Chapter 12

Ethics of Seeking Bankruptcy Protection

As a Turnaround Strategy
Ozzie Mascarenhas S.J, Ph.D
July 25, 2017

Case 12.1 India has a New Bankruptcy Law

The Rajya Sabha on Wednesday, May 11, 2016, passed the Insolvency and Bankruptcy Code 2016, a vital
reform that will make it much easier to do business in India. Once the President signs the legislation, India
will have a new bankruptcy law that will ensure time-bound settlement of insolvency, enable faster
turnaround of businesses and create a database of serial defaulters. The bill, which received the Rajya
Sabhas nod on Wednesday, was passed by the Lok Sabha last week. A majority of the parties in both
Houses supported this legislation after all the amendments proposed by a joint parliamentary committee
were accepted by the government.

The Insolvency and Bankruptcy Code, 2016 (IBC) is the bankruptcy law of India which seeks to consolidate
the existing framework by creating a single law for insolvency and bankruptcy. The Insolvency and
Bankruptcy Code, 2015 was introduced in Lok Sabha in December 2015. It was passed by Lok Sabha on 5
May 2016. The Code received the assent of the President of India on 28 May 2016. Certain provisions of
the Act has come into force from 5 August and 19 August 2016.

The Code seeks to repeal the Presidency Towns Insolvency Act, 1909 and Sick Industrial Companies
(Special Provisions) Repeal Act, 2003, among others.

The Code outlines separate insolvency resolution processes for individuals, companies and partnership
firms. The process may be initiated by either the debtor or the creditors. A maximum time limit, for
completion of the insolvency resolution process has been set for corporates and individuals. For companies,
the process will have to be completed in 180 days, which may be extended by 90 days, if a majority of the
creditors agree. For start ups (other than partnership firms), small companies and other companies (with
asset less than Rs. 1 crore), resolution process would be completed within 90 days of initiation of request
which may be extended by 45 days.

The Code establishes the Insolvency and Bankruptcy Board of India, to oversee the insolvency proceedings
in the country and regulate the entities registered under it. The Board will have 10 members, including
representatives from the Ministries of Finance and Law, and the Reserve Bank of India.

The insolvency process will be managed by licensed professionals. These professionals will also control the
assets of the debtor during the insolvency process.

The Code proposes two separate tribunals to oversee the process of insolvency resolution, for individuals
and companies: (i) the National Company Law Tribunal for Companies and Limited Liability Partnership
firms; and (ii) the Debt Recovery Tribunal for individuals and partnerships

The bill proposes the creation of a new class of insolvency professionals that will specialize in helping sick
companies. It also provides for creation of information utilities that will collate all information about debtors

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to prevent serial defaulters from misusing the system. The bill proposes to set up the Insolvency and
Bankruptcy Board of India to act as a regulator of these utilities and professionals. It also proposes to use the
existing infrastructure of National Company Law tribunals and debt recovery tribunals to address corporate
insolvency and individual insolvency, respectively.

The new code will replace existing bankruptcy laws and cover individuals, companies, limited liability
partnerships and partnership firms. It will amend laws including the Companies Act to become the
overarching legislation to deal with corporate insolvency. It will also help creditors recover loans faster.
Regarding resolving insolvency, India is ranked 136 among 189 countries. At present, it takes more than
four years to resolve a case of bankruptcy in India, according to the World Bank. The code seeks to reduce
this time to less than a year.

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Incidentally, the bankruptcy law provides for even suppliers to initiate insolvency proceedings. If no
resolution is arrived at within 180 to 270 days, the assets have to be auctioned off to recover dues.

The move is also expected to help India move up from its current rank of 130 in the World Banks ease of
doing business index, since all reforms undertaken by 31 May are incorporated in the next ranking. But
implementation will remain the key, analysts point out, as the new code is presaged on the creation of a
complementary eco-system including insolvency professionals, information utilities and a bankruptcy
regulator.
Stressed assets, i.e. bad loans and restructured loans, totaled 20% of the total loans in the system, according to the
Economic Survey 2017. Many of these are long-term loans from banks which depend mostly on short-term funds.
The banks, also blamed for ignoring the need to match asset and liability, may have to halt long-term loans, and
wherever they do, may have to sell off them quickly.

Ashwin Bishnoi, a partner at law firm Khaitan and Co., said the insolvency code proposes a vast change and
its implementation will take time. The code has set the framework for bringing in changes in the debt
recovery tribunals, he said adding that India has many professionals who can easily step into the role of
insolvency professionals.

The bankruptcy code has provisions to address cross-border insolvency through bilateral agreements with
other countries. It also proposes shorter, aggressive time frames for every step in the insolvency process
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right from filing a bankruptcy application to the time available for filing claims and appeals in the debt
recovery tribunals, National Company Law Tribunals and courts.

The code assumes the existence of institutional infrastructure like information utilities and insolvency
professionals, information repositories like stock depositories; a new regulator, without the failings of
existing regulators; and a high-quality adjudication infrastructure. Unless these four pillars are in place, the
Code will fail because of the huge dependencies faced in the debt recovery tribunals.

To protect workers interests, the code has provisions to ensure that the money due to workers and
employees from the provident fund, the pension fund and gratuity fund shouldnt be included in the estate of
the bankrupt company or individual. Further, workers salaries for up to 24 months will get first priority in
case of liquidation of assets of a company,ahead of secured creditors.

Responding to the debate in Rajya Sabha, minister of state for finance Jayant Sinha said the government will
try to go through a stage-wise process to ensure smooth implementation, notifying provisions as and when
the necessary infrastructure is ready.

Along with the proposed changes in Indias two debt recovery and enforcement laws, it will be critical in
resolving Indias bad debt problem, which has crippled bank lending.

Bankruptcy applications will now have to be filed within three months; earlier, it was six months. There are
also provisions that disqualifyanyonedeclared bankrupt from holding public office, thereby ensuring that
politicians and government officials cannot hold any public office if declared bankrupt.

Sinha said the code seeks to protect interest of workers who are the most vulnerable. It enables workmen to
initiate the insolvency process and they will be first in line to get the proceeds of liquidation, he said.

After a public consultation process and recommendations from a joint committee of Parliament, both
houses of Parliament have now passed the Insolvency and Bankruptcy Code, 2016 (Code). While the
legislation of the Code is a historical development for economic reforms in India, its effect will be seen in
due course when the institutional infrastructure and implementing rules as envisaged under the Code are
formed.

The Insolvency and Bankruptcy Code, 2016 - Key Highlights

(See Trilegal Article cited below, May 16, 2016):

The Code offers a uniform, comprehensive insolvency legislation encompassing all companies,
partnerships and individuals (other than financial firms). The Government is proposing a separate
framework for bankruptcy resolution in failing banks and financial sector entities.

One of the fundamental features of the Code is that it allows creditors to assess the viability of a debtor as
a business decision, and agree upon a plan for its revival or a speedy liquidation. The Code creates a new
institutional framework, consisting of a regulator, insolvency professionals, information utilities and
adjudicatory mechanisms, that will facilitate a formal and time bound insolvency resolution process and
liquidation. In other words, the IBC 2016 is creditor friendly as in UK, and not debtor friendly as in the
USA. But the current context of IBC regime and implementation is debt-over-stressed assets (especially
of the 12 companies listed by RBI in 2016 for immediate IBC application).

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1. Corporate Debtors: Two-Stage Process

To initiate an insolvency process for corporate debtors, the default should be at least INR 100,000 (USD
1495) (which limit may be increased up to INR 10,000,000 (USD 149,500) by the Government). The
Code proposes two independent stages:

Insolvency Resolution Process, during which financial creditors assess whether the debtor's business is
viable to continue and the options for its rescue and revival; and

Liquidation, if the insolvency resolution process fails or financial creditors decide to wind down and
distribute the assets of the debtor.

(a) The Insolvency Resolution Process (IRP)

The IRP provides a collective mechanism to lenders to deal with the overall distressed position of a
corporate debtor. This is a significant departure from the existing legal framework under which the
primary onus to initiate a reorganization process lies with the debtor, and lenders may pursue distinct
actions for recovery, security enforcement and debt restructuring.

The Code envisages the following steps in the IRP:

(i) Commencement of the IRP

A financial creditor (for a defaulted financial debt) or an operational creditor (for an unpaid operational
debt) can initiate an IRP against a corporate debtor at the National Company Law Tribunal (NCLT).

The defaulting corporate debtor, its shareholders or employees, may also initiate voluntary insolvency
proceedings.

(ii) Moratorium

The NCLT orders a moratorium on the debtor's operations for the period of the IRP. This operates as a
'calm period' during which no judicial proceedings for recovery, enforcement of security interest, sale or
transfer of assets, or termination of essential contracts can take place against the debtor.

(iii) Appointment of Resolution Professional

The NCLT appoints an insolvency professional or 'Resolution Professional' to administer the IRP. The
Resolution Professional's primary function is to take over the management of the corporate borrower and
operate its business as a going concern under the broad directions of a committee of creditors. This is
similar to the approach under the UK insolvency laws, but distinct from the "debtor in possession"
approach under Chapter 11 of the US bankruptcy code. Under the US bankruptcy code, the debtor's
management retains control while the bankruptcy professional only oversees the business in order to
prevent asset stripping on the part of the promoters.

Therefore, the thrust of the Code is to allow a shift of control from the defaulting debtor's management to
its creditors, where the creditors drive the business of the debtor with the Resolution Professional acting
as their agent.

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(iv) Creditors Committee and Revival Plan
The Resolution Professional identifies the financial creditors and constitutes a creditors committee.
Operational creditors above a certain threshold are allowed to attend meetings of the committee but do
not have voting power. Each decision of the creditors committee requires a 75% majority vote. Decisions
of the creditors committee are binding on the corporate debtor and all its creditors.

The creditors committee considers proposals for the revival of the debtor and must decide whether to
proceed with a revival plan or liquidation within a period of 180 days (subject to a one-time extension by
90 days). Anyone can submit a revival proposal, but it must necessarily provide for payment of
operational debts to the extent of the liquidation waterfall.

The Code does not elaborate on the types of revival plans that may be adopted, which may include fresh
finance, sale of assets, haircuts, change of management etc.

(b) The Liquidation Process

Under the Code, a corporate debtor may be put into liquidation in the following scenarios:

(i) A 75% majority of the creditor's committee resolves to liquidate the corporate debtor at any time
during the insolvency resolution process;

(ii) The creditor's committee does not approve a resolution plan within 180 days (or within the extended
90 days);

(iii) The NCLT rejects the resolution plan submitted to it on technical grounds; or

(iv) The debtor contravenes the agreed resolution plan and an affected person makes an application to the
NCLT to liquidate the corporate debtor.

Once the NCLT passes an order of liquidation, a moratorium is imposed on the pending legal proceedings
against the corporate debtor, and the assets of the debtor (including the proceeds of liquidation) vest in the
liquidation estate.

Priority of Claims

The Code significantly changes the priority waterfall for distribution of liquidation proceeds.

After the costs of insolvency resolution (including any interim finance), secured debt together with
workmen dues for the preceding 24 months rank highest in priority. Central and state Government dues
stand below the claims of secured creditors, workmen dues, employee dues and other unsecured financial
creditors. Under the earlier regime, Government dues were immediately below the claims of secured
creditors and workmen in order of priority.

Upon liquidation, a secured creditor may choose to realize his security and receive proceeds from the sale
of the secured assets in first priority. If the secured creditor enforces his claims outside the liquidation, he
must contribute any excess proceeds to the liquidation trust. Further, in case of any shortfall in recovery,
the secured creditors will be junior to the unsecured creditors to the extent of the shortfall.

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Insolvency Resolution Process for Individuals/Unlimited Partnerships

2.1 For individuals and unlimited partnerships, the Code applies in all cases where the
minimum default amount is INR 1000 (USD 15) and above (the Government might later revise
the minimum amount of default to a higher threshold). The Code envisages two distinct
processes in case of insolvencies: automatic fresh start and insolvency resolution.
2.2
2.3 Under the automatic fresh start process, eligible debtors (basis gross income) can apply to
the Debt Recovery Tribunal (DRT) for discharge from certain debts not exceeding a specified
threshold, allowing them to start afresh.
2.4
2.5 The insolvency resolution process consists of preparation of a repayment plan by the debtor,
for approval of creditors. If approved, the DRT passes an order binding the debtor and creditors
to the repayment plan. If the plan is rejected or fails, the debtor or creditors may apply for a
bankruptcy order.

Institutional Infrastructure
(a) The Insolvency Regulator
2.6 The Code provides for the constitution of a new insolvency regulator i.e., the Insolvency
and Bankruptcy Board of India (Board). Its role includes: (i) overseeing the functioning of
insolvency intermediaries i.e., insolvency professionals, insolvency professional agencies and
information utilities; and (ii) regulating the insolvency process.

(b) Insolvency Resolution Professionals

2.7 The Code provides for insolvency professionals as intermediaries who would play a key
role in the efficient working of the bankruptcy process. The Code contemplates insolvency
professionals as a class of regulated but private professionals having minimum standards of
professional and ethical conduct.

2.8 In the resolution process, the insolvency professional verifies the claims of the creditors,
constitutes a creditors committee, runs the debtor's business during the moratorium period and
helps the creditors in reaching a consensus for a revival plan. In liquidation, the insolvency
professional acts as a liquidator and bankruptcy trustee.

(c) Information Utilities

2.9 A notable feature of the Code is the creation of information utilities to collect, collate,
authenticate and disseminate financial information of debtors in centralized electronic databases.
The Code requires creditors to provide financial information of debtors to multiple utilities on an
ongoing basis. Such information would be available to creditors, resolution professionals,
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liquidators and other stakeholders in insolvency and bankruptcy proceedings. The purpose of this
is to remove information asymmetry and dependency on the debtor's management for critical
information that is needed to swiftly resolve insolvency.

(d) Adjudicatory authorities

2.10 The adjudicating authority for corporate insolvency and liquidation is the NCLT. Appeals
from NCLT orders lie to the National Company Law Appellate Tribunal and thereafter to the
Supreme Court of India. For individuals and other persons, the adjudicating authority is the DRT,
appeals lie to the Debt Recovery Appellate Tribunal and thereafter to the Supreme Court.
2.11
2.12 In keeping with the broad philosophy that insolvency resolution must be commercially and
professionally driven (rather than court driven), the role of adjudicating authorities is limited to
ensuring due process rather than adjudicating on the merits of the insolvency resolution.

Conclusion

2.13 India currently ranks 136 out of 189 countries in the World Bank's index on the ease of
resolving insolvencies. India's weak insolvency regime, its significant inefficiencies and
systematic abuse are some of the reasons for the distressed state of credit markets in India today.
The Code promises to bring about far-reaching reforms with a thrust on creditor driven
insolvency resolution. It aims at early identification of financial failure and maximizing the asset
value of insolvent firms. The Code also has provisions to address cross border insolvency
through bilateral agreements and reciprocal arrangements with other countries.
2.14
2.15 The unified regime envisages a structured and time-bound process for insolvency resolution
and liquidation, which should significantly improve debt recovery rates and revitalize the ailing
Indian corporate bond markets.

Why does India need a bankruptcy law?

The failure of businesses impacts employees, shareholders, lenders, and the broader economy. In a
country like India particularly because of delays in making decisions on the viability of businesses,
tactics employed by company promoters to delay reorganization or attempts to sell off assets, changes of
management or litigation that goes on and on the drag on new business units, jobs, income generation
and economic growth can be significant.

India does have some laws including one on Securitization and Enforcement of Security and other
mechanisms, like Corporate Debt Restructuring or CDR, to address the problem of insolvency of firms.
But the fact is some of these laws, such as the Sick Industrial Companies Act or SICA, have not worked
because of inefficient enforcement and court delays.

