by Jessica Huseman, Staff Writer
NOVEMBER 27 — The number of businesses seeking the protection of Chapter 11 bankruptcy in Texas declined significantly for the first nine months of 2011.
But that’s not necessarily a good sign, according to legal experts.
“There is not a downturn in bankruptcy because things are good,” says Michelle Mendez, a partner in the bankruptcy practice group at Hunton & Williams in Dallas. “It’s because things are so bad that you can’t even afford to file bankruptcy.”
New filings for reorganization and restructuring in the Northern District of Texas plummeted by nearly one-third between the second and third quarters of 2011. The 60 new Chapter 11 filings between July and September of this year were the lowest point in three years.
Chapter 11 filings in Texas’ four federal judicial districts peaked in the second quarter of 2009 with 424 petitions. By comparison, 
new filings for restructuring statewide were less than half – 208 – in the quarter ending in September of this year.
Similarly, Chapter 7 filings are down significantly. The filings for liquidation hit a high in the fourth quarter of 2009 at 776, but they were down to 576 for the last quarter.
While these numbers may indicate an optimistic turn in the economy, the dip in the number of businesses filing for bankruptcy isn’t as cheery as some assume, according to Mendez.
“Most of the time what is really going on is that bondholders are not pushing companies into bankruptcies because there is no way for the bondholder to get out,” says Mendez, who is Treasurer of the State Bar of Texas’ Bankruptcy Section. “So instead of bankruptcy, banks may be pushing them into a new lender.”
Mendez also said new regulations have made it made it more difficult for businesses to file, which is adding to the lower numbers.
“You used to be able to park in bankruptcy court for a few years and wait until the market picked back up,” she said. “You can’t do that anymore. It’s way too fast.”
Judith Ross, partner in the bankruptcy group at Baker Botts in Dallas, isn’t any more optimistic than Mendez, but her reasons are different. She said the value of businesses are so low right now that the parties involved are willing to work things out consensually instead of filing for bankruptcy.
“If you are a bank and you have an asset that you loaned for $1 million and it is now worth $30,000, are you going to try and get it? Probably not,” said Ross, who is the vice chair of the American Bar Associations’ Business Bankruptcy Current Developments Task Force. “There just isn’t much to argue about because values are so low. The borrower won’t file bankruptcy because it costs too much to do so.”
Ross said this situation is dangerous because the inevitable write downs are being delayed by the banks.
“One of the goals of (Chapter 11) bankruptcy is to help preserve jobs and businesses and keep them in our communities,” she said. “If you have a situation that appears on its face to have gotten so bad that no one even cares any more, that’s not good.”
The result is that banks are arguably no longer functioning like banks. In other words, they are no longer putting pressure on debtors in order to be repaid.
Ross believes the banks are so worried about their reserve balances that they are not prepared to take action to collect – especially because they may have to take a write down on their reserve asset values for regulation purposes.
Instead, banks are doing what Ross calls “extend and pretend” – simply extending loans and pretending that everything is okay when it really isn’t.
“Most banks are trying to extend loans and allow debtors to pay them back the best they can because they don’t want to take a write down on the books, because if they do that they have to fund the capital themselves,” she said.
The result is fewer bankruptcies and more situations where the borrower just turns over the collateral to the bank, and walks away from operation of their businesses.
Jessica Huseman is a staff writer for The Texas Lawbook. Her email is jessica.huseman@texaslawbook.net.