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Thursday, September 08, 2016

Enron & ITT Tech

In the late 1990s, the energy company Enron was regarded as "a new-economy maverick" that was able to up-end the energy sector's traditional business model. As a result, it quickly became a Wall Street darling and was soon "one of the nation's ten largest companies." By November 2001, Enron's fates had changed. It was revealed that Enron had been using special purpose entities to hide bad debt and toxic assets from its investors and creditors. This tactic--along with "deceptive bookkeeping" and its executives' criminal actions--swiftly caused the company's collapse. The company's collapse left tens of thousands of employees without jobs, wiped out ~$70 billion of its investors equity, and roiled the financial markets. Within a month, Enron filed a voluntary petition for bankruptcy.

In the late 1990s, the prospect of an Enron bankruptcy would have been unthinkable. But by late 2001, bankruptcy was the best path forward for preserving value for the company's creditors. Indeed, more than $14.6 billion was returned to creditors through Enron's chapter 11 bankruptcy case, an amount that exceeded early estimates by more than 225%. Most notably, Enron's chapter 11 bankruptcy filing allowed the company the opportunity to reorganize its business under a new name for the benefit of the company's creditors and employees.

Enron's bankruptcy case can be contrasted with the treatment of another disgraced Wall Street darling--ITT Educational Services, Inc. ("ITT").

From 2000-03, the shares of publicly-traded for-profit colleges soared, rising 460% during a time period when the S&P 500 lost 24%. ITT was one of the nation's largest for-profit college chains and was often the most profitable one. But, like Enron, ITT saw its fates quickly change. Like Enron, ITT executives were accused of perpetrating a massive fraud. Just this week, these allegations and concerns about the chain's "organizational integrity" and "financial viability" precipitated the U.S. Department of Education's decision to subject ITT to heightened financial oversight and ban it from enrolling new students that require federal financial aid. As a result, ITT abruptly announced that it was immediately closing all of its schools.

Unlike Enron, ITT will not reorganize in bankruptcy. There will be no opportunity for ITT to restructure its operations and emerge from bankruptcy court protection because colleges are functionally prohibited from bankruptcy reorganization. As a result, ITT's creditors are likely to obtain a minimal recovery, ITT's faculty and staff will all lose their jobs, and ITT's students will have to try to make other arrangements for completing their education. Why the difference? What justifies treating the ITT's of the world differently from the Enron's of the world? In a series of articles (including this forthcoming one), I have sought to explain why I think that this sort of differential access to bankruptcy reorganization is inappropriate. And in future blog posts, I look forward to explaining some of my thoughts and reading your responses.

Posted by Matthew Bruckner on September 8, 2016 at 09:49 AM | Permalink

Comments

What's this about?
"except that this paragraph shall not apply to a nonprofit institution, the primary function of which is to provide health care educational services (or an affiliate of such an institution that has the power, by contract or ownership interest, to direct or cause the direction of the institution’s management or policies) that files for bankruptcy under chapter 11 of title 11 between July 1, 1998, and December 1, 1998;"

Some kind of special provision for one particular institution that they wanted avoid naming directly?

Posted by: brad | Sep 8, 2016 4:06:59 PM

Brad, it has always seemed that way to me. But the provision predates my entry to the bankruptcy world and I've never been able to track down who it was meant to apply to after the fact.

Posted by: Matthew Bruckner | Sep 9, 2016 11:15:23 AM

Professor -

I would be interested in some additional color around your statement that colleges are functionally prohibited from bankruptcy reorganization and how you view a case such as In re Morris Brown College (Bankr. N.D. Ga., Case No. 12-71188).

Also, do you not expect that ITT will file for Chapter 11 in order to effectuate an orderly wind-down and utilize section 363 to effectuate sales of whichever of its assets have value? Isn't ITT more like a failed retailer that begins closing stores, laying off staff and liquidating inventory before filing for bankruptcy to complete the process?

Posted by: Randy | Sep 9, 2016 1:10:08 PM

Randy,

Thanks for engaging. I'm glad to try to explain. When I wrote "functionally prohibited", I meant that the prohibition is one of economics and not one of law. Most colleges and universities receive a substantial percentage of their annual revenue from students who take advantage of Title IV's student loan and grant programs. However, only an "institution of higher education" is permitted to participate in those Title IV programs. And 20 USC 1002(a)(4)(A) excludes from this definition any institution that "has filed for bankruptcy". Therefore, it's not that colleges and universities may not file for bankruptcy (as Morris Brown clearly demonstrates), but that most colleges could not survive a bankruptcy filing because they are dependent on Title IV dollars.

In many ways, I think that Morris Brown is an exception that proves the truth of my statement. It's a tiny school (~30 students) that has teetered on the brink of financial collapse for a long time. To my mind, it's chances of becoming financially stable while eschewing the business model pursued by the vast majority of other institutions is slim.

And yes, I expect that ITT will--as Corinthian Colleges did--file for bankruptcy to liquidate its remaining holdings, obtaining fire sale prices for its assets. What I don't expect is for ITT to use Chapter 11 to reorganize because without access to Title IV, its reorganization prospects are nil.