Like in the West, a modern law with a focus on speedy closure will help firms on the brink to be either
restructured or sold off with limited pain for all involved. In some cases, if this is done swiftly, assets can
be put to good use and the firm can be revived. Delaying a decision on whether to shutter a firm or to try
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to revive it causes destruction of value for all involved. Indian policymakers have recognized this. For
banks or lenders, the money recovered can be lent again, promoting efficient allocation of resources,
besides development of financial markets such as a bond market with clarity on repayment for debtors.
An efficient and swift insolvency regime ensures greater availability of credit or funds for businesses by
freeing up capital, and is thought to boost innovation and productivity. Hopefully, the current regime of
NCLT and IBC will do just this.

References

Vikraman, Shaji (2015), Explaining the Bankruptcy law and the need to have one, Indian Express, November
5, 2015.
"Lok Sabha passes bill to fast track debt recovery", The Economic Times, 2 August 2016
"Insolvency and Bankruptcy Code" (PDF). Gazette of India. Retrieved 31 May 2016.
"Notification" (PDF). E-Gazette. Gazette of India. Retrieved 22 August 2016.
"Legislative Brief of the Code" (PDF). PRS India. Retrieved 18 August 2016.
"India Overhauls Century-Old Bankruptcy Laws in Win for Modi", Bloomberg, 11 May 2016
India: The Insolvency And Bankruptcy Code, 2016 - Key Highlights, Trilegal, Last updated 18, May
2016.

What is Corporate Bankruptcy?

Bankruptcy in the legal sense occurs when the firm cannot pay its bills or when its liabilities exceed
the fair market value of its assets. In either of these situations, a firm may be declared legally bankrupt.
However, creditors generally attempt to avoid forcing a firm into bankruptcy if it appears to have
opportunities for future success. Edward Altman (1968) estimated the impact of five financial ratios on
the probability that a firm will declare bankruptcy. Most external observers of a firm rely on these
financial indicators to predict decline and bankruptcy. [Chapter 13 provides a more detailed presentation
on bankruptcy, bankruptcy law and strategic bankruptcy].

How to Predict Bankruptcy

In a model prepared by Altman (1968), five basic ratios were utilized in the prediction of corporate
bankruptcy. Analyzing empirical evidence from firms that failed, Altman (1968) estimated the impact of five
financial ratios on the probability that a firm will declare bankruptcy with the following Z scores equation:

Z = 1.2 x1 + 1.4 x2 + 3.3 x3 + 0.6 x4 + 1.0 x5

where

x1 = Working capital/total assets

x2 = Retained earnings/total assets
x3 = Earnings before Interest and Taxes (EBIT)/book value of total debt
x4 = Market value of equity and preferred stock/book value of total debt (or total liabilities)
x5 = Sales/total assets.

Variable one is a liquidity ratio; variable two is a financial gearing ratio; variable three is a profitability
ratio or earnings ability; variable four is a size of a firms total equity to debt leverage ratio, a liability ratio
or indirectly, a shareholder wealth creation metric, and variable five is a revenue performance ratio. The
model attaches highest weights to profitability ratio (x3) and lowest weight to shareholder value variable(x4).
According to Altman, a Z score below 1.8 indicates sure failure; a score of 1.8 to 2.99 indicates probable
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non-failure, and a score of greater than 3.0 indicates assured corporate health or non-failure. This model
predicts bankruptcy with 95 percent accuracy one year prior to bankruptcy and with 72 percent accuracy
two years prior to bankruptcy.

The Z scores, however, are not a good predictor for more than two years before bankruptcy. In this
sense, the model is not very useful, since banks and investors, using conventional methods, can predict
bankruptcy or that a firm is headed for insolvency two years before it actually happens. One could enhance
predictability by including the standard deviations of these ratios in the Z equation. [For further
improvements on predictability of Z scores, see Altman, Haldeman and Narayanan (1977); Dambolona and
Khoury (1980)].

Because it is difficult to determine the market value of private companies (see x 4), this model was
designed for public companies. Altman (1983: 108) believed that the market value of a firm is a more
effective indicator of bankruptcy than the commonly used ratio of net worth to total debt. Book value may
be used when calculating the X score for privately held companies. If book value is substituted for market
value, however, then the X coefficients would be changed.

Altman (1983:120-24) suggested the following revised model:

Z' = 0.717x1 + 0.847x2 + 3.107x3 + 0.420x4 + 0.998 x5

A larger area of uncertainty is associated with Z' scores, which indicates bankruptcy at a value of 1.23
(compared to 1.81 for Z scores) and non-bankruptcy at 2.90 (compared to 2.99 for Z scores).

Z or Z' scores, weights and cut-off points, however, may differ across countries, industries and
markets, will change over time as economic conditions change, and accordingly, Z scores will differ in
their predictive capacity. Hence, great care must be exercised in interpreting and drawing conclusions
from the Z scores (Slatter and Lovett 1999). For instance, Argenti and Taffler (1977) applied Altmans
(1968) model to UK financial data and concluded that financial gearing and profitability measures were
the most significant ratios in predicting failure, and that liquidity ratios are of less importance. Currently,
with the information of data and large computer processing capacity, Z scores for industries have been
developed (e.g., Syspass in the UK, S&P in the US).

Hambrick and DAveni (1988) studied 57 large bankrupt firms and 57 matched industry survivors to
determine what differentiated them over time (e.g., in the ten years preceding failure in the case of
bankruptcy). Their findings suggest: 1) failures showed signs of relative weakness very early, as far as
ten years before they failed. 2) The failures, on average, had significantly lower equity-to-debt ratios than
the matched industry survivors for each of the ten years examined before failure, with pronounced
deteriorations for the bankrupts in the last two years before bankruptcy. 3) Their operating performance,
measured by net-income/assets (or ROA = return on assets), was also significantly inferior to or lagged
the survivors in all the years observed.

These findings are linked and intertwined: poor profits limit any increases in equity (in the form of
retained earnings) and cause the firm to take on more debt to finance operations. The power of
equity/debt and net income/assets in predicting bankruptcy (measured by R-square values in a Logit
analysis using these as independent variables together with others) increased from 0.32 in the fifth year
before bankruptcy, to 0.39 in the fourth, 0.44 in the third, 0.79 in the second and 0.89 in the first year
before bankruptcy. Variables such as working-capital/sales did not feature as a marked difference
between bankrupts and survivors, presumably because the bankrupts maintained a satisfactory cushion for
current obligations. This cushion collapsed, however, in the two years immediately preceding
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bankruptcy, thus indicating significant differences in working-capital/assets between bankrupts and
survivors. The fact that bankrupts showed signs of relative weakness as early as ten years before failing
suggests: 1) that organizational death was a protracted process that 2) could be early detected, predicted
and controlled.

How to Avoid Corporate Bankruptcy

Here are some suggestions from Edmond P. Friermuth, a banking consultant from Santa Monica, CA,
who was also a banker for 10 years, making loans to small and medium businesses: (See Jacobs 1984):

1. Analyze companys financial difficulties, their extent and their causes.

2. Estimate cash receipts and cash disbursements for the next three to six months.

3. Analysis under (2) would indicate disbursements exceed receipts. Hence, be aggressive in
collecting receivables but do not let go accounts payables.

4. The immediate remedy for paying payables is to cut expenses as quickly as possible. Take a
hard look at all expenditures, especially payroll. In general, small businesses have more
employees than they need; they feel reluctant to fire slack labor.

5. Do not mislead your creditors. Your creditors, upon consistent defaults in payment, will look
at your disbursements, especially, your payroll. Follow them if they suggest serious labor
attrition. Cooperate with your creditors to keep your business out of bankruptcy proceedings.

6. Even though Chapter 11 protects you from your aggressive creditors for a while until you
reorganize, it is an expensive process. Chapter 11 protection involves filing fees with the
Bankruptcy Court, referee and trustee fees, attorney fees, asset appraisal fees, accounting fees,
auctioneer and other liquidation fees, customary court costs for recording and transcribing the
proceedings, and the like. The ailing business can ill-afford these fees. Moreover, it consumes
time, energy, emotions, anxiety and fear all of which deter you from turning your business
around. Hence, avoid Chapter 11 at all costs.

Recent Bankruptcy Filings in the U. S.

It should be noted that not all the companies that fail, register their failure with the governments or
other institutions like the Dun and Bradstreet (D&B) that provide regular statistics on bankruptcy filings.
For instance, there is no public record of discontinued firms. Discontinued firms are those that
entrepreneurs voluntarily discontinue operations of for a variety of reasons, such as loss of capital,
inadequate profits, and ill health or retirement. As long as the creditors are paid in full, discontinued
firms are not tantamount to failure or bankruptcy, and hence, will not be tallied by D&B. Every year
several hundred firms are started, almost an equal number are discontinued, and even more, transfer
ownership and control (Bibeault 1999:9-10).

Financially distressed firms seek either bankruptcy or out-of-court restructuring settlements. In

general, large (e.g., Fortune 500) firms seek bankruptcy while smaller firms (who cannot afford heavy
bankruptcy court fees and prolonged litigations) seek out-of-court restructuring. Those who seek
bankruptcy may either choose to liquidate the firm or the institution under Chapter 7 provisions or seek to
reorganize it under Chapter 11 provisions. Those firms seeking out-of-court restructuring can also choose
to either reorganize or liquidate. Reorganizing under both cases has two fundamental options: a) reduce

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or reschedule debt payments and b) sell assets or issue new equity (Gilson 2001: 24). Schematically: (See
Exhibit 12.1)
Exhibit 12.1: Options of Financially Distressed Firms

Options of Financially Bankruptcy Protection Financial Strategies

Distressed Firms Provisions
Total liquidation
Usually larger firms in bankruptcy Chapter 7 for Liquidation Foreign joint ventures excluded
courts: Reduce or reschedule debt
Chapter 11 for Reorganization Sell assets and/or issue new equity
Total liquidation
Usually smaller firms out of Chapter 7 for Liquidation Foreign joint ventures excluded
bankruptcy courts Reduce or reschedule debt
Chapter 11 for Reorganization Sell assets and/or issue new equity

During 1980-2000, all business bankruptcies in the United States that sought Chapter 7 protection
exceeded 11.5 million, averaging to over half million a year with a spread of about 0.23 million on either
side of the mean. Table 12.1 provides details. The least number of Chapter 7 filings were 234,594 in
1983 and the highest number was 1,035,696 in 1998. During the same period, namely 1980-2000, all
business bankruptcies that claimed Chapter 11 liquidation numbered over 344,000, averaging to over six
thousand per year with a standard deviation (SD) of 5,746. The highest Chapter 11 bankruptcy filings
were 24,740 in 1986 and the least were 6,348 in 1980. Thus, during 1980-2000, Chapter 7 bankruptcies
each year outnumbered about 33 times Chapter 11 bankruptcies. During the same period, 2,275 public
companies, totaling over $692 billion in assets, filed for Chapter 11 bankruptcy protection, and an equal
number of companies have restructured their debt out of court.

Average assets of public company Chapter 11 bankruptcy filings lost during 1980-2000 surpassed 281 million
dollars (SD = 218.97). The highest mean loss in assets per company was $719.8 million in 1990 while the lowest
average was $26.95 million in 1980.

The annual compound growth rate during 1980-2001 differs across different types of bankruptcy
filings and has been as follows (See Table 12.1):

For Chapter 7 public companies: 9.73

For Chapter 11 public companies: 5.36
For Chapter 7 nonpublic companies: 6.41
For Chapter 11 nonpublic companies: 2.17
For all Chapter 7 bankruptcy filings: 6.46
For all Chapter 11 bankruptcy filings: 2.21

Thus, judged by 1980-2000 bankruptcy data in the USA, Chapter 7 Bankruptcy filings of public
companies have grown the fastest at 9.73 percent, while Chapter 11 bankruptcy filings for nonpublic
companies have grown the least at 2.17 percent during 1980-2001. Generally, larger publicly held firms
seek Chapter 11 protection (Bibeault 1999: 10). However, judged by assets lost for Chapter 11
bankruptcy filings of public companies, the liability per bankrupt company has been growing at 16.15
percent each year since 1980.

During 1980-2000, in the United States, more than 1,500 companies have split themselves through
equity spin-offs or by issuing tracking stocks, creating over $700 billion in new publicly traded equity.

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Also during the same period, hundreds of corporate downsizing programs have laid off more than 10
million employees. Remarkably, all three types of corporate restructuring activities have grown almost
every year during this period, through both booms and busts in the economy (Gilson 2001).

A Statistical Analysis of Recent U. S. Bankruptcy Filings

Trend analysis is presented in Table 12.2. Based on 1980-2001 data, there is a significant positive
linear trend in the growth of Chapter 7 bankruptcies among all businesses: the correlation coefficient
between time (in years) and the number of Chapter 7 bankruptcies is 0.949 (p < 0.000; df = 21). The
regression trend equation is:

Number of Chapter 7 bankruptcies = -7.9E+07 + 40,165.35 (Year) (Adjusted R2 = 0.901; F = 171.96) (1).

Specifically, the number of Chapter 7 bankruptcies among non-public companies shows a stronger
linear trend than the same number among public companies:

Chapter 7 non-public company bankruptcies = -7.825E+07 + 39,595.74 (Year) (Adj. R2 = 0.900; F = 171.79 (2).
Chapter 7 public company bankruptcies = -11,288.78 + 569,609 (Year) (Adj. R2 = 0.601; F = 28.63 (3).

That is, in general, Chapter bankruptcy filings among both public and non-public companies have
been increasing each year. Using this regression equation, we can project Chapter 7 bankruptcy filings
for future years, say 2001-2020 (for details see Exhibit 12.2).

Based on 1980-2001 data, there are no significant linear trends in relation to Chapter 11 bankruptcies
among either public or non-public companies. The same 1980-2001 data also reveal a positive significant
relationship between the number of Chapter 11 public company bankruptcies and the total assets lost:

Number of Chapter 11 public company bankruptcies in a given year = 88.609 + 0.598 (Total assets lost by the
Chapter 11 public companies that year) (Adjusted R2 = 0.296; F = 9.427; p < 0.006). (4).

Exhibit 12.2: Forecasting Chapter 7 Bankruptcies among Public and Non-

Public Companies for 2001-2020
Year Extrapolated number of
Chapter 7 bankruptcies
among public companies
Extrapolated number of Extrapolated number
Chapter 7 bankruptcies of Chapter 7
among non-public bankruptcies among
companies public and non-public
companies

2001 10,910 979,731 990,641

2002 11,480 1,019,327 1,030,807
2003 12,050 1,058,923 1,070,973
2004 12,619 1,098,519 1,111,138
2005 13,189 1,138,114 1,151,303
2006 13,758 1,177,710 1,191,468
2007 14,328 1,217,306 1,231,634
2008 14,898 1,256,902 1,271,800
2009 15,467 1,296,497 1,311,964
2010 16,037 1,336,093 1,352,130
2020 21,733 1,732,051 1,753,784

13
 Based on a correlation analysis of the 1980-2001 bankruptcy filings data, the following conclusions
are plausible:

1. The higher the number of Chapter 7 bankruptcy filings among all businesses in a given year, the
lesser the Chapter 11 bankruptcy filings. [The correlation between the two variables is 0.439, p <
0.046].

2. The higher the number of Chapter 11 bankruptcy filings among public companies, the higher are the
total assets lost by the Chapter 11 bankruptcy companies. [The correlation between the two variables
is 0.576, p < 0.006].

