Preparing For The Bankruptcy "Wave": Using Legal Process Outsourcing Before, During And After Chapter 11

Sunday, June 1, 2008 - 01:00

Stephen D. Kong

CPA

The Bankruptcy Landscape

As the economy and financial markets continue on their downward slide and consumer pessimism grows, experts are in agreement that a deluge in U.S. Chapter 11 bankruptcy filings (as well as out-of-court workouts) is looming on the horizon. For example, as early as last September Moody's forecasted that the rate of bankruptcies of highly leveraged companies would more than double over the following 12 months. Through the first four months of 2008, 2,700 companies have filed for Chapter 11 protection - approximately 6,200 petitions were filed in all of 2007. Also quite telling is the fact that 27 companies have defaulted on their debt so far this year, already exceeding 2007's total of 16.

These dire predictions should be a shock to no one. The Big Three - diminishing liquidity, a slowdown in consumer spending, and the increased cost of doing business - have spread the pain far beyond the subprime industry. This is evidenced by the nature of recent, high-profile bankruptcies ranging from home retail (Linens 'n Things) to airlines (Frontier) to casinos (Tropicana Entertainment) to restaurant chains (Buffets Holdings).

What has been a surprise, though, is that the expected surge in bankruptcy legal work has not yet materialized. Nevertheless, law firms are reacting and readying themselves for the inevitable onslaught. A March 31, 2008 Wall Street Journal article noted that "law firms across the country are betting that bankruptcy work will be their most promising avenue of growth, and are accelerating their recruitment of restructuring specialists." In anticipation of more cases, Skadden has taken the unusual step of hiring a third co-leader of its corporate restructuring group. As characterized by the head of Proskauer Rose's bankruptcy practice in a recent USA Today piece, "The flood hasn't come yet, but the leading wave of the flood is in sight."

The Alignment Of Bankruptcy Needs And LPO Services

"Doing more with less" seems to be the prevailing theme in business today as everyone tries to deal with the economic uncertainty. In bankruptcy, the philosophy is no different. To minimize creditor losses, save jobs, preserve investor equity and ensure the health of the on-going concern, debtors and creditors are always looking for ways to cut costs while at the same time, maximizing efficiency.

The goals of Legal Process Outsourcing, or LPO, are quite similar. LPO involves sending domestic legal work (e.g., litigation document review, contract drafting, legal research) abroad to be performed by foreign attorneys, who are billed out at much lower rates than their American counterparts. Most LPO providers, including my company CPA, use India as their offshore hub, which offers additional advantages such as a surplus of legal talent, a legal system based on British common law, and a time differential with the U.S. that allows for a U.S./India round-the-clock legal operation. These are just some of the factors that allow LPO corporate clients to slash unnecessary expenses - namely, huge legal bills - while at the same time reduce their legal risk by having a pipeline of highly skilled attorneys ready to be deployed on a project at a moment's notice. It should be clear then that the strengths of LPO - providing timely, low-cost, legal services solutions without sacrificing quality - should have special appeal in today's economic climate and in the bankruptcy context.

What LPO Can Offer In Chapter 11

LPO can provide customized solutions for any entity affected by a Chapter 11 filing, and at any time during the bankruptcy lifecycle. First, there should be a ready market for LPO services at the pre-petition stage. LPO can play a key document and contract management support role for debtors going the pre-pack bankruptcy route and for those opting to avoid a formal Chapter 11 altogether with an out-of-court restructuring. Vendors, service providers, contractors and customers of financially-distressed companies should have a substantial need for an LPO provider's contract drafting, review and management services. Having payments, transfers and contracts invalidated or rejected in bankruptcy can be extremely costly. It follows that the manner in which pre-petition transactions and contracts are structured and documented can have an enormous impact on whether transactions will survive legal attack and whether you ultimately have a legal remedy when the bankruptcy is commenced. In these situations, LPO provides cost-efficiency from the perspective of results achieved, as well as how you got there.

