that our society employs. The opportunity to have a second chance is available, but at a very high cost. The process of rewarding winners and punishing losers suggests that this second chance is the exception, rather than the rule. Organizations that fail play an important role as examples of how not to run a business. "If you erode the frontiers of Chapter 11, and depart from the traditional basis for rehabilitating a company," remarks New York banking lawyer Jack Gross, "you may get to the point where the law will be so amended as to make rehabilitation an almost impossible task. And that will hurt the company that really and sorely needs rehabilitation" (quoted in Glaberson, 1983). They may be allowed to make a comeback of some sort, but Chapter 11 is not intended to give them some great advantage in their reassertion. Rather, it is available for companies to use as a last resort to eliminate disadvantage. The long-run gains that individual companies now seek under Chapter 11 may indeed provide a long-run demise in the punitive, competitive forces underlying our market system. That this loss of our basic free market orientation would be dangerous is reflected in the responses our society, through

Congress particularly, seems to be making to companies using Chapter 11 in innovative but unintended ways. The stakes here are great. A cornerstone of our free market system is ready to crumble.

It is not our desire in this effort to point a judgemental finger at any particular party or organization. We have focused on a few organizations that opted for innovative Chapter 11 actions because of the convenience of their cases and because public scrutiny of their actions comes with their decisions to use Chapter 11. The decision makers in these situations clearly acted for their companies and their stockholders. That is their job. Perhaps if any party is at fault it is the society as a whole, which had not made explicit enough at the outset the kind of societal contract it made with the business sector, this societal contract being the ethical expectation purportedly violated.

It is our intention to point a finger at the issue itself. The immediacy of the issue - the vitality of current debate over Chapter 11 - demands the involvement of all parties, all voices in the society, not just those of pro-labor or pro- management lobbyists. This is a societal issue, and all stakeholders have a responsibility to help determine the outcome. Hopefully, our align- ment of the issues underlying the ethical, societal, and strategic angles of Chapter 11 will help those stakeholders to analyze the issue, whether or not the opinions emerging from their analyses concur with ours.

N o t e s

1 The authors wish to thank Carvan Adkins for legal research on bankruptcy laws. 2 Following Continetal's (and Braniff's) refuge in Chapter 11 and their subsequent restructuring as low- cost carriers (as a result of wage concessions won from employees), United and American Airlines (major competitors of Continental and Braniff) put intense pressure on their unions to accept a two-tier wage struc- ture in which recently hired personnel were paid con- siderably less than employees with seniority even though their work was identical. Other amines in the industry are expected to follow this lead. 3 An interesting case in point is that of Ford Pinto,


where evidence was introduced in court to show that Ford was aware of the hazard in the event of rear end collisions. Could Ford have utilized Chapter 11 provision to surmount claims arising from rear-end collisions? The cases cited in the paper lead one to believe that they could have done so. That Ford chose not to do so lends a degree of credit to Ford's ethics in a very nasty situation.

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Area of Management, College of Business Administration,

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Chapter 11: Strategic advantage and social anathema?

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