Turnaround Management and Bankruptcy

A Research Companion

Jan Adriaanse, Jean-Pierre van der Rest, Jan Adriaanse, Jean-Pierre van der Rest

• Publisher: Routledge
• Year: 2017
• ISBN:
  9781317572718
• Edition: 1
• Topic: Business
• Subtopic: Strategia di business
• Index: Business

Written by leading experts in the field of business, finance, law and economics, this edited volume brings together the latest thoughts and developments on turnaround management and business rescue from an academic, judiciary and turnaround/insolvency practitioner perspective.

Turnaround Management and Bankruptcy presents different viewpoints on turnarounds and business rescue in Europe. Presenting a state-of-the-art review of failure research in finance, such as on bankruptcy prediction, causes of decline, or distressed asset valuation. It also presents the latest insights from turnaround management research as well as giving a contemporary insight into law debates on insolvency legislation reform, cross-border judicial issues, bankruptcy decision-making by judges and competition policy in distressed economies. Finally, the book provides a regional and sector perspective on how the current crisis affects Europe, its government policies and industry performance.

In this way, the volume presents a modern, interdisciplinary and scholarly overview of the latest insights, issues and debates in turnaround management and business rescue, developing a European perspective in an attempt to redress the predominance of an American orientation in the academic literature. It aims at a wider audience interested in turnarounds and failure, such as faculty and students in the fields of law, business, economics, accountancy, finance, strategic management, and marketing, but also at judges, insolvency practitioners, lawyers, accountants and turnaround professionals, as well as the EU and government officials, staff of trade unions and employer's associations.

Part I
Historical Perspectives

1
The History of Corporate Turnaround Management

Personal Reflections

Donald Bibeault

First-ever recipient of the TMA Lifetime Achievement Award for corporate turnarounds

1.1 Introduction

Turnaround management is a process dedicated to corporate renewal. It uses analysis and planning to save troubled companies and returns them to solvency. It also identifies the reasons for failing performance in the market and rectifies them. The turnaround cycle is not truly complete unless the company returns to sustained revenue growth and profitability. Short of renewed growth, the process must be considered as restructuring rather than a turnaround. The confluence of three primary drivers preconditioned the rapid development of the turnaround profession in the latter part of the twentieth century:

1. The legal environment was reformed in a manner that recognized corporate resuscitation as beneficial to economic society.
2. The development of a professional body of knowledge allowed for the formal study required of a profession.
3. A more challenging business environment required new management skills beginning in the 1970s. The oil crises and rapid technological change drove the need for a different type of corporate leader.

1.2 The Legal Recognition of Resuscitation as Economically Beneficial

From its early beginnings, the profession of turnaround management has been highly influenced by national policy regarding the legal position of creditors versus debtors. In general, professional turnaround management practice developed more robustly in the United States because of the U.S. bankruptcy law emphasis on rehabilitation. In Ancient Greece, bankruptcy did not exist. If a man owed debt he could not pay, he and his wife, children, or servants were forced into ‘debt slavery,’ until the creditor recouped losses through their physical labor. Many city-states in Ancient Greece limited debt slavery to a period of five years; debt slaves had protection of life and limb, which regular slaves did not enjoy. However, the creditor could retain servants of the debtor beyond that deadline, and they were often forced to serve their new lord for a lifetime, usually under significantly harsher conditions. An exception to this rule was Athens, which by the laws of Solon forbade enslavement for debt; consequently, most Athenian slaves were foreigners (Greek or otherwise). There is also documentation of bankruptcy in East Asia. The Yassa of Genghis Khan contained a provision that mandated the death penalty for anyone who became bankrupt three times.

A failure of whole nations to meet bond repayments has been seen on many occasions. Philip II of Spain had to declare four state bankruptcies in 1557, 1560, 1575, and 1596. In medieval times, the plunder of victory staved off bankruptcy of the victors but often plunged the vanquished defeated nations into bankruptcy. Although the development of international capital markets was quite limited prior to 1800, there were, with some regularity, the defaults of France, Portugal, Prussia, Spain, and the early Italian city-states.

1.2.1 The History of United Kingdom Bankruptcy Law

The Statute of Bankrupts of 1542 was the first statute under English law dealing with bankruptcy or insolvency. During its long history, the United Kingdom’s insolvency laws heavily favored banks’ and other creditors’ interests. The astonishing depravity of conditions in debtor prisons made insolvency law reform one of the most intensively debated issues in nineteenth-century England. The novelist Charles Dickens, whose father had been imprisoned while he was a child, pilloried injustice through his books, especially David Copperfield (1850) and Hard Times (1854). In spite of that, only one major reform bill was introduced to Parliament between 1831 and 1914.