Second, offshoring legal services can be an integral part of the bankruptcy process after the filing and as the Chapter 11 moves forward. LPO providers can provide document review and management for creditors conducting due diligence of the debtor's finances and operations, and for debtors complying with inquiries, investigations and reporting requirements. On the contract review and management side, LPO is an ideal solution for debtors trying to cost-effectively determine what contracts they need to properly operate, for creditors who must identify and timely assert potential reclamation claims, and for both debtors and creditors who must get their arms around contracts, appraisals and the like so that they can make essential, asset valuation calculations. Bankruptcy litigation, characterized by time-sensitive motion practice, is still another area where LPO - through legal research/document preparation services - can provide a real benefit. In addition, LPO providers can easily leverage their existing skills and capabilities to support a debtor's claims review process, such as facilitating claims reconciliation and evaluating the accuracy or validity of claims.

Third, besides being an effective short-term approach, LPO represents an attractive long-term solution as well. How? Well, every Chapter 11 debtor should be thinking of making LPO an important part of its reorganization plan, and by doing so making LPO a permanent, cost-efficient part of how the company does business in the future when it emerges from bankruptcy protection. Why? Because this is an approach that, due to its cost-conscious appeal, will help the debtor garner support from creditors and the courts so it can get out of Chapter 11, and help it maintain success once it does so.

Cautionary Tales

Doubts may persist about the usefulness of LPO in the "real" bankruptcy world. The naysayers will argue that things haven't changed much in bankruptcy practice in recent years and that traditional legal approaches to due diligence, contract analysis, claims review and the like are doing just fine, thank you. But that position couldn't be more short-sided, or more wrong.

Look at what's happening out there. In a widely publicized story, the conduct of one top-tier law firm was recently criticized by the bankruptcy examiner in the New Century Financial Chapter 11. The firm apologized for failing to turn over more than 700,000 emails relevant to an investigation into the debtor's cash collateral strategy, and reports indicate that its estimated $25 million legal fee may be reduced by the court because of the non-disclosure.

The National Law Journal reported in March of this year that trustees and receivers have become more active than ever in bringing actions against attorneys, accountants and other entities that they believe contributed to the debtor's insolvency but may not be directly involved in the bankruptcy case itself. For example, the U.S. Trustee in Philadelphia filed suit in April 2008 against a number of investment banks alleging that they improperly kept the lender alive (while collecting substantial fees) by enabling it to overstate the value of its assets on its books. In other situations, inquiries have been launched that may eventually lead to lawsuits. The U.S. Bankruptcy Court in Pittsburgh overseeing 300 insolvencies has just authorized a wide-ranging investigation of Countrywide Financial Corp.'s mortgage processing systems and whether it has systematically abused its borrowers.

Stories abound about the unbelievable legal fees being generated in bankruptcy proceedings. Approximately 40 law firms have been retained, and about $300 million in legal and professional fees has been spent, in Delphi's still on-going Chapter 11. The once unattainable $100 million fee for a single law firm on a single bankruptcy case has now been achieved, and legal bills of $10-20 million for a restructuring of a reasonably-sized company are now the norm in the industry.

Put simply, the picture is looking grim for many involved in the bankruptcy process. Whether an entity on the periphery of the process or the debtor itself, no one seems to be immune from the intensified oversight and scrutiny that will, in turn, generate a need to perform document reviews, contract analysis, and legal research as quickly and efficiently as ever before. Whether you are a debtor or a creditor, you will continue to pay your law firms a hefty premium for even basic bankruptcy legal services. Using LPO to handle some of the core, bankruptcy legal functions provides a company with the resources necessary to properly comply with its mounting compliance obligations, while at the same time, empowering the company to assert control over escalating legal costs.

A Parting Message

No one is saying that offshoring legal services is the perfect fit in every situation and that it is somehow the panacea for all the ills of a distressed company. However, the case for using LPO in formal bankruptcies and in out-of-court restructurings couldn't be any more compelling. Insolvency departments, restructuring officers, crisis managers and other players in the bankruptcy world are doing a real disservice to debtors and creditors alike by not at least considering LPO as a viable option in the process and in their reorganization plans.

Stephen D. Kong is a Legal Process Consultant with CPA Legal Services, a leading provider of legal outsourcing services. He is an attorney with extensive litigation and legal management experience in both the private and government sectors. Prior to joining CPA, Mr. Kong was the Deputy General Counsel and former Acting General Counsel of the U.S Small Business Administration in Washington, D.C. Mr. Kong is primarily responsible for assessing the litigation resource need of prospective clients, proposing cost-effective, legal process solutions, and consulting on implementation and execution of the project plans .

Please email the author at skong@cpaglobal.com with questions about this article.