3. There is a significant and positive correlation (r = 0.455, p < 0.038) between Chapter 7 and Chapter
11 bankruptcy filings for the public companies.

4. There is a significant and negative correlation (r = -0.436, p < 0.048) between Chapter 7 and Chapter
11 bankruptcy filings for the nonpublic companies.

Bankruptcy is a flexible and powerful tool for negotiating periods of financial distress. Hence, the
number of bankruptcy corporate filings in the United States continues to rise through good and bad
economic times (Grant 2003). However, there are a variety of alternatives to bankruptcy that corporations
must be aware of before they file for bankruptcy, and they must understand the dynamics, choices and
options that are available throughout and within the bankruptcy process. That is, bankruptcy is not the
only option of the debtor when in financial and fiscal trouble. There may be several other ways of
resolving ones financial trouble without resorting to bankruptcy. There is no rule of thumb or an
easy formula about how far into debt one can be before considering bankruptcy. Each case is
different. A general rule is that bankruptcy should be a last resort. For many people in financial
trouble, bankruptcy is both undesirable and unnecessary (Strohm 1997: 8).

Currently, for many businesses, however, bankruptcy is a looming reality, one that can take many forms.
The most widely recognized form is Chapter 11 that permits a reorganization of the corporation, as opposed
to liquidation under Chapter 7. In general, U. S. Bankruptcy code assumes, at least from an economic
analysis viewpoint, that business failure is not always inevitable or bad, and both legal protection and
economic efficiency can enable viable firms for a better reallocation of resources, corporate survival and
even corporate resurgence (Blanc 2002).

Business failure, including the legal procedures of corporate bankruptcy liquidation and reorganization,
is a sobering economic reality reflecting the uniqueness of the American way of corporate death (Altman
1983). Dun & Bradstreet yearly classifies bankruptcies by presumed cause as follows:

Experience factors that lead to business failures are management incompetence,

lack of line experience, and unbalanced experience.
Economic factors include low profits, high interest rates, loss of market, and low
consumer spending. Both these factors combined explain most of the business
failures (e.g., 89% in 1986, 92% in 1987) (Dun & Bradstreet 1988).
Expense Factors: The remaining ten percent of business failures are normally
due to expense causes such as lack of sales, heavy operating expenses, and
management neglect.

More recently, Dun & Bradstreet has renamed expenses causes to finance causes that include
problems such as burdensome institutional debt, insufficient capital, and heavy operating expenses. This
14
categorization, however, assumes that all bankruptcies are reactions rather than proactive actions
(Delaney 1992:38). Often, bankruptcy could be a proactive strategy.

Bankruptcy and Credit

Bankruptcy assumes credit. It is premised on the issuance of credit. We live in a market society where
extensions of credit are woven into the fabric of our everyday life. We use water, heat, electricity, phones,
and other daily utilities on credit - the bills come only at the end of the payment period. Without credit,
most of us could not afford to pay for our education, our first home, our first new or used car, that exotic
vacation or that expensive wedding. Most people pay back every penny they owe, mostly due to self-
esteem than out of fear of collection agencies or the law. Others repay debt out of a feeling of moral
obligation. Creditors seldom have to resort to the legal process. Creditors, however, would not grant us
credit if there were no mechanism by which their rights over debtors could be safeguarded. Bankruptcy
Law is one such instrument.

However, not all of us are equally honest in paying off our debts or equally smart in managing them.
Those who fail to pay their creditors are most often not those who are dishonest but rather those who find
themselves in dire financial difficulties brought about by circumstances ranging from improvidence to
bad luck. Business bankruptcies usually result from a combination of poor business management and
unfavorable market conditions (Stanley and Girth 1971). Thus, American law has always put limits on
creditors ability to use the legal process. Even though in the 17 th century, English law frequently treated
debtors as miscreants who deserved whatever fate befell on them, the 17 th and 18th century American
lawmakers tried to balance the rights of creditors and debtors. Laws ensuring creditors rights to recover
money owed them were always tempered with the concern for the debtors procedural and substantive
rights (Baird 2003:30-31). In general, the English Bankruptcy Law is creditor-friendly, while the
American Bankruptcy Law is debtor-friendly.

Consumer versus Corporate Bankruptcy Filings in the U.S.: 1982-2002

Bankruptcy filings rose in 2002 to an all-time high of 1.5 million petitions. From 1995 through 1998,
the number of petitions has increased each year while the U. S. economy continued to grow, with the year
1998 representing the eighth straight year of economic growth. Bankruptcy filings dropped during 1999-
2000, but picked up again in 2001 to 1.44 million. Among the bankruptcy filings in 2001 were Enron, then
the worlds largest power and gas provider. Enron, the then seventh largest firm in Fortune 500 with assets
close to $62 billion, filed for chapter 11 bankruptcy on December 2, 2001, till then the largest in the history
of the U. S. (almost twice the size of the Texaco bankruptcy filed in 1987). Enrons stock price plummeted
from $90 per share a year before filing to $ 0.26 per share just a few days before fling the petition. The next
year, WorldCom Inc. filed Chapter 11 bankruptcy with an asset value of $103.9 billion, dwarfing Enron.
The same year, Global Crossings Ltd. filed chapter 11 bankruptcy with assets $25.4 billion and Adelphia
Communications did the same with assets of $24.4 billion (see Bankruptcy.com).

Table 12.3 provides statistics on bankruptcy filings, by businesses and consumers, for the years 1982-
2002. During this span of 21 years, total bankruptcy filings exceeded 18.8 million, averaging to 896,200
a year with a spread of 393, 300 on either side of the mean. The minimum filings were 348,521 in the
year 1984 and the maximum filings were 1,505,306 in 2002.

During 1982-2002, the total number of bankruptcy filings by corporations exceeded 1.23 million,
averaging to 58,769 a year with a spread of 13,802 on either side of the mean. The minimum filings were
35,472 in the year 2000 while the maximum filings were 82,446 in 1987, incidentally, the same year the
15
U. S. had the highest activity of mergers, acquisitions and divestitures. Business bankruptcies were a
small percentage of the total bankruptcy filings in any given year, the minimum being 2.6 percent in 2002
and the highest being 18.2 percent in 1882. That is, the percentage share of business filings has been
steadily going down from 18.2 percent in 1882 to 2.6 percent in 2002. Nevertheless, business filings have
been relatively high each year in terms of absolute numbers.

In addition, during 1982-2002, the total number of bankruptcy filings by consumers was 17.586
million, averaging to 837,429 a year with a spread of 408,029 on either side of the mean. The minimum
filings were 286,307 in 1984 and the maximum filings were 1,466,105 in 2002. Consumer bankruptcies
were a large percentage of the total bankruptcy filings in any given year, the minimum being 81.80
percent in 1882 and the highest being 97.40 percent in 2002. That is, the percentage share of consumer
filings has been steadily increasing from 81.8 percent in 1882 to 97.40 percent in 2002 of the total
bankruptcy filings.

Thus, while business filings have been relatively decreasing during 1982-2002 (correlation between
time and the number of business flings is 0.830), consumer filings have been steadily increasing during
1982-2002 (correlation between time and the number of consumer flings is 0.971). There is a
significantly negative correlation between business and consumer bankruptcy filings (r = - 0.784, p <
0.01). Personal bankruptcy filings might have reached 2 million by 2006. In which case, given that there
were 100 million households in the U. S. A. in 2006, there is a two per cent chance that any household
could seek bankruptcy in 2006.

Not all companies that fail, however, register their failure with the governments or other institutions
like the Dun and Bradstreet (D&B) that provide regular statistics on bankruptcy filings. Thus, Table 13.1
underestimates business and consumer failures.

Theories of Corporate Bankruptcy

Several theories have been proposed in the management literature to explain or justify corporate
bankruptcies. We review some theories. They are important in the application of Chapter 11 procedures.
Chapter 11 decides which firms should be dissolved or which reorganized and permitted to continue in
business based on its analysis of reasons for bankruptcy.

Economic Theories of Bankruptcy

Economists assume that bankruptcy is a technical, financial state in which a firms debts outweigh its
assets. Micro-economic models assume that a firm in such a position will be forced out of business and
other more efficient firms will replace it. These models assume that more productive firms are constantly
replacing less productive firms, thereby leading to increased market efficiency and equilibrium (Day
1975; Hirschman 1970; Adrich 1979; Hanna and Freeman 1977). In general, economists fail to
understand the process or operation of corporate bankruptcy since economic theories focus more on the
exit of the failing firms rather than the reasons of their failures (Hirschman 1970).

The bankruptcy process is a significant part of the natural selection component of any survival of
the fittest model, and one must ask whether it works properly to allow efficient firms to stay in business
while seeping away inefficient firms. Chapter 11 procedures must carefully decide which of the almost
60,000 firms that every year seeks bankruptcy filings (see Table 12.1) should be allowed to reorganize
and which should be liquidated. That is, how does the court decide which firm is efficient and which
inefficient before making the reorganization/liquidation decision?
16
 Macroeconomists, unlike microeconomists, have paid attention to the process rather than the state of
corporate bankruptcy. Thus, Altman (1971, 1983) investigated the relationship between business failure
and other aggregate macroeconomic phenomena, developing a multivariate model to predict national
levels of bankruptcies. Many analysts in this tradition have predicted the level of bank failure based on
balance sheet items and a series of large-scale cyclical market factors in the overall economy (Gordon
1971; Johnson 1970; Meyer and Pifer 1970). These analysts conclude that bankruptcy is caused, and can
be also explained, by internal balance sheet data and cyclical macroeconomic market economic factors.
This conclusion, however, is not very different from that of Dun & Bradstreet and the US Commerce
Department views (Delaney 1998: 40).

There are several problems with this macroeconomic perspective: (Delaney 1998: 40-42)

1. These analysts take balance sheet data for granted as the only portrayal of the firms financial state.
Unfortunately, much of what winds up in the annual balance sheet or bankruptcy filing balance sheet
is actually constructed by various institutional actors in the firms network, whose power and
influence to shape the bottom line can very much affect the numbers in the balance sheet or
income statement or in the cash flow statements.

2. Accordingly, these analysts focus on ratio analysis based on balance sheets, such as debt-to-equity,
debt-to-asset, and cash flow indicators, and then widen their vision to national market factors such as
national interest rate or stage in the business cycle. These macro models, by their nature, tend to
ignore the immediate socioeconomic milieu of the firm: its relationship with creditors, suppliers,
employees, customers, insurers, the government, courts, and other organizations within its immediate
network.

3. Given (1) and (2), the big assumption is that bankruptcy is mainly an internal managerial decision,
and that links between firms and markets are at best tenuous. Bankruptcy is interpreted as just one
permutation of a larger category of alternatives such as the voluntary exit of the firm from the
market, foreclosure or attachment, voluntary compromise with creditors, or straight bankruptcy.
Bankruptcy, in this view, is a last resort and part of the larger phenomenon of business failure.

4. All these consideration under (1), (2) and (3) make several problematic assumptions: a) bankruptcy
is an economic state that a firm finds itself in when its liabilities outweigh its assets; b) bankruptcy is
an organizational response or adaptation to market conditions; c) hence, bankruptcy can be
predicted through ratio analysis of micro balance sheet indicators within the firm and macro market
indicators outside the firm; d) that balance sheet indicators are empirically definable,
mathematically measurable, and not subject to dispute, and e) that bankruptcy is mainly caused
by problems internal to the firm or endemic to the domestic or global marketplace. All these
assumptions are questionable.

Legal Theories of Business Bankruptcy

Influenced by economic (micro and macro) theories, legal theory of bankruptcy suffers from the same
questionable assumptions (a) to (e) stated above. Hence, legal theory believes:

a) Bankruptcy law is not concerned, and should not be, with business rehabilitation. Instead, the
court should only be concerned with what is most efficient for the overall economy.
b) Thus, bankruptcy law, if designed properly, must encourage creditors and debtors to choose
bankruptcy at the time when it maximizes the money available to creditors as a group.

17
 c) That is, the court chooses between reorganization and liquidation based on whether the firm is
worth more kept operation (i.e., reorganized) or sold off (liquidated) (Baird 1986).
d) Thus, legal theory focuses on designing bankruptcy procedures that impel firms and their
creditors to choose bankruptcy at the most efficient time (Posner 1972; Weistart 1977; Weston
1977).

Such a legal theory has its own problems (Delaney 1998: 43-45):

Courts assume that firms behave rationally, but never analyze their actual behavior in bankruptcy.
Management literature has demonstrated that organization exist and function in a world of
bounded or limited rationality, limited knowledge, conflicting goals, and pressure from creditors
that weakens rational thinking, (Simon 1976; March and Simon 1958; Nelson 1981).

Few empirical studies exist to test whether firms behave as the economic and legal theories predict.
White (1989) verified that bankruptcy rules have actually encouraged firms and creditors to choose
options that maximize their own interests and not those that maximize the money available to all the
creditors as a group.

It is far from clear that given the deductive framework of the legal and economic theories, whether
bankruptcy rules trigger the efficient outcomes the theories predict.

Apparently, according to the legal theory, bankruptcy law does not worry about questions of the
fairness of allocation of proceeds among creditors, because these questions are handled outside the
bankruptcy law.

That is, the rights of each party in a bankruptcy case are established prior to the bankruptcy filing
and the bankruptcy court need only enforce pre-petition rights. For instance, commercial banks
often bargain for the priority of their claims by adding covenants to loans made to corporations such
that no other loan can take precedence in case of bankruptcy.

Then who resolves other sociological questions such as, What power do various parties have to
bargain for superior positions before and in bankruptcy? How do they get this power? For instance,
do a commercial bank, labor unions, and an asbestos victim have equal bargaining power to gain
precedence? If not, bankruptcy may not act as a neutral debt-collection device that fairly treats all
those who make a claim on the debtor.

The legal rules are supposed to ensure that all parties on the same level are treated fairly, and the
role of the bankruptcy judge is to balance the equities of all parties. But how does the judge
balance the equities of parties with vastly different interests?

It is assumed that the bankruptcy judge makes a decision based on his or her view of the rights of
various parties. But how does the judge ascertain the rights of various parties, when some parties
will pressurize the courts to have their interests protected?
In most cases, reorganization plans are subject to extensive negotiations that result in a great deal of
bargaining over payoffs. One priority level, for example, may agree to take less and give another
priority more in order to gain their endorsement of the reorganization plan.

Sociological Theories of Bankruptcy

Several theories in sociology have been addressing the problem and process of corporate bankruptcy.
In general, these theories do not assume bankruptcy as a static technical state in which a firms debts
outweigh its assets. Instead, they recognize that bankruptcy is a strategy and try to analyze the dynamics,
causes and process of this strategy. All theories agree that bankruptcy, as a strategy, is an inter-
18
organizational construction of business crisis where in several key players or institutions, such as banks,
creditors, suppliers, customers, employees, courts and governments are involved. The theories differ in
their approach or understanding of bankruptcy as an inter-organizational strategy.

Managerialism: This is the oldest view linked to seminal authors such as Berle and Means (1932,
1968) and Burnham (1941). Their main thesis is that the two major attributes of management, namely,
ownership of wealth and control of managerial operations, have become divorced. The capitalists who
owned the firms and were driven by a profit motive are slowly separated from the managerial class of
executives who may have other concerns (e.g., employee welfare, social welfare) other than the bottom
line. This rift or managerial revolution (Burnham 1941) was brought about by three factors:
concentration of corporate power and influence, the increasing dispersion of stock ownership resulting in
the diffusion of control by the owners of the capital, and increasing separation of ownership and control in
everyday management of the firm (Berle and Means 1968: xxix). With reduced pressure for profits,
professional managers took full control of the firm, and even absolutized this power in relation to capital,
risk and market opportunity. Some of this absolutization of corporate power ignored the inter-corporate
nature or the inter-organizational aspects of the firms, backfired and resulted in bankrupting the firm.
Dun & Bradstreet analysis of bankruptcy (discussed earlier) supports this view.

