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The Definitive Work on Pain (1)

 

... will probably be created from either (a) trying to develop a definitive, prospective definition of "fair use" that works or (b) trying to figure out what unsecured creditors are going to get out of a Chapter 11 bankruptcy proceeding; both are far more fiendish than The Machine. I spend an awful lot of time pondering possibility (a); with the Borders situation, I'll change to (b). Unfortunately, as we'll see, that's not a route out of the Pit of Despair — especially for authors.

First of all, we must make one thing clear: Authors are not creditors of Borders (well, except for self-published authors, but they're merely publisher and author in one for this purpose). Instead, the creditors are publishers and distributors... and, as I've noted previously, landlords and utilities and employees and tax authorities and so on. That's because the purpose of bankruptcy is twofold:

• ensuring an orderly distribution of the debtor's assets to creditors, in equal proportion for equally situated creditors; and
• giving the unlucky/improvident debtor a fresh start and chance to rebuild his/her/its life

For the moment, we're going to concentrate on the first aspect. The key point is "equally situated", because not all creditors are equal. Some creditors have secured interests, and (in most situations, and almost certainly for the Borders matter) can expect to get all of their money/secured interests back... except when they are "oversecured" (the value of the security interest is greater than the remaining actual debt due; consider a car loan that is almost paid off). Within the general group of unsecured creditors, the Bankruptcy Code establishes certain priorities; all of the creditors in higher priority must be paid in full before creditors in the next-lower priority get anything. See 11 U.S.C. § 507.

With that in mind, let's deconstruct the initial bankruptcy petition that was filed by Borders (PDF), and try to estimate what the publishers (and, hence, the authors) might receive. Keep in mind that this is only a thumbnail, initial analysis, and should not be relied upon for much more than justification for following the matter with some knowledge of the context. Do not treat any of the following as legal advice; or as material for tax planning; or, indeed, for anything other than just context. Also, for simplicity's sake, I will silently round all figures to four or fewer significant digits.

The petition (page 6) discloses total debts of $1.293 billion against assets of $1.275 billion. If Borders voluntarily liquidated today outside of bankruptcy — and did not require any assets to continue in business, nor require any administrative expenses to liquidate, nor have any secured interests — this would result in paying 98.6% of all claims. But watch the magic of bankruptcy priorities at work:

• First, one must remove all secured claims. Unfortunately, as a large Chapter 11 matter of a retailer, this is an entirely unpredictable matter... and the Bankruptcy Court (properly) waived the requirement to file a statement of secured interests. These secured interests will include both the obvious (mortgages on properties Borders actually owns, instead of leases) and the less obvious (the security interests in cash flow demanded by lenders, such as the abortive refinancing attempt that led to the bankruptcy filing). Unfortunately, the bankruptcy petition doesn't provide much insight on this... but SEC filings do. The most-recent quarterly statement (filed 09 December 2010) and annual report (filed 01 Apr 2010) disclose lots of claims that are categorized as "secured by inventory" and "secured by receivables," amounting to approximately $975 million. However, given that Borders does not actually own books on its shelves that are actually returnable for full credit — instead, these are properly consignments — the claims on inventory are likely to be recast as "unsecured" by the bankruptcy court during the free-for-all. The value of "inventory" disclosed on the most-recent quarterly report was $896 million, leaving claims secured by cash flow of $79 million.

  Subtracting that undoubted secured claim from both sides above, that leaves remaining debts of $1.214 billion against remaining assets of $1.194 billion, already dropping liquidation repayment rate (LRR) to 98.3%.

• Next, one must remove unsecured claims in priority order, under the priorities established in § 507. Once again, this will require substantial cross-referencing with the annual and quarterly reports, plus an estimate of further liabilities and cash flows to date. In short, it's an art, not a science... and must account for the fact that the highest-revenue quarter for publishing retailers is a quarter beginning in early November and stretching through late January, which is precisely that period not covered by a relevant SEC filing.

  First up will be administrative expenses of the bankruptcy filing itself (§ 507(a)(2))... including, naturally enough, attorney's fees. (Hey, lawyers wrote the Bankruptcy Code; you didn't really think they'd be willing to stand in line with the unwashed masses, did you?) The purely administrative expenses for a retailing operation, such as the costs of doing inventory checks and special sales and the fees charged by liquidation specialists, are typically slightly over 3% of the stated face value of that inventory; in round numbers, we should allow $30 million here. Legal fees that are chargeable out of the bankruptcy estate will be much less predictable, and range from negligible to exhorbitant... especially when, as for Borders, there are major shareholders with reputations for asset-stripping, greenmail, and failed turnarounds. As a round number, I would allow about $25 million if the case stays in Chapter 11, and $40 million or more if converted to liquidation under Chapter 7. These expenses are pure deductions from assets available to creditors. Thus, assets have now been reduced to $1.139 billion, dropping LRR to 94%.

• Next, one must remove certain claims by employees for back pay (up to $10k, § 507(a)(4)) and contributions to benefit plans (up to $10k, § 507(a)(5)). From what I understand, Borders has not fallen behind on (a)(4) payments, but is probably behind a bit on (a)(5) payments. Nonetheless, with only around 8,500 full-time employees a year ago (nonunionized to boot) and some reduction in employment over the past year, the maximum claim in this category would be $85 million, and is likely less than $20 million. Subtracting that estimated $20 million from both assets and liabilities leaves us with debts of $1.194 billion, assets of $1.119 billion, and an LRR of slightly under 94%.
• Next, one must remove taxes due and accrued prior to the filing (§ 507(a)(8)). For a company operating at a loss, the income-tax proportion will, of course, not be an issue. Sales taxes, property taxes, excise taxes, etc., however, are not. Once again, the abbreviated filings make calculating this very difficult. The $44.1 million figure at the end of January, 2010 is probably representative of the amount currently due and owing; the problems with the economy in 2010 are largely offset by significant increases in local taxation rates in many localities, plus the better 2010 holiday selling season. Subtracting a rounded $45 million from both assets and liabilities leaves us with debts of $1.15 billion, assets of $1.07 billion, and an LRR of slightly over 93%.

And now it's time for the real fun to begin: Arguing over the unsecured claims of lenders against the inventory, versus the publisher claims, and considering existing trade debt to the publishers. But that's for next time (which will hopefully be before the end of the holiday weekend). Our temporary summary is that before these arguments begin — and pretending for the moment that Borders was liquidating, and thus would not require any further cash and/or inventory to continue operating — there's already a 7% loss to publishers at best on their trade debt receivables (amounts owed by Borders for inventory shipped to Borders but not yet paid for). Of course, it's nowhere near that optimistic after untangling the rest of things. The key point to take away from things is that the publishers — and, hence, authors — are second-to-last in line for money, being ahead only of common stockholders in the corporation (who will get nothing, except perhaps shares in the reorganized entity).

Labels: intellectual property, jurisprudence, publishing