Why are Delaware and New York Bankruptcy Reorganizations Failing?

Abstract

In recent years, about 70% of the large, public firms that file for reorganization choose the bankruptcy courts of Delaware (about 55%) or New York (about 15%). In an earlier study, LoPucki and Kalin found that firms emerging from those courts refiled bankruptcy at rates four to seven times the rate for firms emerging from other U.S. bankruptcy courts.

The study reported in this paper examines all 98 firms emerging as public firms from the bankruptcies of large, public firms in U.S. bankruptcy courts from 1991 to 1996, the period of Delaware's ascendency. Using four measures of failure, refiling, business discontinuation, post-bankruptcy earnings, and plan failure, this study finds rates of Delaware failure ranging from two to ten times the rates of Other Court failure in the five years after emergence. New York's failure rates were between those of Delaware and Other Courts. The study concludes that firms emerging from Delaware and New York reorganizations fail more often.

Prefiling characteristics of the firms, including measures of their sizes and levels of financial distress, were not related to failure. Nor were there important measurable differences in the firms choosing Delaware or New York and those choosing Other Courts. The study concludes that characteristics of the filing firms do not cause Delaware and New York's high failure rates.

The study discovered five characteristics of the reorganization process that may contribute to Delaware's higher failure rates. Delaware reorganization appears not to fix the business; firms emerge from Delaware reorganization with higher leverage; prepackaged cases fail heavily in Delaware but not in Other Courts; Delaware reorganization is faster; and Delaware plans are simpler. The paper concludes that the causes of Delaware's high failure rates are endogenous to Delaware's reorganization process. Large public firms in financial distress are flocking to the bankruptcy courts least likely to reorganize them successfully.

Keywords: bankruptcy, reorganization, Delaware, New York, failure, refiling, Chapter 22

JEL Classification: K22, K19, K41, K29