Resource-Dependency: Reacting to the simplistic managerial view of bankruptcy, the resource-

dependency school postulated the corporation exists in a larger environment composed of other
organizations (e.g., competitors, suppliers, governments, labor unions, markets) that affect and constrain
the corporation. Thus, managers are not fully autonomous since they must cope with this environment
(Aldrich 1979; Pfeffer and Salancik 1978; Thompson 1967). The corporation sets its goals and objectives
while adapting to this environment. Major corporate strategies such as joint ventures, mergers,
acquisitions and divestitures were formed to reduce unpredictability in the environment (Pfeffer 1972).
This view, however, considered the firm as a passive adaptor if the environment and did not focus on the
corporations power to manipulate or create its environment. Bankruptcy is the failure of the corporation
to adapt to its environment. While this view of bankruptcy may be true, it does not explain why some
firms proactively transformed their environment to avoid bankruptcy (these are cases of successful
turnarounds) while others failed to do so and faced bankruptcy.

Finance-Hegemony: This theory looks beyond the boundaries of the corporation to understand
organizational behavior and bankruptcy. The main thesis is that the hierarchical dominance of financial
institutions (e.g., commercial banks, insurance companies) controls corporations. For instance, the largest
commercial banks control the activities of the largest corporations in the U. S. (Fitch and Oppenheimer
1970). Other scholars belonging to the finance-hegemony school, however, believe that this financial
dominance is not absolute nor deterministic but episodic. It results from three factors: 1) finance capital
is the universal commodity required by all firms, placing banks in a particularly powerful position; 2)
there are a few large banks that control most of the capital while the borrowers are many; 3) unlike other
commodities that are exchanged for cash or kind, money is exchanged for itself by more money to be paid
at a later date, and the lender can exercise control over the activities of the borrowing organization till the
capital is paid. Bankers sit on the boards of corporations exercising control (Mintz and Schwartz 1985).
Some bankers can dump stock creating corporate crisis leading to bankruptcy (Glasberg 1981, 1985)

Synthesizing Theories of Bankruptcy

Sociology of bankruptcy that combines all three theories, managerialism, resource-based dependence
and finance-hegemony, better explains some fundamental questions in bankruptcy:

19
 Who chose the bankruptcy? Possibly, not one person, but a combination of factors forced the
bankruptcy choice.

What was the cause of bankruptcy filing? The actual causes may be many and arising from the inter-
organizational conflicts in goals among the various parties involved in a bankruptcy filing. Some
parties might have exerted more power than others in forcing bankruptcy or avoiding bankruptcy..

Who would run the company after reorganization? Possibly, some of the parties that exerted higher
power would decide the choice of the executives of the reorganized firm.

Who will exert the highest control in bankruptcy procedures? In general, debtors are inclined to satisfy
their big creditors first, hoping to do business with them again. Debtors have the natural tendency to
pacify big creditors even at the expense of small and scattered public investors. Thus, large creditors
and repeat players will have an advantage over groups that are less powerful and less organized (e.g.,
asbestos victims in the Manville case; see Galanter 1974).

Who will win in this bankruptcy contest? Several could win, lose, or be not affected. It can be a win-
win situation. Some institutions will have more power to push the action in their favor.

Corporate power includes several levels (see Bacharach and Baratz 1962; Lukes 1974; Mintz and
Schwartz 1985):

Authority: B complies because B recognizes As command as reasonable.

Influence: Without resorting to threats A causes B to change its actions.
Effective access: A is in a position to alter Bs decision-making apparatus.
Coercion: A secures Bs compliance by the threat of deprivation.
Force: A strips B of any choice other than compliance.
Constraint: By its actions, A alters the profile of options available to B.

A bankruptcy as a process and strategy is an interplay of authority of banks, influence of

shareholders, effective access of creditors and suppliers, coercion and force on the part of major creditors
who fear losing their stakes, or constraints imposed by employees, labor unions and customers. Large
organizations engage in constraining, coercing and influencing behavior of other organizations. For
example, when the three big automakers in the U. S. had surplus cash they each opened their own auto-
parts divisions (Delphi, Visteon and Moses), thus virtually constraining and even bankrupting existing
spare-parts manufacturers.

Economists who postulate rational behavior of firms have typically assumed that a firm that falls
behind does so for a good reason (Hirschman 1970: 1-2). Legal theory assumes this assumption of full
rationality on the part of the organizational actors as they confront bankruptcy (Baird 1987; Jackson
1986). This theory believes, accordingly, that two firms facing the same economic conditions (e.g., levels
of assets, debts, cash flow and profits) would react to bankruptcy laws similarly. Granovetter (1985) has
challenged this assumption: rational actors will behave dissimilarly when confronted with similar choices.
This because all decisions are embedded in social contexts of relations, institutions and interests and
economic contexts of uncertainty, risk and ignorance. Social relations and economic conditions can
influence the relative efficiency of the various courses of action. Hence, different firms but similarly
positioned may react differently to the environment. Recognizing the embeddedness of social action
helps to understand the play of power in the shaping of rationality in bankruptcy. Much of the literature
on bankruptcy underplays the importance of network relationships in predicting and understanding
organizational behavior (Delaney 1998: 57).

20
Pre-bankruptcy Planning of Alternatives

Various alternatives are available to the debtor in relation to bankruptcy:

a) Is it best to liquidate under provision of state law or the Bankruptcy Code?

b) Is an out-of-court settlement more feasible?
c) Is seeking an outside buyer a better alternative?
d) Or, is filing a chapter 11 petition best under the circumstances?

Liquidation of a business may be done in several ways. Many small businesses can effect liquidation
by ceasing operations and leaving its corporate debt unpaid. When a product/service is inferior, the
demand for the product is declining, the distribution channels are inadequate, or other major problems
exist that cannot be rectified, either because of the economic environment or managements
incompetence, it may be best to liquidate the company immediately (Grant 2003:33). Businesses may
also liquidate under a more formal process, by transferring their assets to an assignee that liquidates the
assets and distributes the proceeds to the creditors. In bankruptcy, corporations may liquidate under either
chapter 7 or chapter 11.

Assignment for the benefit of creditors: Under state law, a remedy available to corporations in
distress is an assignment for the benefit of creditors. Under this provision the debtor voluntarily transfers
title to its assets to an assignee that then liquidated them and distributes the proceeds to all creditors.
Depending upon state law, this process may require the consent of all of the creditors, or at least
agreement (implied or stated) to refrain from taking action. The appointment of a custodian over
substantially all of the assets of the debtor gives creditors the right to file an involuntary petition. Many
small businesses elect to liquidate their businesses using the assignment of assets alternative (Grant 2003:
31).

Out-of-court settlement: The use of this procedure is increasing in the last two or three decades.
There are more agreements reached out of court than through the bankruptcy courts. In most situations
where there is some hope that a business could be rehabilitated, an out-of-court settlement should at least
be considered, as it may be the best alternative in such circumstances. The debtor, through counsel or
credit association, calls for an informal meeting of the creditors for the purpose of discussing its financial
problems. A credit association is composed of credit managers of various businesses in a given region.
In many cases, the credit association enables an out-of-court settlement, providing advice, and serving as
secretary for the creditors committee. At a meeting of this type, the debtor will describe the causes of
failure, discuss the value of assets (especially those unpledged) and the unsecured liabilities, and answer
questions the creditors may ask. The main objective of this meeting is to convince the creditors that they
will receive more if the business is allowed to operate than if it is forced to liquidate and that all parties
will be better off if a settlement can be worked out (Grant 2003: 32).

There are many reasons why it is advisable for the debtor to meet with its principal creditors as soon
as it becomes obvious that some type of relief is necessary: a) The debtor still has a considerable asset
base to protect; b) many key employees may leave when they see unhealthy conditions developing, and
early corrective action may encourage them to stay; c) prompt action may enable the debtor to maintain
some of the goodwill that was developed during more successful periods of the company; d) the debtor
may learn early from the credit association or the creditors how to contain business problems or to seek
the right type of action; e) when no action is taken, you force the creditors to take an action, either to call
for an informal meeting or file for bankruptcy.

21
 Advantages of an out-of-the court settlement are: a) it is less disruptive of business operations; b)
more businesslike solutions can be adopted; c) frustration and delays are minimized; d) agreement often is
reached much faster; e) reduces professional fees substantially; f) an out-of-the-court settlement may give
you an opportunity to prepackage bankruptcy filings plan that your creditors may pre-approved such that
subsequent bankruptcy procedures may be expedited, and e) cost of restructuring are generally less.

Disadvantages of an out-of-the court settlement are: a) a settlement needs the cooperation and consent
of substantially all creditors, and it may be difficult to persuade distant creditors to accept a settlement
that calls for less than 100 percent payment; b) the assets of the debtor may be subject to attack when the
settlement is pending; c) the informal composition settlement does not provide a method to resolve
individual disputes between the debtor and the creditors; d) executory contracts, especially leases, may be
difficult to avoid; e) there is no formal way to recover preferences or fraudulent transfers; f) certain tax
law provisions make it more advantageous to file a bankruptcy court proceeding, and g) priority debt
owed to the U. S. government (under Revised Statue section 3466) must be paid first (Grant 2003: 33-34).

Finally, a chapter 11 provision may be used for various objectives: a) work out an arrangement with
the creditors such that the debtor is allowed to continue in business, secure an extension of time, pro-rata
settlement, or some combinations of both; b) complete reorganization of the debtor affecting secured and
unsecured creditors and stockholders; c) a corporation may also liquidate under chapter 11.

In deciding which course of action to take, it is important to ascertain what caused the debtors
current problems, whether the company will be able to overcome its current difficulties, and if so, what
measures will be necessary to turn the business around. To help with this determination, it may be
necessary to project he operations for 30-day periods over at least the next three years to six months,
indicating the areas where steps will be necessary in order to earn profit (Newton 2003: 30). On this
exercise is done, the answer to the four questions above would depend upon several factors, including
(Newton 2003:31):

Size of the company.

Whether the company is private or public.
Number of creditors, secured or unsecured, public or private.
Commitments made to minority interest resulting from roll-ups of partnerships into the parent.
Nature of debt, including prior relationships with creditors and pending lawsuits, especially class
action against the debtor.
Executory contracts, especially leases.
Tax impact, including special tax considerations given to companies in bankruptcy.
Nature of management, including managerial competence and existence of mismanagement or
irregularities.
Availability of interim financing and the extent to which lenders need protection offered in a
bankruptcy filing.

Pre-bankruptcy Planning

Planning prior to filing chapter 11 is a major determinant of the success of the reorganization. Five
major steps are needed for a successful pre-bankruptcy planning (Grant 2003: 36-41):

Cash Management: Cash accumulation to finance the reorganization should be the first and foremost
concern of the debtor. How to obtain cash to operate the first few weeks will be an immediate concern.
Use existing payroll accounts and honor employee payroll checks. Pay any back wages. Use existing
bank accounts and honor drawn checks. Demand daily reporting and analysis of cash balances. Sweep

22
accounts receivables and other cash accounts and effectively manage cash during the case. Set up new
cash accounts: real success depends on obtaining new accounts and financing throughout the
reorganization process. Develop a cash management system for post-petition operations.

Operations Management: Continuous operations are essential for a chapter 11 entity. Open
communication with suppliers, buyers, and employee representatives are vital to a successful
reorganization. Install procedures for reviewing purchasing procedures including extra charges and
pricing problems. Study vendor and supply problems, including an identification of critical vendors and
alternative suppliers. Develop a plan to handle and verify requests for reclaiming goods and to pay for
goods for which the reclamation was properly made. Obtain assets in hand of third parties, including
inventory in transit. Establish procedures to ensure that pre-petition debt is not paid without proper
authorization and identify unauthorized pre-petition debt payments. Establish procedures for redressing
consumer complaints of warranties and guarantees not honored, rebates not paid, and other just claims not
fulfilled. Develop a plan to discuss chapter 11 with the employees, a program of expense reimbursement
(for business expenses paid by employees), and to discuss modification to collective bargaining
agreements and retiree benefits.

Legal Requirements: Appoint a legal team to do the overall planning of pre-filing activity and
preparation of court documents. Decisions for the legal team include: a) which subsidiaries should file
and which should not, corporate separateness, intermingled funds, cross-collateralization, extend of trade
indebtedness, cash flow and prospects, location of operating assets, and possibility of defraying costs of
debtors administration; b) selection of venue for filing (e.g., Delaware, Southern district of NY); c)
selection of time to file (e.g., a time in the business cycle when cash or inventory level and trade payables
are at the highest level); d) preferences and fraudulent transfers (see below); f) tax considerations (proper
timing can result in a tax claim being a priority claim payable over a period of six years instead of an
administrative expense payable as of the effective date of the plan; g) preparation of petitions; h)
preparation of board of directors and i) preparation of plan of reorganization.

Financial Reporting and Taxes: Duties of the finance and tax team include: a) prepare a list of the
20 largest creditors (Rule 1007d and Form 4); b) develop schedule of assets and liabilities, statement of
affairs, and schedule of executory contracts (Rule 1007); c) prepare monthly operating reports for court
and creditors; d) set up new liability accounts; e) set up new asset accounts for selected items such as
inventory and accounts receivable; f) develop a claims processing plan; establish compliance reporting
procedures for debtor-in-possession financial agreement; g) select a filing date (e.g., near month-end, or
end of a quarter or fiscal year); h) consider tax issues (e.g., pre-petition taxes may be deferred up to six
years; withholding taxes or trust taxes may you still liable under either Internal Revenue Code (IRC 6672)
or state laws), and i) complete assessment of existing record

Public Relations: The PR team has a sensitive role and should be prepared fro the flood of inquiries
that occur after filing. The methods and timing of imminent filing information-diffusion can make a
tremendous difference in the levels of cooperation received from creditors and other public organizations.
PR planning should include: a) develop a statement describing the reasons for filing for press release,
letters to shareholders and the like; b) schedule announcement dates to each category of interested parties
with a communication matrix; c) prepare press releases; d) develop a program for ongoing
communication with management, employees, key customers, and vendors; e) identify specific
individuals within the organization who will be responsible for answering questions consistently and
reliably; f) identify individuals to answer questions from the press, and g) consider the impact filing for
chapter 11 may have on stakeholders outside the U. S.

23
 The parties who need to be informed about chapter 11 filing include shareholders, customers,
suppliers and other vendors, sales representatives, union officials, institutional creditors, public debt
holders, regulator agencies, community officials and members of the news and financial press.
Information that need to be communicated includes causes of filing, nature of bankruptcy process, impact
of filing on current operations, events that led to the filing, financial highlights, financing during
bankruptcy, and strategic action the company is taking for the profitable future of the company (Grant
2003: 40-41).

Concluding Remarks: Bankruptcy as a Corporate Strategy

Corporations invoke chapter 7 or chapter 11 bankruptcy protections for a variety of reasons many of
which do conform to doctrinal, legal or economic predictions. Firms may choose bankruptcy for 1)
forestalling law suits, 2) to force a compensation system in place of the tort system, 3) to eliminate union
contracts, 4) to reduce a court award in a corporate takeover battle, 5) to force the government to take
over responsibility for a pension plan or healthcare coverage promised to the retirees, 6) to avoid cleaning
up a toxic waste site, 7) to alter a bargaining relationship, or 8) revenge against a competitor (Delaney
1992:161). In general, organizations with larger resources, superior public relations and legal
knowledge, and access to legal and financial specialists are able to use bankruptcy more easily that
organizations or individuals without these resources.