In my earlier post, I meant only to contrast Enron's opportunity to reorganize itself with ITT's lack of opportunity to do so. Why should we deny colleges the chance to reorganize, but allow Enron and its ilk the chance to do so?

Posted by: Matthew Bruckner | Sep 9, 2016 2:52:00 PM

Matthew -

Thank you for the response and additional information. It certainly helped me in understanding what you meant by functionally prohibited. And, certainly I agree that the inability for students to access those financial aid resources would be fatal to most attempts at reorganizations in the traditional sense.

Your additional explanation raised for me the question of whether there are other similar situations. Initially, focusing on the fraud element (which seems to be the linkage between your ITT and Enron examples), I thought of Madoff and securities brokerage regulations. Had the Madoff filing included an attempt to reorganize and continue BLMIS as an on-going but non-fraudulent brokerage, regulators would have been unlikely to reinstate the required licenses.

However, it then occurred to me that the existence or absence of fraud is more likely not the key element. Rather, it is the necessity for federal funding or federally-guaranteed funding. The ability for certain aspects of Enron's businesses to be reorganized and continue on was a result of those businesses to secure sources of capital that were sufficient to support their go-forward needs (and that the market viewed the assets as having a meaningful going concern value independent of the allegedly fraudulent conduct).

Similarly, it appears that the statute that you cite is focused solely on the occurrence of a bankruptcy filing regardless of the existence of fraud. If I understand that correctly, does this not look more like the DOE loan guarantees that ultimately doomed companies such as Solydra and Fisker when those companies were unable to meet the requirements for continuing access to those guarantees? I recognize that the particular examples that I cite saw their funding access cut-off prior to their bankruptcy filings, but I presume that a bankruptcy filing would have triggered the same consequences had it preceded the cut-off.

The similarity that I suggest between the university bankruptcy funding issue that you reference and the DOE loan guarantee issues that I reference is that, in both situations, alternate sources of financing sufficient to support the needs of the debtors did not exist such that the inability to access the federally-provided or guaranteed financing dooms the companies to liquidation.

Posted by: Randy | Sep 9, 2016 7:14:24 PM

Hi Randy,

I believe that your comments are spot on. Thanks for them. I did focus on Enron and ITT because of the fraud connection. And you're right, fraud seems like it should not be the key element. Yet, Congress appears to have been concerned with fly-by-night colleges fleecing students and then avoiding their obligations by filing for bankruptcy. See S. REP. No. 102-58 (1991), at *19 (noting the concerns of the Inspector General). The Senate Report that appears to have prompted Congress to exclude colleges from accessing Title IV funds if they file for bankruptcy noted that "Victimized by unscrupulous profiteers and their fraudulent schools, students have received neither the training nor the skills they hoped to acquire and, instead, have been left burdened with debts they cannot repay." Id., at 33-34. These comments are the sole explanation I've been able to uncover so far in researching two articles. To my mind, Congress appears to have been concerned with fraud and that's why I highlighted Enron in my initial post about ITT.

I don't know much about the loan guarantees (and their conditions) in Solydra and Fisker. But you're definitely correct to point out that a key difference between a possible reorganization in Enron and in ITT is that ITT cannot reorganize without federal funds, but Enron was always going to be funded by non-governmental sources (if at all). However, let me point out that Medicare and Medicaid are approximately as important to healthcare providers and suppliers as Title IV funds are to colleges and universities. Yet, hospitals don't automatically lose access to Medicare and Medicaid if they file for bankruptcy. I'm exploring this discrepancy in my current project and I'll share some thoughts from it soon. I appreciate you bearing with me.

Posted by: Matthew Bruckner | Sep 9, 2016 8:30:40 PM

Hospitals don't automatically lose access to Medicare if they file for bankruptcy, thankfully, but (as I'm co-writing an amicus brief about at the moment), if Medicare terminates them, as they often do (of course, many hospital bankruptcies are caused by prepetition termination), most courts hold hospitals can't get judicial review of those terminations, seek to enjoin them under 362, move to assume their provider agreements, etc., unless they first administratively exhaust, which can be a death sentence. See, for example, the Eleventh Circuit's recent opinion in Bayou Shores. Anyway, I'm happy to see some extended bankruptcy blogging on a generalist law blog for a change.

Posted by: Asher Steinberg | Sep 9, 2016 11:32:11 PM

Matthew, I think I tracked down the reference. It appears to refer toAllegheny University of the Health Sciences.

http://www.acpinternist.org/archives/1998/12/failure.htm

Posted by: brad | Sep 15, 2016 2:57:59 PM

Thanks, Brad. I've researched Allegheny's bankruptcy and knew they had medical schools but didn't look into what happened to them when the hospital system reorganized. It promises to be a fruitful avenue of further research. Much appreciated!

Posted by: Matthew Bruckner | Sep 15, 2016 5:43:42 PM

FYI, ITT has begun liquidation in bankruptcy court: http://www.reuters.com/article/us-itt-education-bankruptcy-idUSKCN11N01U

Posted by: Matthew Bruckner | Sep 22, 2016 11:05:16 AM

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