The first minor reform step was the Joint Stock Companies Act of 1844. The law allowed the creation of companies by registration rather than royal charter. On top of this came the Limited Liability Act of 1855 which regulated that investors in companies had their liability limited to the amount of debt. The Debtors Act of 1869 finally abolished imprisonments for debt altogether. Among insolvent companies,’ creditors’ claims, secured claims, liquidators’ expenses, and wages of workers were given statutory priority over other unsecured creditors. Up until recent times, the appointment of a liquidator for the benefit of creditors appeared to be absolute. In the infamous case of Laker Airways, and unlike U.S. carrier bankruptcies, the company’s planes immediately stopped flying, never to be flown again under the Laker standard. It all came to an abrupt ending on the weekend of February 5, 1982. The appointed liquidator sold many of Laker’s assets, including modern DC-10 and Airbus A 300 aircraft, at bargain basement prices within a few days’ time.

After the “Cork Report” of 1982, the major new objective for UK insolvency law became creating a ‘rescue culture’ for business. Under Schedule B1, paragraph 3, the primary objective of the administrator is “rescuing the company as a going concern,” but if that is not possible, then the administrator will usually sell the business. The administrator must oversea the realizing of the property distributed to creditors. Focus in the situation is with how, and by whom, ministries are appointed. The holders of a ‘floating charge,’ which is usually all of the company’s creditors (typically the company bank), have an almost absolute right to select the administrator. The directors of the company may attempt to appoint an administrator out of court, but if the bank intervenes, it may install its own preferred candidate. The court has the power to refuse the bank’s choice, but rarely exercises it. In practical situations, the bank has asked the company directors to appoint the administrator from the bank’s own list.

In the UK Insolvency Act of 1986, any company could voluntarily ask the courts to reduce debt they owed in the hope that the company may survive. Importantly, secured preferential creditors’ entitlements cannot be reduced without their consent. This differs markedly from Chapter 11 of the U.S. bankruptcy code where the so-called cram-down procedure allows the court to approve a plan over the wishes of creditors if they receive a value to what they were owed. The procedure takes place under the supervision of an insolvency practitioner, to whom the directors will submit a report on the company’s finances in the proposal for reducing the debt. In practice, this procedure is infrequently used because a single creditor can veto the plan and seek to collect the debt.

1.2.2 United States Leadership in the Concept of Resuscitation

The history of bankruptcy in the United States has been a continual tug-ofwar between various interests, mainly creditors versus debtors. The concept of resuscitation was not always dominant in the United States. The U.S. Constitution of 1789, Article 1, Section 8, gave Congress the power to establish uniform laws on the subject of bankruptcy throughout the United States. In 1800, Congress passed the first federal law relating to bankruptcy. The Bankruptcy Act of 1800 was very creditor oriented and only permitted involuntary bankruptcies of merchant debtors. diplomatist Edmund Roberts, President Andrew Jackson’s envoy to the Far East, incorporated American concepts of bankruptcy protection into Article VI of the Roberts Treaty with Siam (Thailand) of 1833. Whereas the United States seemed committed to a balance between creditors’ and debtors’ rights, an objective review of the legislation at that time would indicate that creditors were in a superior position.

After the financial panic of 1837, Congress passed the Bankruptcy Act of 1841, which allowed voluntary bankruptcies to be filed by debtors, a truly modern evolution. The Bankruptcy Act of 1867 partially redressed what creditors felt was an imbalance in favor of debtors. The immense growth of the United States in the nineteenth century partially fueled the notion of rehabilitation. These early acts and the Bankruptcy Act of 1898, known as the Nelson Act, established the modern concepts of debtor-creditor relations. The Bankruptcy Act of 1898 was in effect until the Bankruptcy Reform Act of 1978.

Indeed, when the 1906 earthquake destroyed San Francisco, A. P. Giannini, then head of the Bank of Italy (shortly after the Bank of America) lent funds ‘on account’ to many merchants to rebuild the city. Additionally, because of careful reinvestment of the bank’s earnings, Wells Fargo and Company not only prospered during the 1920s but was also in a good position to survive the Great Depression. Following the collapse of the banking system in 1933, Wells Fargo was able to extend immediate substantial help to its troubled correspondents. Ransom M. Cook, later chairman of Wells Fargo and an advisor on my landmark 1979 PhD dissertation, worked on many of those ‘bank workouts’ during the Great Depression and the postwar prosperity that followed. This excellent experience propelled him into the presidency of Wells Fargo in 1962 and subsequent chairmanship in 1964.

In most European Union member states, debt discharge is conditioned by a partial payment of the obligation and by a number of requirements concerning the debtor’s behavior. In the United States, discharge from bankruptcy has fewer conditions as governed by the plan of reorganization. Within the European Union, there is a broad spectrum of approaches with the United Kingdom coming closest to the U.S. system. Other member states of the EU provide the option of a debt discharge. Spain, for example, passed a bankruptcy law in 2003 that provides for debt settlement plans that can result in a reduction of debt (the maximum of one-half of the amount) or an extension of the payment period for up to five years.

The principal focus of modern insolvency legislation and business debt restructuring no longer rests on the elimination of the insolvent entity. Most advanced countries in 2015 place an emphasis on the rehabilitation and continuation of the business entity.