Whatever might be the internal reasons of the individual debtor or the corporation in financial
distress, the bankruptcy law presumes the debtors are honest but improvident and unlucky. The
bankruptcy proceedings are meant to bring timely relief to the debtors so that they have a fresh start, the
creditors have justice meted out to them, and the nation and the world at large are better off from the
future earnings of the debtors.

24
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29
 Table 12.1: Business Bankruptcy Filings in the United States: 1980-2000*

Year Public Companies Non-Public All Businesses

Companies
Chapter 7 Chapter 11 Total Assets Lost Chapter 7 Chapter 11 Chapter 7 Chapter 11
in Chapter 11
Bankruptcies
($billions)
1980 2433 62 1.671 246703 6286 249,136 6,348
1981 1921 74 4.703 258743 9967 260,664 10,041
1982 1150 84 9.103 256494 18737 257,644 18,821
1983 1031 89 12.523 233563 20163 234,594 20,252
1984 1404 121 6.530 233593 20131 234,997 20,252
1985 1791 149 5.831 279195 23225 280,986 23,374
1986 2255 149 13.033 372197 24591 374,452 24,740
1987 2289 112 41.503 404472 19789 406,761 19,901
1988 3020 122 43.488 434862 17568 437,882 17,690
1989 3522 135 71.371 473471 18146 476,993 18,281
1990 3006 115 82.781 540328 20668 543,334 20,783
1991 3421 125 83.202 653039 23864 656,460 23,989
1992 2741 91 54.283 678922 22543 681,663 22,634
1993 2705 86 16.752 600275 19088 602,980 19,174
1994 2688 70 8.336 564552 14703 567,240 14,773
1995 4076 84 23.471 622074 12820 626,150 12,904
1996 5715 84 13.999 804685 11827 810,400 11,911
1997 7536 82 17.245 981836 10683 989,372 10,765
1998 14820 120 28.940 1020876 8266 1,035,696 8,386
1999 14431 145 58.760 912643 9170 927,074 9,315
2000 15583 176 94.786 855222 9659 870,805 9,835

Total 97,539 2,275 692.311 11,427,744 341,894 11,525,283 344,169

Mean 4644.73 108.33 32.967 544,178 16,280 548,823 16,389
S.D. 4558.43 30.98 29.821 258,915.7 5738.24 262,627.3 5,745.96
Minimum 1031 62 1.671 233,563 6,286 234,594 6,348
(year) (1983) (1980) (1980) (1983) (1980) (1983) (1980)
Maximum 15583 176 94.786 1,020,876 24,591 1,035,696 24,740
(year) (2000) (2000) (2000) (1998) (1986) (1998) (1986)
Range 14552 114 93.115 787,313 18,305 801,102 18,392
Annual
Compound 9.73 5.36 16.15 6.41 2.17 6.46 2.21
Growth rate g
during 1980-
2000

* Columns data 3, 4, 7 and 8 are from New Generation Research, Inc. (2001); columns 2, 5 and 6 are deduced or estimated
from columns 3, 7 and 8. For instance, column 6 = columns 8-3; column 5 = columns 7(6/8) rounded, and column 2 =
columns 7-5].

30
 Table 12.2: Regression Trend Analysis of Bankruptcy Filings:
Independent Variable: Year of Bankruptcy Filing

Dependent Constant B R2 t p
Variable:
Bankruptcy
Filings
Chapter 7 -7.825E+07 39595.74 0.900 0.949 13.107 0.000
Non Public
Companies

Chapter 7 Public --1128878 569.609 0.601 0.775 5.351 0.000

Companies

Chapter 11 666020.8 -326.503 0.079 -0.353 -1.645 0.116

Non Public
Companies

Chapter 11 Public -2489.004 1.305 0.019 0.261 1.180 0.352

Companies

All Chapter 7 -7.9E+07 40165.35 0.895 0.949 13.113 0.000

Companies

All Chapter 11 663,531.8 -325.197 0.077 -0.351 -1.635 0.119

Companies

31
 Table 12.3: Total Bankruptcy Filings by Businesses and Consumers
[Source: Administrative Office of the United States Courts]

Calendar Total Business Filings Consumer Filings

Year Filings Number Percent of Number Percent of
Total Total
1982 380212 69207 18.20 311005 81.80
1983 348881 62412 17.89 286469 82.11
1984 348521 62214 17.85 286307 82.15
1985 412510 71277 17.28 341233 82.72
1986 530438 81235 15.31 449203 84.69
1987 577999 82446 14.26 495553 85.74
1988 613465 63853 10.41 549612 89.59
1989 679461 63235 9.31 616226 90.69
1990 782960 64853 8.28 718107 91.72
1991 943987 71549 7.58 872438 92.42
1992 971517 70643 7.27 900874 92.73
1993 875202 62304 7.12 812898 92.88
1994 832839 52374 6.29 780465 93.71
1995 926601 51959 5.61 874642 94.39
1996 1178555 53549 4.54 1125006 95.46
1997 1404145 54027 3.85 1350118 96.15
1998 1442549 44367 3.08 1398182 96.92
1999 1319465 37884 2.87 1281581 97.13
2000 1253444 35472 2.83 1217972 97.17
2001 1492129 40099 2.69 1452030 97.31
2002 1505306 39201 2.60 1466105 97.40

Total 1982-2002 18,820,186 1,234,160 17,586,026

Mean 896,199 58,770 8.81 837,430 91.18
SD 393,301 13,803 5.68 408,029 5.68
Median 875,202 62,304 7.27 812,898 92.73
Minimum 348,521 35,472 2.60 286,307 81.80
Maximum 1,505,306 82,446 18.20 1,466,105 97.40
Range 1,156,785 46,974 15.60 1,179,798 15.60

32
 Case 12.2:
Dow Corning Company: Strategic Bankruptcy Settlement
[This Appendix is derived from Mascarenhas (2007), Responsible Marketing Concepts, Theories, Models, Strategies
and Cases, North Richland Hills TX: Roval Publishing Co., 308-331]

December 17, 1991, a San Francisco jury awarded $7.34 million in retributive damages to a
Californian woman, Maryann Hopkins, who claimed that her breast implants had ruptured and had caused
an immune system disease. The jury found Dow Corning Corporation (hereafter, DCC) liable under breach
of warranty and fraud claims. It claimed that DCC had marketed her a defective Silicone-Gel-Filled Breast
Implant (hereafter, SBI) that allegedly contributed to her autoimmune disorders (See Hopkins v. Dow
Corning Corp., No. 92-16132, 1992; WL 176560; N. D. Cal. May 27, 1992). DCC was charged with fraud
of deliberately failing to disclose the hazards of SBIs it knew for two decades. DCC was convicted for
withholding, concealing and misrepresenting vital information concerning potential health risks associated
with their SBIs and to have misrepresented its research results to medical professionals and the regulators of
the Food and Drug Administration (hereafter, FDA) [New York Times (NYT), December 17, 1991, A5; Wall
Street Journal (WSJ) 12/21/1991, B1, B8].

Early 1962, Jean Lindsay, a Texan woman, was the first to be operated successfully with a DCC
breast implant. It made instant medical history. Jean is still happy and satisfied with her product. Between
Jean Lindsay and Maryann Hopkins some two million women have undergone breast implant-surgery in the
United States, a million more elsewhere - the vast majority selecting the silicone-gel filled implants. Breast
implants have become the second most practiced form of cosmetic surgery, following liposuction (fat
removal). In 1991, breast implants annually fuelled an over $600 million cosmetic breast surgery business
in the U.S. Each year about 120,000, U.S. women undertake breast implants for breast augmentation and
another 21,000 for breast reconstruction following partial or radical mastectomies. Plastic surgeons receive
anywhere from $1,000 to $7,500 for each procedure.

Between 1962 and 1992, the story of breast implants has been fraught with controversy, punctuated
with horror, dotted with thousands of litigations and climaxed with exorbitant damage-claims. The plot is
still thickening as more complaints against gel implants are recorded in the national registry. Currently,
SBI-related product liability suits on DCC run into thousands. DCC is the largest implant manufacturer
with 45% of its sales abroad (WSJ, March 5, 1992, B1, B5). The cost of litigation to DCC could be
astronomical, even though DCC has a $250 million insurance coverage for such contingencies. As of 1992,
DCC had sold more than 600,000 implants, more than any competitors (e.g., McGhan, Squibb), and it was
estimated that more than one million women had SBIs (WSJ 03/11/1992, B7).

In 1991, DCC had three major breast implant manufacturers as competitors: McGhan Medical
Group, Mentor Corporation, and Bioplasty, Inc. Currently, there are other competitors who manufacture
SBIs such as Bristol-Myers Squibb, Baxter Healthcare, Union Carbide, and 3M. No manufacturer of breast
implants is currently immune from suit.

Around 1995, the major U. S. breast implant manufacturers with percentage complaints (out of a
total 26,643 complaints received) were (Nader and Wesley 1996: 390):

Dow Corning: 16,232 complaints (60.92% of all complaints received).

Surgitek (Bristol-Myers): 5,263 complaints (19.75%).
Baxter Health Corporation: 1,716 complaints (6.44%).
McGhan Medical Inc.: 1,709 complaints (6.41%).
33
 Mentor: 1,065 complaints (4.00%).
Cox-Uphoff (CUI): 490 complaints (1.85%).
Bioplasty Inc.: 169 complaints (0.63%).

DCC Corporate Background

In 1942, the parent companies, Corning and Dow Chemical, entered into an agreement to create a
subsidiary corporation, the Dow Corning Corporation (DCC), each parent holding fifty percent equity
share. Corning provided the silicone technology while Dow Chemical supplied the necessary chemical
processing and manufacturing know-how. Dow Chemical Corporation was founded in 1897, headquartered
in Midland, Michigan, and employed around 62,000 worldwide and earned $942 million from $18.8 billion
sales in 1991. In the year 2000, Dow Chemical ranked 78 among Fortune-500 companies, reported $23
billion in revenues, 21.5 percent over 1999, $1.5 billion in profits, and $27.6 billion in assets. In the
following year 2001, Dow Chemical rose to rank 60 among the Fortune-500 companies, reported $27.8
billion in revenues, 20.8 percent over 2000, $385 million loss in profits, a fall of 125.5% from 2000, and
$35.5 billion in assets (Fortune, April 15, 2002, F-3). Dow Chemical Corporation manufactures a vast array
of products such as pharmaceuticals, chemicals, consumer and agricultural products. The DCC joint
venture produced silicone-based chemicals with 35% world market share.

Corning Incorporated (originally Corning Glass Products) was founded in 1851, headquartered in
Corning, New York, and employed 30,000 worldwide earning $317 million from $3.3 billion sales-revenues
in 1991. In the year 2000, Corning ranked 252 on the Fortune-500 listing, reported $7.3 billion in revenues,
51.1 percent over 1999, $422 million in profits, and $17.5 billion in assets. In the following year 2001,
Corning fell to rank 289 in the same listing, reported $6.27 billion in revenues, 13.8 percent off from 2000,
$5.498 billion loss in profits (that is, 1,403% in the negative since 2000!), and $12.8 billion in assets
(Fortune, April 15, 2002, F-11). Corning Inc. is a producer of specialty glass products.

DCC was legally incorporated in February 1943 and is headquartered in Midland, Michigan. It
employed 8,400 worldwide in 1991, with earnings of $159.2 million on 1991 sales of $1.84 billion. DCC
has been over 50 years in the silicone business, and is the world's largest and most versatile manufacturer
producing over 2,000 silicone products such as molybdenum silicone, polycrystalline rigid silicone, thin to
elastomeric silicone fluids, resinous silicones, silicone based health care products, rubbers, sealants and
orthopedic appliances.

Silicone is the main constituent in sand and quartz rock and is one of the commonest elements of
the earth. Silicone can perform several functions: it can lubricate, seal, bond, release, encapsulate, defoam,
insulate, coat, waterproof and enter the composition of varied products such as semiconductors, sealants,
deodorants, shampoos and cosmetics. Silicone-based specialty chemicals are used for automotive,
aerospace, construction and electronics industries. DCC sealants were used as O-rings for space shuttle, as
also for the Silly Putty novelty toy!

DCC is the pioneer producer of silicone-gel-filled based breast implants (SBIs). In 1991, DCC
supplied the majority of implants for reconstruction and augmentation surgeries. Three basic types of
silicone breast implants were then in use: the silicone gel filled implant, the inflatable envelope, and the
double lumen implants. The most natural in appearance and feeling is the gel implant that consists of a
seamless silicone envelope filled with silicone gel.

34
Health Related Problems with Silicone Breast Implants
Technically, all implants can rupture and leak. Most silicone gel implants, especially those
manufactured before 1985, were known to have small amounts of silicone gel bleed or leak through the
shell. In the early 1980s, DCC developed a low bleed gel implant with a silicone shell that was less likely
to bleed, although this leakage occurs to some extent in all silicone gel implants even those that have not
ruptured. During the last two decades, thousands of patients, doctors and researchers have claimed
numerous side effects, allegedly caused by the SBIs. Most of the furor and litigation over breast implants
has been over connective tissue diseases such as lupus, arthritis, scleroderma, and immune system disorders
(Orr 2001). Most of these side effects are associated with silicone-gel leaks or bleedings that travel through
the body infecting tissues and vital organs in the process. About one to five percent of implants have also
been known to rupture causing a large spill of silicone. Major side effects include:

Connective Tissue Diseases: a group of more than 100 illnesses characterized by chronic and
harmful inflammation of the connective tissues of the body (e.g., bones, joints, muscles,
tendons, ligaments and skin). Rheumatoid arthritis, a most common connective tissue disease in
the United States in which joints become painful, swollen, stiff or deformed, is also associated
with breast implant disorders.

Autoimmune Disorders: the body forms antibodies around perceived foreign invaders and
attacks its own tissue. Common disorders include: Scleroderma, a rare autoimmune disease
that can affect many organs and tissues of the body. The antibodies cause the hardening of the
skin and cause a build-up of fibrous tissue in the lung and other organs. They also cause
disfigurement, and can be fatal if internal organs are affected. Specific autoimmune disorders
include: Granuloma: lumps of silicone form beneath the skin in breast area as scar tissue;
Lupus Erythematosus, a chronic disease that causes inflammation of connective tissues,
including tendons and cartilages, causing chronic joint pain and rashes.

Cancer - implants are transparent and are alleged to block mammography screening and other
diagnostic tests for breast cancer. Saline breast implants on the other hand do not interfere
with mammography.

Since the FDA banned SBIs officially in 1992, plastic surgeons today generally use either
smooth-wall saline-filled implants (which report fewer problems with wrinkling) or texture saline-filled
implants (that have a lower incidence of capsular contracture, i.e., a tightening or hardening of the scar
tissue around the implant). 1 When saline-filled implants leak out of the silicone shell, the surrounding
tissue usually absorbs the salt water without much difficulty. However, when silicone bleeds through the
shell, it usually requires surgical removal of the material. Fortunately, the body tends to isolate the
majority of the silicone within the scar capsule, making surgical removal much easier. The explanting
surgeon, however, must use techniques that minimize the risk of free silicone contacting body tissues and
that all scar capsule is removed, since it contains silicone particles.

The DCC Bankruptcy Chronicle since 1991

Since the SBI controversy and litigations against DCC erupted in December 1991 after the Hopkins
case, we use 1991 as the base year for narrating the DCC-SBI case. In 1977, DCC had lost its first suit, with
a verdict against the company for $170,000. Thereafter, until 1989, only six breast implant cases had gone to
trial, and of these, only two resulted in jury verdicts, and only one against DCC (Stern v. DCC, No. C 83-
1
See, Susan E. Kolb, MD, Atlanta, GA (1999), The Silicone Breast Implant Controversy, at eBody.com; specifically at
http://wwwcontent.ebody.com/plastic_surgery/articles/199908/article33.html downloaded on August 20, 2001.

35
2348 MHP, November 15, 1984; Marks v. Minnesota Mining & Mfg. Co. 232 Cal. Rptr. 594; in 1987).
Soon after the Hopkins case, the FDA imposed a moratorium on the use of SBIs, expressing concerns about
their safety. Soon after the moratorium was issued, the number of breast implant cases escalated, and by the
spring of 1993, more than 1,000 breast implant cases had been filed in federal courts alone (WLN Breast
Implant Pathfinder, Wests Legal News, January 16, 1997; available in 1997 WL 12523, at *6). By 1995, the
SBI litigation had risen to become the largest class action in history (WSJ, October 4, 1995, A15).

The Hopkins case stirred nationwide controversy and publicity surrounding breast implants.
Thousands of angry and injured women complained to the FDA that their health had deteriorated from
ruptured SBIs. In addition, during this time, several consumer- safety advocacy groups began to demand
investigation of the safety of SBIs. This prompted the FDA to convene an outside panel of experts in
November 1991 to investigate the issue of SBI safety.

The FDA assembled an eleven-member panel to hear the testimony on the safety of the implant
products. After months of hearings, the panel disclosed its findings on February 20, 1992. The panel
affirmed that there was an appalling lack of information about the safety of the implants, but nevertheless
recommended that the silicone gel breast implants be still available to women for breast-reconstruction, but
under strict controls that will allow further study to determine their long-term safety. Access would be
severely restricted for women who want implants for cosmetic purposes such as breast augmentation or
enhancement. The panel decided against banning implants as it found no conclusive evidence that the
devices were at fault for the health problems reported, and because the breast implants fulfilled a "wide
public need." On April 20, 1992, Dr. David Kessler, Chairman of the FDA, made a final announcement on
the fate of implants: he just reconfirmed the panel's ruling of February 20, 1992.

We present a timeline of major milestones in the DCC Chronicle that ended with bankruptcy:

December 1991: A San Francisco jury awards $7.34 million to Maryann Hopkins after finding her autoimmune
system problems (mixed connective tissue disease) were caused by silicone-gel breast implant-rupture. DCC was
found guilty of fraud and malice in failing to disclose hazards it knew of.

December 20, 1991: The Justice Department is still considering the question whether DCC mis-branded its
silicone implants by making false and misleading safety claims. Information released about corporate memos
during the trial prompted the FDA to subpoena those records from DCC with the purpose of conducting its own
research on the safety of the product. A letter, dated December 20, stated that the FDA had reason to believe that
DCC may have withheld for a decade or longer critical safety data from the agency regarding the dangers of SBIs.
DCC was required to submit all safety data as part of its pre-market application. DCC successfully appealed and
fought against documents-release because the information, if disclosed to competitors, would jeopardize its
competitive position.

1992: Silicone breast implants accounted for a mere one percent of DCCs revenues (i.e., $1.84 billion revenues
in 1991) it generated 8% of Dow Chemical's profits and 25% of Corning's profits for the same year (Pitt and
Groskaufmanis 1994: 951-54).

January 6, 1992: Thirty years after its invention and introduction, the FDA commissioner, Dr. David Kessler,
announces a 45-day moratorium on new sales of SBIs pending a panel review of implant safety. All the four
implant-manufacturers agree to stop production. Meanwhile ten to fifteen thousand women in the U.S. are
waiting for breast implants. DCC refuses to release internal documents concerning the safety of the silicone-gel
breast implant. The FDA, supported by the Justice Department, intends to make public DCC's internal documents
sooner than expected (WSJ, 02/18/1992, B1, B8; WSJ, 02/21/1992, A3).

February 11, 1992: Only hours after making its internal documents public, DCC announces that some company
executives knew of the implant hazards. On a conciliatory strategy, the DCC Board names Dow Chemical
36
 executive, Keith R. McKennon, Chairman and CEO of DCC to replace incumbent CEO Lawrence A. Reed, who
is demoted as DCC's Chief Operating Officer. Former chairperson John S. Ludington becomes chairperson
emeritus. McKennon, known for his diplomatic abilities over scientific issues including those of Dow Chemical's
Agent Orange, is charged with a mission: to resolve DCC's troubles concerning its controversial silicone-gel
breast implant.

February 11, 1992: McKennon makes several important concessions (New York Times, 02/11/1992): a) the
implant was hazardous; b) the FDA's process of reviewing implant safety is valid; c) DCC will make several new
efforts to answer product-safety questions; d) DCC will start a trust fund for women who want their implants
removed but cannot afford it; e) DCC will continue research on implant safety, and f) to enable this, DCC will
collaborate with the FDA in maintaining an implant registry to track possible links with subsequent illnesses.

March 1992: DCC takes a $250 million general liability, excess and umbrella liability insurance program to cover
the risk associated with SBIs. DCCs primary insurer in this regard is Zurich Insurance Company which would
cover $5 million in claims with $3 million retained by DCC; $20 million coverage is provided by Anglo
American Insurance Co. and Zurich Re, both of which are based in London, UK; $75 million is covered by X. L.
Insurance Co., and the remaining $150 million coverage is picked up by A. C. E. Insurance Company, Ltd.

March 5, 1992: while DCC stops marketing breast implants domestically and internationally (Time, March 30,
1992, 51)), the other three competitor companies were found to continue exports of breast implants abroad,
despite FDA's warning to the contrary. As of this date, DCC was the largest implant manufacturer with 45% of its
sales abroad (WSJ, March 5, B1, B5).

March 11, 1992: The cost of litigation to DCC could be astronomical, even though DCC has a $250 million
insurance coverage for such contingencies. Attorneys warn DCC that punitive damages may well exceed 1
billion. DCC has sold more than 600,000 implants, more than any manufacturer. It is estimated that more than 1
million women have silicone gel implants (WSJ, 03/11/1992, B7).

March 12, 1992: No long-term research on SBIs has yet taken place. Over 2 million women to this day have
received breast implants. More recent breast implants rupture less frequently compared to those a decade ago.
Silicone molecules, however, may still permeate the envelope and migrate into tissues of the body to trigger
autoimmune disorders (WSJ 03/12/1992, A4).

March 12, 1992: The American Society of Plastic and Reconstructive Surgeons (ASPRS) continues to emphasize
breast implant promotion over product safety. The ASPRS collects millions of dollars from its members for
lobbying Washington and the FDA to keep the implant devices on the market. In 1992, the ASPRS imposes a
special levy on its members to raise a "war chest" of $3.9 million over the next three years primarily for
augmented lobbying (WSJ, 03/12/1992, A1, A4).

March 27, 1992: In response to increasing litigations to silicone products, the FDA set up a Federal Register that
publishes periodic announcements regarding breast implants and product safety, (See Federal Register, 57:
10702-01; 1992).

December 1992: Following FDA decision of April 1992, SBI related litigation explodes. Prior to April 1992, the
SBI industry has suffered only 200 tort claims filed against it over an almost thirty-year period. By December
1992, within eight months from the FDA decision, over 10,000 SBI-related tort claims had been filed (Orr 2001).
On the other hand, aside from common medical malpractice claims for local complications following surgical
procedures, saline breast implants have been relatively trouble and litigation free. Both SBIs and saline breast
implants contain silicone!2
2
Silicone is used in over 500 medical products. DCC introduced SBIs in 1962. In the 1970s and 1980s, there were four
primary types of breast implants, three of which used silicone. SBIs consist of an outer shell made of solid silicone that is then
filled with a silicone gel. Foam or sponge covered implants are identical to the SBIs, except for a foam or sponge coating and a
double lumen implant. Double lumen implants have an inner shell surrounded by an inflatable outer layer. Saline filled breast
implants have the same solid silicone outer shell of these other implants, but they are filled with a saline or saltwater solution.
Most breast implant litigation has centered on the various SBIs and not the saline filled variety (Snyder 1997).
37
 January 1993: DCC takes a write-off of $94 million before taxes against 1991 and 1992 earnings due to the SBI
controversy. By 1993, DCC has captured about 35% of the SBI market, and it has no clue regarding the extent of
the product liability claims till then.

February 1994: In Gladys J. Laas, et al. v. Dow Corning, et al., Gladys Laas was awarded $5.2 million
compensatory damages, and the District Court of Harris County, Texas, 157th Judicial District, awarded her
husband $1 million for loss of consortium. DCC was liable for 80% of the verdict, and Dow Chemical for the
remaining 20%. The jury found DCC guilty of misrepresentation and engaging in a false, misleading or deceptive
act or practice that was cause of the plaintiffs injuries. Dow Chemical is accused of aiding and abetting; this was
later overturned and DCC assumed 100% of the liability (Breast Implants on Trial: Frontline).

March 1994: Judge Pointer dismisses plaintiffs alter ego claims of Dow Chemical and Corning Inc., the giant
parents of DCC, thus making the lesser-funded DCC solely responsible for all the damages, and temporarily
saving the parents from exposure to general liability and damages. This decision, however, was made without
prejudice to bringing both the parents back into the case if facts so warranted.

March 1994: Hence, with the view of getting the giant parents to contribute to the settlement fund, since March
1994, plaintiffs lawyers have focused intensive discovery on how Dow Chemical and Corning could be involved
in the research, development and production of DCCs SBIs. This effort has resulted in the identification of new
documents, previously unknown to the plaintiffs, which will be the basis of a motion to reinstate the parents as
defendants to be heard possibly in January 1995.

April 1995: A landmark decision changes the face of the SBI case. Chief Judge Pointer hands down decisions
for the first time that SBI litigations can be brought directly against the parent company of DCC: Dow Chemical
(In re Silicone Gel Breast Implants Products Liability Litigation, II, nos. 77 and 78). Judge Pointers argument
was that Dow Chemical was significantly involved with Dow Cornings breast implants (Ibid. No. 82).

May 15, 1995: Dow Corning was facing, as of May 1995, a future of seemingly endless, repetitive, and
expensive endless cases [John C. Coffee, Jr., (1995), Class Wars: The Dilemma of the Mass Tort Action,
Law Review, 95: at 1386-87]. DCCs claims projection turned out to be vastly underestimated, resulting in
many more claims than were originally anticipated [See Richard A. Nagareda (1996), Turning from Tort to
Administration, Michigan Law Review, 94: at 955]. Overwhelmed by thousands of personal injury cases
pending against it (some 19, 000 by April 1995), DCC files Chapter 11 bankruptcy protection in the Michigan
federal court. 3 DCC chose bankruptcy protection in order to reorganize and resolve its mass tort liabilities.
The Chapter 11 reorganization was viewed as a quick fix that would resolve all liabilities in one
proceeding, (Coffee 1995, at 1387).4 Bankruptcy reorganization has comparative advantages over a mass

3
The practical effect of Chapter 11 protection is a stay of all creditor claims pending against the petitioner/debtor, while the debtor
works out a plan to pay the debt. The filing of the petition automatically invokes the stay, which prevents all entities from either
commencing or continuing actions against the debtor [see Richard I. Aaron (1993), Bankruptcy Law Fundamentals]. The automatic
stay, however, is not a permanent feature of Chapter 11 protection. As long as the debtor can show a realistic prospect of
reorganization, the court will not terminate the stay order [see Martin J. Bienenstock (1987), Bankruptcy Reorganization,
Practicing Law Inst. No. 97, p. 7].
4
Note that the filing of Chapter 11 bankruptcy as a tactic to stay present and future litigations worked to the benefit of Johns-
Manville Company in the asbestos litigation and A. H. Robins Company in the Dalkon Shield litigations. In both cases,
payments to the victims were postponed for years, and in some cases, dramatically reduced [cited in Mark Curriden (1995),
Implant Global Settlement in Jeopardy, A. B. A. Journal, August 1995, at 34]. DCCs incentives for choosing bankruptcy,
however, were somewhat unconventional: a) DCC seemed intent on preserving the mass tort class action settlement; b) in fact,
DCC sought to lock claimants within it by eliminating any incentive to opt out; but given that bankruptcy stays past, present and
future litigations against the debtor, opting out gains a claimant little but costs him or her the right to participate in the settlement;
c) once claimants were frozen into the class action, benefits would then be reduced since opt-outs are discouraged; d) individuals
who had already opted out from the settlement will eventually receive compensation under the Chapter 11 bankruptcy
reorganization plan [see Evan Caplan (2000): Milking the Dow: Compensating the Victims of the Silicone Breast Implants at
the Expense of the Parent Corporation, Rutgers Law Journal, 29: 121-153; also in Where Theres Smoke Theres Fire claims,
38
 tort class action as a means of achieving equitable resolution of mass tort liabilities that is fair to tort creditors
(Coffee 1995: at 1458).

May 17, 1995: In the DCC case, a byproduct of the bankruptcy petition was the destruction of the global
settlement agreement of Judge Pointer in the Lindsey v. DCC case. Another result was that plaintiffs who
could no longer sue DCC could now settle on a new target: the Dow Chemical, the parent company of DCC
[George Flynn (1995), Dow Corning Removed from Implant Trials, Houston Chronicle, May 17, 1995,
A21]. This case would then be that of direct and vicarious responsibility against the parent company, also
technically called piercing the corporate veil. 5

July 1995: It could be years before DCC's reorganization plan will be put into effect. 6 Generally, the Chapter 11
reorganization plan contemplates an orderly liquidation of the assets and distribution of the debtors proceeds to
the plaintiffs. Accordingly, the reorganization plan will rearrange DCC's assets and arrange payment of their
liabilities. All DCC cases in the U.S. will be on hold until the bankruptcy court releases them. The bankruptcy
court will not rule on an individual claim, but will estimate the class aggregate claims. If the latter exceed DCC
assets, there may be true bankruptcy (Breast Implant Newsletter, Acheson & Co. Harrington v. DCC et al., Issue
14, 07/17/96; Detroit News, 01/11/1997).

October 1995: Presumably instigated by Alabamas U. S. District Court Chief Judge Sam Pointers landmark
decision of April 1995, allowing plaintiffs to sue the parent company, Dow Chemical, for the wrongs of its
subsidiary, DCC, a Nevada jury hands down a $14 million verdict against Dow Chemical in favor of Charlotte
Mahlum of Elko, Nevada. In 1985, Mahlum underwent a double mastectomy to remove cancerous cells in her
breasts, and later in the year, a breast reconstruction surgery using SBIs manufactured by DCC. In 1990, Mahlum
began to experience muscle pain, chronic fatigue and nerve disorders. In 1993, she was diagnosed with immune
system and neurological disorders, and the doctors removed her breast implants only to discover that the implants
had ruptured and leaked into other organs. That same year, Mahlum filed suit in Nevada District Court, alleging
that both DCC and Dow Chemical were responsible for producing the breast implants that had caused her health
problems (In re Silicone Gel Breast Implants Products Liability Litigation, II, nos. 84-89). Since DCC had filed
for bankruptcy in May 1995, and because bankruptcy filing automatically stays tort litigation against the debtor,
only Dow Chemical was left as the remaining defendant. Mahlum contended that even though Dow Chemical
had not technically manufactured the SBIs, it was as responsible for their negative side effects as DCC because
the former had performed studies on silicone for DCC. The jury agreed with Mahlums claims against Dow
Chemical, and awarded her $10 million in punitive damages along with $3.9 million in compensatory damages,
and $200,000 to her husband for loss of consortium (In re Silicone Gel Breast Implants Products Liability

September 16, 2000, at Baxterno gofer@magiclink.com or http://www.info-implants.com/tony/smoke/9.html; see also John C.