1.3 Development of a Professional Body of Knowledge

In the case of professional turnaround management, the development of a meaningful and coherent body of knowledge poses a particularly unique problem. It is difficult, if not impossible, for those who teach but do not ‘do’ turnaround strategies to develop them in a purely academic setting. On the other hand, turnaround management is much more intensive than conservator management. The highly chaotic world of turnarounds is not conducive to the reflection necessary for practitioners to create a coherent body of knowledge. Up until the late 1970s, as turnaround management began to be carved out as a separate management specialty, there existed no coherent strategic framework to explain what was going on in the trenches.

The first glimmer of corporate turnaround tactics was based on the ‘scientific management approach’ first formulated by Frederick Wilson Taylor (1856–1915). Closer to the mark was the work of Henry Fayol (1841–1925). Indeed, Fayol was the earliest manager to examine his own personal experience systematically and try to extract from that a theory of management. A qualified mining engineer, he was made the manager of a coal mine at the early age of twenty-five. At thirty-one, he became general manager of a group of mines, and at forty-seven, he became the managing director the combined mines—a post that he held for thirty years.

Throughout his career, Fayol showed all the signs of a successful line manager. This became most obvious when he took over the top job of a steel combine, which was then almost bankrupt. By the time he retired, the business was more than twice its original size and one of the most successful steel combines in Europe. In 1916, he published the book Administration Industrielle et Générale, which was not available in English translation until 1929 (known as General and Industrial Management).

The works of Taylor and Fayol are complementary in a number of ways including those pertaining to processes, organizational rationality by the scientific technique, and the rules managers work with to encourage their workers. From a corporate turnaround perspective, I appreciate Fayol’s contribution more because he dealt with the management of the organization as a whole, whereas Taylor stressed the management of the operations. Fayol directed his at the activities of all managers, whereas Taylor concerned himself with first-line managers and the scientific method. Fayol wrote from personal executive experience being the managing director of a large French mining firm.

In the 1950s and 1960s, there were occasional magazine articles and a paucity of academic treatises on the subject of turnaround management. There were a number of periodical articles dealing with a portion of the overall problem. Such titles as “Pruning the Product Line,” “The Death and Burial of Sick Products,” and “Phasing out Weak Products” were typical of the genre. None dealt with the fundamental strategic framework.

Beyond brief articles, the development of a body of knowledge progressed along two principal axes. First, there was the functional approach of functional turnaround actions as exemplified by the 1972 compendium assembled by Joseph Eisenberg. Eisenberg’s approach was simple; it included individual chapters by experts in their functional areas. Only one of Eisenberg’s twelve chapters discussed the essential role of the chief executive in the turnaround. Other chapters focused on marketing, production cash management, computer activity, and a supportive compensation program. Whereas commendable, this did not provide enlightenment on a comprehensive strategic framework.

In the mid-1970s, Dan Schendel moved away from the traditional case method by developing and testing mathematical performance models on strategy. Dan Schendel, Richard Patton, and James Rise wrote an interesting article entitled “Corporate Turnaround Strategies.” This research work was the first to take the empirical direction in strategy analysis utilizing data analysis, although the sample size was small. Schendel’s work was under the auspices of the Krannert Graduate School of Industrial Administration at Purdue University. Schendel and Patton closely followed the article with their own in August 1975 on the proceedings of the Academy of Management entitled “An Empirical Study of Corporate Stagnation and Turnaround.” This article featured quantitative data on the difference between turnaround and nonturnaround companies. It also presented quantitative metrics that contrasted the decline and renewal stages of a turnaround.

The second axis was the contribution to our understanding of corporate decline. The management challenges posed by corporate growth were ably illustrated by the work of Larry E. L. Greiner, in “Evolution and Revolution as Organizations Grow.” A meaningful contribution to the understanding of corporate decline was made by Michael J. Kami and Joel Ross in their book Management Crisis: Why the Mighty Fall (1973). John Argenti did an excellent job of explaining corporate collapse in his 1976 book Corporate Collapse: The Causes and Symptoms. The missing element in these academic approaches was the necessary input of experienced executive-level turnaround leadership to give nuance and realism to the description of the process. Nearly all the aforementioned contributions were descriptive in nature and not pre-scripted in nature. I’ve always felt that description is valuable but prescription is essential.

By the mid-1970s, I had been deeply involved in real-world turnarounds for a decade. I was perplexed that no fundamental strategic framework existed with meaningful insight. At the same time, I was pursuing a ten-year adult evening PhD program at Golden Gate University in San Francisco. I worked diligently for most of the 1970s filling the void that I felt existed in the body of knowledge of turnaround management. My doctoral committee advisors included two turnaround management pioneers, Mr. Frank Grisanti of the firm Grisanti & Galef and Mr. Ransom Cook, former chairman of Wells Fargo bank. In addition, I conducted taped interviews with nineteen other turnaround leaders. The transcripts of these taped interviews totaled more than 1,500 pages. Eighty-one other turnaround leaders kindly contributed to a detailed survey on their turnaround efforts. Altogether, my doctoral dissertation advisors, the executives interviewed, and those who responded to the questionnaire had turned around more than 300 companies during their careers. Many hundreds of articles and books were cited in a sixty-nine-page bibliography.

The result of this ten-year effort was a comprehensive thousand-page PhD dissertation ...