Coffee, Jr., (1995), Class Wars: The Dilemma of the Mass Tort Action, Colum. Law Review, 95: at 1409].
5
In general, most courts, following the traditional view, have granted summary judgment in favor of the parent companies on
the issues of direct and vicarious responsibilities. They argue that the corporate identity of the parent company is distinct from its
subsidiaries, that there is just a tenuous relationship between them, and therefore, plaintiffs against the subsidiary (DCC) could
not pierce its corporate veil, namely, the parent company (Dow Chemical). The concept of piercing the corporate veil of
limited liability is alternately known as holding the corporation liable for acts of its alter ego. Under the doctrine of limited
liability, a creditor has generally recourse only against the corporate entity whose acts give rise to the liability, and not the parent
corporations or stockholders.
6
A widely held criticism against Chapter 11 is that it provides too much protection for the debtor-corporation. Critics complain
that the ailing (Chapter 11) debtor companies languish under the protection of the bankruptcy court for years while the same
managers who lead the company to ruin remain in control and continue to make the decisions, and may purposefully delay
settling the plan and paying its creditors [See Lynn M. LoPucki (1993), The Trouble with Chapter 11, Wis. Law Review, 729].
Further, Chapter 11 requires a specified amount of the business-debtors post-petition income to go toward funding the
reorganization plan. During this time period, the debtor in possession (in our case, the DCC), retains control of the corporation,
operates its business in a typical manner, and is a virtual trustee for these purposes, all of which could really delay the settlement
plan (U. S. C. 11, Section 1101 (1994)). Critics of the Chapter 11 reorganization view DCCs strategy as litigation-driven
decision that is ethically unattractive since DCC is not perceived to be in the sort of financial crunch that warrants bankruptcy
protection (Implant Firm Seeks Protection, Dallas Morning News, May 16, 1995, at 1A; see also Curriden (1995, p. 34).

39
 Litigation, II, nos. 90-93).7 Judge Steinheimer denied Dow Chemical when it subsequently, notwithstanding the
verdict, appealed for a new trial. 8

January 1996: Plaintiffs have alleged that Dow Chemical should be found liable for DCCs alleged torts based
on two broad theories: a) Dow Chemical owns 50% of DCC stock; b) Dow Chemical directly participated in
DCCs silicone gel filled breast implant business (see Thomas Gilroy and Patrick M. Creaven (1996),
Drafting the Form 10-K, PLI Corporation Law and Practice Course Handbook Series No. 917, at 402). But
for justifying piercing the corporate veil in the case of DCC, the plaintiffs must also offer evidence of undue
control, manipulation, or other improper action by Dow Chemical in relation to SBIs. 9 Otherwise, the plaintiff
carries the burden of proving the basis for piercing the corporate veil.

January 1996: Having failed to meet their burden, the court correctly found that the evidence presented was
insufficient to pierce Dow Cornings corporate veil. The court reasoned as follows: a) There is no evidence of
intermingling or commingling of funds or of any improper loans between DCC and its parent companies: Dow
Chemical and Corning Inc.; b) there is no evidence that the parent companies drained the assets of DCC, even
after the former had knowledge of the potential liability of SBIs; c) there is no evidence that DCC was
undercapitalized by the parent companies; d) although the parent companies and DCC had significant contacts,
these do not amount to manipulation and control that would support the piercing of the corporate veil; and e)
the various business dealings between the parent companies and DCC appear to have been carried out with due
regard for the separate existence and interests of each (In re Silicone Gel Breast Implants Products Liability
Litigation, 837 F. Supp. at 1134-38).

February 1996: Plaintiffs next argue that Dow Corning was a joint venture of the parent companies insisting

7
A similar result was initially reached in a Texas jury verdict against Dow Chemical in 1995. The jury found Dow Chemical
jointly and severally liable with DCC in the amount of $5.23 million for having encouraged or assisted DCC with the marketing
of untested breast implants [Laas v. Dow Corning Corp., No. 92-16550 (Tex. Dist. Ct., Harris Cty., 157 th Dist., Feb. 15, 1995)].
Specifically, Dow Chemical was assessed 20% liability and DCC 80% liability for Laas injuries. Dow Chemicals liability was
premised on the jurys finding that Dow Chemical knowingly gave substantial encouragement or assistance in marketing silicone
breast implants using materials that had not been adequately tested [cited in Jack W. Snyder (1997), Silicone Breast Implants:
Can Emerging Medical, Legal, and Scientific Concepts be Reconciled? Journal of Legal Medicine, 18: at 174. See also Thomas
Gilroy and Patrick M. Creaven (1996), Drafting the Form 10-K, PLI Corporation Law and Practice Course Handbook Series
No. 917, at. 403].
8
See, Steve Wilson (1995), Different Standards of Proof Blur Breast-Implant Verdict, Arizona Republic, November 3, 1995, A2;
for other newspaper coverage on the Laas case, see New York Times, October 30, 1995, A14; Washington Post, October 31, 1995, D1;
Boston Herald, October 31. 1995, p.4; Virginian Pilot, November 5, 1995, E1). Since the DCC reorganization plan may endlessly
delay payments to victims already suffering losses because of faulty SBIs, plaintiffs attorneys filed suit against the parent companies,
especially, Dow Chemical, since it had a deeper pocket of the two parent companies. For literature in this regard see: Peter H. Turza
and Mark Snyderman (1996), In Search of Deep Pockets, New Jersey Law Review, 146: November 25, pp. 33ff; Paul A. Williams
(1994), Removing Hands from Deep Pockets: Restrictions on Punitive Damage Recovery in Strict Products Liability, UMKC
Law Review, 62: pp. 619ff). The Bankruptcy Code itself reflects a general leniency toward the debtor who is constructing a
reorganization plan. During the reorganization plan process, the debtor may retain certain parts of the property from the estate, or sell
certain parts of the estate that may be subject to liens, extend maturity dates on receivables, or change interest rates on outstanding
securities (U. S. C., 11: Section 1123 (a) (5) (1994); see also Martin J. Bienenstock (1987), Bankruptcy Reorganization, Practicing
Law Inst. No. 97, at 679). One of the key differences between Chapter 11 and Chapter 13 is that the former does not prescribe time
limits for the execution of the plan. These specifics are determined by the plan itself (U. S. C., 11: Section 1332, (1994)). The
provisions of a confirmed reorganization plan, however, bind the debtor and the creditors, whether all creditors accept the plan or not
(U. S. C., 11: Section 1141 (a), (1994)).
9
Currently, there appears to be no uniform bright line rule for determining when the parent corporation can be held liable for the
acts of the subsidiary (Baker v. Raymond International Inc., 656 F. 2d, at 179). However, there are exceptional circumstances
where the courts will exercise their equitable power to hold the controlling parties liable for the obligations of their
instrumentality (Baker v. Raymond International Inc., 656 F. 2d, at 179). The courts will generally pierce the corporate veil
when: a) the subsidiary corporation is the alter ego of its owners or shareholders; b) the corporation is used for illegal purposes;
and c) the corporation is used as a sham to perpetuate a fraud (see Villara v. Crowley Maritime Corporation, 990 F. 2d, 1489,
1496 (5th Cir. 1993)).

40
 each of the two parent companies had 50% equity control of DCC with an intention to share in DCCs profits.
10
The plaintiffs attempted to bolster their joint-venture argument by proving that the sharing objectives of the
parent companies were evidenced by certain financial arrangements, loans from the parent companies to DCC,
and additional insurance coverage. In rejecting this joint venture theory appeal, the courts argued that the
parent companies had no agreement to share, or even to be individually liable for DCCs debts and losses. ( In
re Silicone Gel Breast Implants Products Liability Litigation, 837 F. Supp. at 1138-40).

February 1996: Plaintiffs urge further: they claim that the parent companies with so much of their equity tied
with DCC should have supervised DCCs operations and therefore, are liable for inadequate supervision. They
invoked in support of their argument the Restatement (Second) of Torts (Section 315) that imposes a duty on
corporate shareholders to supervise activities of the subsidiary company that are foreseeably harmful to third
parties.11 On this issue, the court held that strict liability that is implied in the Restatement of Torts 1865 is a
state subject, and that the Restatement has never been expanded to include such a duty either in Alabama, or in
any other jurisdiction (In re Silicone Gel Breast Implants Products Liability Litigation, 837 F. Supp. at 1140).

March 1996: Plaintiffs argued yet further, the parent companies were allegedly liable under theories of fraud,
conspiracy, concert of action, aiding and abetting, or collective liability for their part in the testing, production,
and distribution of the SBIs. The fraud and conspiracy allegations were premised on the notion that the parent
companies, along with DCC, knew about the hazards of SBIs, and either concealed or suppressed these facts.
The other theories of concert of action, aiding and abetting, or collective liability for production were argued
from the fact that the parent companies actively participated in the development and funding of the SBIs even
to the extent of supplying and manufacturing the materials (In re Silicone Gel Breast Implants Products
Liability Litigation, 837 F. Supp. at 1140). The court rejected this argument asserting that the parent company
owes no duty of disclosure to buyers of a subsidiarys products. Moreover, the court affirmed that there was a
lack of evidence to form a solid link between the parent companies and DCC during any stages of the silicone
research, production, or marketing. Specifically, the court ruled that there is no evidence: a) that the parent
companies had any special knowledge of the alleged harmfulness of DCCs implants; b) that either parent
company manufactured or supplied raw materials that have directly contributed to any defect or hazardous
condition of SBIs, and c) that their participation of funding was anything other than the proper activities of
corporate shareholders.

10
There is no precise definition yet for a joint venture in the management or legal literature. In general, joint venture is a
form of business organization similar to business partnership but less like a corporation. Some of its distinguishing
characteristics are: a) each parent company must make substantial equity contribution to the subsidiary or joint venture; b)
because of which the parent companies may exercise some control over the joint venture, but not in turn be controlled by it; c) but
the joint venture is a joint enterprise that is wholly independent from the parent companies; d) the joint venture enjoys separate
production and marketing capabilities; e) because of the last two features, the joint venture is particularly suitable for high risk
and new technology products (Joseph F. Brodley (1982), Joint Ventures and Antitrust Policy, Harvard Law Review, 95: at pp.
1521-26). By all these characteristics, DCC was a joint venture, and therefore the parent companies could be jointly and
severally liable for DCCs responsibilities (see, In re Silicone Gel Breast Implants Products Liability Litigation, 837 F. Supp. at
1138). Note that when in a 1994 Connecticut breast implant Master File of 160 individual cases filed against DCC the
plaintiffs urged the joint venture theory, the court acknowledged that while several key facts reflect that the histories of DCC
and parent companies were closely intertwined, they were separately incorporated entities, they must be respected as
separated entities, and that their interactions did not amount to create liability for the parent companies ( In re Connecticut Breast
Implant Litigation, No. CV93-0999999S, 1994 WL 668032, at *1-6, (Conn. Super. Ct. Nov. 21, 1994)).
11
The Restatement (Second) of Torts 1965, Section 315, provision states: There is no duty so to control the conduct of a third
person as to prevent him from causing physical harm to another unless a special relationship exists between the actor and the
third person which imposes a duty upon the actor to control the third persons conduct. Given that the parent companies
founded DCC, and each owned a 50% share in DCC, and that DCCs silicone gel filled breast implants were trademarked with
Dow Chemical logo, one could safely argue for a special relationship between the actor (Dow Chemical and Corning) and the
third person (DCC) that would impose upon the former the duty to supervise the conduct of the latter (DCC). But the court
denied existence of this special relationship requiring more stringent criteria than those mentioned above. In general, the U. S.
courts, obviously to safeguard the autonomy of the third person and for avoiding too many chain reactions following loss of self-
control, are very reluctant of piercing the corporate veil.

41
 March 1996: The plaintiffs next invoked the theory of negligence, this time in a class action suit in New York:
Dow Chemical should nevertheless be found directly liable for negligent testing and research concerning the
toxicity, biological activity, and the safety of the SBIs (In re New York State Silicone Gel Breast Implants
Products Liability Litigation, 632 N. Y. S. 2d at 953). Moreover, the plaintiffs urged, Dow Chemical breached
its duty to use reasonable care in the research and testing of the silicone product (Ibid, at 955). 12 The New York
court rejected both arguments reasoning thus: a) that Dow Chemical was very detached from the overall
beginning-to-end process of breast implant production and sale; b) although there was a possibility that Dow
Chemical had a duty to the consumers of its research product (i.e., DCC's SBIs), the liability does not extend
ad infinitum to any potential ultimate user of a product which contains a silicone component; c) Dow Chemical
has no control over the usage that silicone has or will be put to in the future based on its initial testing and
studies of silicone; hence, to impose liability on Dow Chemical for injuries incurred by ultimate consumers of
all products that contain silicone, when it has no control over who manufactures silicone or who purchases
silicone, flies in the face of well established tort principles; d) the mere fact that Dow Chemical gave advice to
DCC, does not suggest that the former owes a duty to then-unknown customers of the latter (In re New York
State Silicone Gel Breast Implants Products Liability Litigation, 632 N. Y. S. 2d at 957).

March 1996: In disposing plaintiffs claim of corporate control, the Michigan court held that the plaintiffs,
under the facts, could not pierce the corporate veil to reach the parent companies. The court noted that
Michigan law requires a corporations separate identity to be respected unless the subsidiary has become a
mere instrumentality of its parents. Because all corporate formalities between the parent companies and
DCC had been observed since DCCs inception, the court argued, there was no evidence that DCC is a mere
instrumentality of the parent companies (In re Michigan State Silicone Gel Breast Implants Products Liability
Litigation, 880 F. Supp. at 1315-16).

March 1966: The plaintiffs next urged the theory of fraudulent concealment and misrepresentation on the
part of Dow Chemical and therefore, that Dow Chemical had the duty to: a) disclose its alleged knowledge of
the dangers of using silicone in the human body; and b) to correct the information its had released about the
safety of silicone as implants in the human body. 13 The courts rejected both claims: a) once again citing the
tenuous link between Dow Chemical and the ultimate consumer of DCCs products, and b) that Section 551
(2c) was inapplicable, since there was no fiduciary relationship between the plaintiffs and Dow Chemical, and
hence no business relationship (In re TMJ Implants Products Liability Litigation, 880 F. Supp. at 1317).

March 1996: The plaintiffs next relied upon Section 876b of the Restatement (Second) of Torts 1977 for their
aiding and abetting and conspiracy claim which states that one party can be held liable for the torts of another
if the first party knew that the second partys conduct constitutes a breach of duty and give substantial assistance
or encouragement to the second party so to conduct itself. The courts noted that, although there was some
interaction between the researchers of DCC and the scientists of Dow Chemical, a) that Dow Chemical did not
knowingly provide substantial assistance to DCC for an aiding and abetting claim; b) there are no facts
indicating that Dow Chemical knew which silicones were used in the implants, much less did Dow Chemical
agree with DCC on any aspects of its TMJ business; c) there was insufficient evidence to show that DCC was
heavily dependent upon Dow Chemical for help in the manufacturing of the TMJ implants. The court rejected
similar arguments of the plaintiffs invoking trademark licensor theories as well as negligent performance of Dow
Chemical. Ultimately, Chief Judge Magnuson, speaking for the Court added, the court is convinced that

12
In a related case, plaintiffs sought recovery against DCC for damages that were allegedly caused by its temporomandibular
joint (TMJ) implants on the grounds that Dow Chemical had corporate control of DCCs products. Doctors recommend the TMJ
implants primarily to relieve pain associated with improper function of the patients temporomandibular joints. According to the
plaintiffs, the TMJ implant that contained either Teflon or silicone disintegrated, causing serious injuries to the jawbone and
surrounding tissue (In re TMJ Implants Products Liability Litigation, 880 F. Supp. at 1311 (D. Minn. 1995), aff-d, 113 F. 3d at
1314-15 (8th Cir. 1997). . The courts held that the plaintiffs could not, under the facts, pierce the corporate veil to reach the
parent companies (In re TMJ Implants Products Liability Litigation, 880 F. Supp. at 1311 (D. Minn. 1995), aff-d, 113 F. 3d at
1484 (8th Cir. 1997).
13
The plaintiffs relied here on Section 551 (2)c of the Restatement (Second) of Torts 1965 which provides that one party to a
business transaction has duty to disclose when subsequently acquired information makes previous representation misleading
or untrue or believed to be so.
42
fundamental flaws in Plaintiffs claims would prevent liability in every state. (In re TMJ Implants Products
Liability Litigation, 880 F. Supp. at 1319-22).

Spring 1996: The Canadian Journal of Plastic Surgery (vol.4, no.1, Spring 1996) publishes a study involving 352
SBIs implanted between 1963 and 1995. The study found that the early implants (1963-72) rarely ruptured as
they were first constructed of a firm gel and a thick envelope. Because many women, however, suffered from the
firm SBIs and painful breasts, as they caused the build up of scar tissue around the implants, the manufacturers
produced a softer implant. These second-generation SBIs (1973-87) were made of much softer gel and thinner
envelopes. The study estimated that about 80% of women with second generation SBIs have leaking or ruptured
implants. This failure rate increases with the age of the SBIs and is 95% after 12 years. The problem of firm and
painful breasts, however, continued with the second generation of SBIs, and hence, manufacturers produced third
generation SBIs (1988-92) made of a stronger envelope, which while reducing rupture rates, still causes hard and
painful breasts.

December 2, 1996: DCC announced its Plan of Reorganization (POR) in the bankruptcy proceedings. DCC's
POR sets aside $2 billion in two funds for women with SBI complaints: the first fund is $600 million against
300,000 claims averaging $2,000 per claim. The second fund of $1.4 billion is set aside for litigation type claims.
DCC is proposing a common issue causation trial to determine once and for all if SBIs cause disease. DCC
proposes the use of an independent panel of experts from various fields such as medicine, epidemiology,
immunology, rheumatology and toxicology. If the court rules that SBIs do not cause disease, the $1.4 billion goes
back to DCC. If the court rules otherwise, then each woman has to do an individual trial to prove she has the
disease and that SBI caused it (Breast Implant Newsletter, Acheson & Co., Issue 16, 12/03/96).

December 2, 1996: Meanwhile, the Committee representing women with SBIs (the Torts Creditors Committee)
will file its own POR within the next few weeks before Justice Spector in the Michigan Bankruptcy Court. The
Bankruptcy Court will then accept one of the PORs, or come up with one of its own. It may be a year before a
POR is put into effect.

April 7, 1997: As of this date, the Michigan Bankruptcy Court has not yet ruled either the DCC POR or that of
the Torts Creditors Committee. Meanwhile, DCC has filed an Omnibus Disease Objection to Breast Implant
Claims. This motion seeks to have the disease claims completely separated from the individual's local injury
claims (e.g., capsular contracture, rupture, bruises and infections, chronic local pain, necrosis of the nipple) and
seeks to have the court rule that SBIs do not cause the autoimmune disease (Breast Implant Newsletter, Acheson
& Co., Issue 18, 04/21/97).

August 18, 1997: The first District Court jury ever to hear a class-action lawsuit filed by more than 1800 SBI-
affected women from Louisiana (Spitzfaden v. Dow Chemical Corporation) found that: 1) Dow Chemical did not
properly test the material for SBI safety in humans, and 2) that Dow Chemical suppressed or concealed
information with respect to the dangers of SBIs in the body (Washington Post, 08/19/97, A01; Breast Implant
Newsletter, Acheson & Co., Issue 19, 09/05/97). DCC is a subsidiary of Dow Chemical and Corning Inc. Dow
Chemical does not manufacture SBIs; together with Corning it created DCC to manufacture SBIs; each parent
company holds 50% equity in DCC. But attorneys still claim that Dow Chemical did the original SBI testing.
Jurors will next testify whether the SBIs caused the health problems suffered by a subset of eight women from the
1800 class-action plaintiffs.

August 25, 1997: In April 1977 Judge Spector of the Michigan Bankruptcy Court had rejected the Plan of
Reorganization (POR) of both DCC and the Tort Creditors Committee. DCC files a second POR. The new plan
includes a $2.4 billion settlement to settle all claims worldwide (see Dow Corning Raises Offer for Implants,
The Financial Post, August 26, 1997, at 1). Under this plan, DCC will set up a settlement trust and a litigation
trust: the settlement trust with funds for both accounts coming from the $2.4 billion settlement.

August 25, 1997: Once the Bankruptcy Court Judge Arthur Spector approves the Disclosure Statement
describing the Plan, the plan-documents and a ballot will be mailed to every woman who has filed a claim. At
that point, the women will be asked only to vote for or against the plan. If the Plan is approved by 92% of the
voters, then the women will receive participation forms for their specific claims. The ability to have a subsequent
43
jury trial is not affected by ones vote for or against the Plan.

August 25, 1997: This plan includes settlements with women in all provinces of Canada, Australia, and New
Zealand. The Settlement Plan was jointly negotiated with attorneys representing women with breast implants in
those countries.

August 25, 1997: The Second POR provides payments for people who have claims for other products covered,
such as artificial joints that use silicone products [e.g., the temporomandibular joint (TMJ)]. They can claim
similarly structured payments as those of SBIs.

August 25, 1997: In addition to the above fund of the Second POR, the plan calls for a $1.3 billion payment for
commercial creditors: this class of claimants represents primarily financial organizations who bought the debt
from banks and other creditors to whom it was originally owed. The debt was approximately $1 billion; the rest
represents interests accrued since Chapter 11 protection date.

November 21, 1997: Judge Spector rejects even the second POR of DCC and appoints a mediator. Meanwhile,
DCC has refused to negotiate with the Torts Credit Committee. As of this date, there are about 130,000 U.S. and
41,000 non-U. S. claims that have filed against DCC.

July 8, 1998: The DCC and plaintiff attorneys for tens of thousand (about 170,000 to date) of SBI patients and
victims agree to a $3.2 billion settlement, a long-awaited step ending one of the most heated battles in American
corporate history. DCC did not admit any wrongdoing. DCC could now emerge from Chapter 11 bankruptcy that
it entered in 1995 for protection from as many as 19,000 implant-damage suits. DCCs plaintiffs and their
attorneys had rejected the previous plan offered last December for $3 billion payable for over 16 years. Their
counter offer in March requested $3.8 billion over two to three years. The revised settlement plan (RSP) offers
$3.2 billion payable in 15 years.

July 8, 1998: The tentative agreement allows the plaintiffs and their lawyers to receive damages as early as next
year. The $3.2 billion RSP provides a wide variety of payment options to personal injury claimants who have
filed a proof of claim in Dow Cornings Chapter 11 case. For the first time, women can combine up to three
settlement choices that result in base payments ranging from $2,000 to more than $250,000, for those who meet
the requirements. Women who want to settle their claims immediately and who do not intend to file a disease
claim can select an expedited payment of $2,000. They can also combine this payment with $5,000 for implant
removal surgery and $20,000 for ruptured implant explanation, as long they qualify for those additional options.
Over and above these three payments, those women who have demonstrated autoimmune disease claims, such as
scleroderma, lupus, or vasculitis, may receive as much as $250,000 each. Claims will be processed through the
Dow Corning Settlement Program Claims Office using an already existing claims processing facility, with the
same processing procedures and personnel as the claims office established in the Multi-District Litigation (MDL)
Court under the Revised Settlement Plan (RSP).

July 8, 1998: The RSP is modeled after the widely accepted plan offered by other SBI manufacturers (see
Appendix 11.A). This plan was overwhelmingly accepted by tens of thousands of women with breast implants
from Baxter, Bristol-Myers, 3M or Union Carbide.

July 8, 1998: DCC believes the RSP is financially manageable. The RSP will be funded through DCCs
operating cash flow, the substantial amount of insurance proceeds to which the courts have ruled the company is
entitled, supplemented by debt. DCCs shareholders and those of Dow Chemical and Corning, Inc. have made
available the proceeds of joint insurance and a $300 million revolving loan facility to make additional funds
available if necessary. Once U. S. Bankruptcy Judge Arthur Spector of the Eastern Court of Michigan approves
the RSP, it will be mailed to claimants for a yes or no vote (within a 60-day solicitation period). If an
overwhelming majority approves the plan, and the Bankruptcy court confirms it, then the RSP is ready for
implementation.

January 7, 2000: ALN has posted on its website an Adobe PDF file copy of Judge Spectors 12/21/99 opinion
on whether the Dow Corning Reorganization Plan and its Proponents comply with the Bankruptcy Code.
44
February 25, 2000: after 30 years of service, Judge Pointer decides to retire from the bench after the end of
March 2000, and at that time another judge from ALN will assume the role of transferee judge in MDL926.
Judge Pointer acknowledges more than 27,000 breast implant cases that were transferred to ALN during the past 7
years. When retirement becomes effective, the Judge hopes to leave fewer than 70 cases pending in the court.

March 1, 2000: Judge Andrews advises, as of this date, that all appeals received by him prior to 1/15/2000 have
been finalized (except those requesting reconsideration) and that there are 34 pending appeals (including those
requesting reconsideration).

March 15, 2000: The Claims Office in Cincinnati will be closed at the end of April 2000; calls to that office after
April 13, 2000 will be forwarded to the office of the Plaintiffs Liaison Counsel in Birmingham, Alabama.

May 24, 2000: Escrow Agent, Edgar Gentle, informs the court that all rebate checks (about 110,000) have been
mailed as of May 22, 2000. Addresses who do not receive the checks by June 1, 2000 should report in writing to
Edgar Gentle.

May 25, 2000: Attorneys are advised not to charge fees and/or expenses on rebate checks of less than $1000 paid
directly to the claimants (and not via attorneys).

April 1, 2000: It is anticipated that upon the retirement of Judge Pointer on April 3, 2000, District Judge Edwin
L. Nelson of the Northern District of Alabama will be designated by the Judicial Panel on Multi-District
Litigation (JPMDL) as the Transferee Judge of MDL926.

April 10, 2000: Judge Nelson has been designated as the transferee judge of MDL926 effective as of April 10,
2000. Judge Nelson expresses gratitude to Judge Pointer for leaving a well-oiled and effective organization and a
relatively clean deck to handle MDL926. Judge Nelson will communicate with judges, lawyers, litigants and
other interested persons through the MDL926 webpage at mdl926@alnd.uscourts.gov.

April 10, 2000: The Office of Claims Assistance Counsel will be closed by April 14, 2000; the Court
expresses its appreciation to the attorneys of that office that have provided independent legal advice to
more than 100,000 breast implant cases for the past seven years. After April 14, 2000, interested persons may
still obtain information by topics as follows:

Breast implant product identification issues Office of Plaintiffs Liaison in Birmingham, AL at 205-252-6784.
Claims in the Dow Corning Corporation Bankruptcy Dow Hotline 888-875-5949 (recorded message only).
Claims in the Revised Settlement Program RSP Claims Office 800-600-0311.
Claimant payments to be received under RSP RSP Claims Office 800-345-0837.
Any other matter - Office of the Plaintiffs Liaison Counsel in Birmingham, Alabama 205-252-6784.

May 15, 2000: In the future, for all orders and other documents to be posed on its Web page, the Court intends to
use the PDF file format. This will require users to install the Adobe Acrobat reader as a plug-in for their
browsers; (the Adobe Acrobat reader can be downloaded free from www.adobe.com). The previously posted
document on the Web page will not be converted to PDF, but will stay in standard HTML.

May 30, 2000: Of the approximately 27,500 cases filed in or transferred to the ALN Court, all are resolved; only
54 cases remain open for reconsideration. Only 18 new cases have been transferred to ALN since Jan 1, 2000.

June 23, 2000: Only 50 cases are still pending in MDL926: of these 19 were filed in ALN originally, and the
remaining 31 were transferred from other courts.

July 17, 2000: As of this date, Judge Andrews reports that he has only 10 pending appeals that include loose
motions. All appeals received before May 15, 2000 have been resolved, except where there is request for
reconsideration. Judge Andrews processes cases on a first in/first-out basis. Under provisions established by
the Court (Orders 27L and 27N), decisions by Judge Andrews on appeals from the Claims Administrator are final.
45
 In other words, the Court does not accept further appeals.

July 24, 2000: The scientists meeting conducted by the Institute of Medicine with the expert help of independent
scientists in Washington, D. C., for investigating SBI safety concludes, after reviewing available literature on the
subject, that SBIs are not linked with any major disease like cancer of connective tissue disorder.

September 1, 2000: As of this date, Judge Andrews reports that he has still 13 pending appeals that include loose
motions. All appeals received before July 1, 2000 have been resolved, except where there is request for
reconsideration.

December 15, 2000: By Order of MDL 926 (the Silicone Gel Breast Implant Products Litigation: National
Multidistrict Litigation 926 Document Depository) this court granted a dividend payment of $470 to each other
Foreign Registrant in accordance with the Foreign Settlement Program. These payments were issued and mailed
on December 12-13, 2000, made payable to the claimant (and any lien-holder) only and are not to be subject to
attorney fees or expenses.

April 26, 2001: A long running study links breast implants to lung and brain cancer. This is not a cause-and-
effect relationship, but just a correlation or link, said Dr. Louise A. Brimton, chief of the National Cancer
Institutes environmental epidemiology branch, and who heads the study. He added, We need more research for
establishing causal links. Dr. Brintons group identified 13,500 women who received breast implants before
1989 and followed them for an average of 13 years. The women were compared with a control group of 4,000
other plastic surgery patients and with the general population. The study results that focused on a comparison
between these three groups were based on questionnaires completed by 7,500 of those invited for the study, as
well as medical records, and in some cases, death certificates. The average age of the breast implant group was
34, all had implants for at least 8 years, most had silicone-gel filled implants that were banned by the FDA in
1992; about 10% had saline implants. The key result is that women in the implant group were three times as
likely to die of diseases of the respiratory tract, primarily lung cancer, as the women in the plastic surgery group,
and twice as likely to die of brain cancer. The study could not fully account for smoking differences in the test
groups, said Dr. Brinton [See Sheryl Stolberg (2001), Study Links Breast Implants to Lung and Brain Cancer,
New York Times, April 26, 2001].

Ethical Responsibility Issues Regarding DCC and SBIs

Several legal, ethical and moral responsibility issues can be raised regarding the Dow Corning Case
in relation to its SBI. Discuss the following:

a) To what extent were DCC and its marketing executives morally responsible for developing,
manufacturing and marketing SBIs whose harmful effects to recipients they were aware of
within a year from product launch?

b) To what extent was DCC "unethical" in continuing to manufacture silicone-gel filled breast
implant products that were not stringently tested for their autoimmune disorders or related
diseases?

c) To what extent was DCC "unethical" in withholding, concealing or misrepresenting

hazard-information on silicone-gel breast implant products from the FDA, the plastic
surgeons or the consumers?

d) To what extent was DCC justified in seeking Chapter 11 protection from the class-action
suit of thousands of victims suffering from SBI-related autoimmune disorders?

e) To what extent was the bankruptcy judge legal and moral in including DCCs parent
companies for paying the damages to SBI victims, thus piercing the corporate veil?

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47