More Dot-Coms File Chapter 11
By Michael Liedtke
AP Business Writer
Sunday, Oct. 14, 2001; 2:17 p.m. EDT SAN FRANCISCO As the economy crumbles, some Internet companies are going out of business the same way they ran their businesses unconventionally.
They're filing bankruptcy in a way that has angered investors and creditors who worry that company insiders are positioning themselves for one last windfall.
In the past year, a wave of hopelessly insolvent dot-coms have filed for bankruptcy under Chapter 11 an option usually reserved for companies trying to resurrect their business instead of auctioning off their assets under Chapter 7, the traditional route for dead-end companies.
Most failed dot-coms still file Chapter 7 bankruptcies, according to statistics compiled by BankruptcyData.com, a Web site that tracks filings across the country.
Through late September, Chapter 7 petitions accounted for 79 of the 139 bankruptcy filings made by businesses with a "dot-com" in their corporate names, according to BankruptcyData. The statistics don't include the bankruptcies of many other Internet businesses that don't contain a dot-com in their names.
Including companies of all types, 26 percent of the 35,323 business bankruptcies last year came under Chapter 11, according to the American Bankruptcy Institute, an Alexandria, Va. research group.
Chapter 11 liquidations are becoming more common in the Silicon Valley, the heartland of doomed dot-coms. Recent prominent cases include: New Economy magazine publisher Standard Media; Olympics Web site provider Quokka Sports; online grocer Webvan; wireless Internet provider Metricom; and pioneering online merchant Egghead.com.
Liquidating a company under Chapter 11 of the bankruptcy code is legal and, according to attorneys, often a prudent strategy for large businesses trying to preserve the value of intellectual property or other unique assets. In return, the retained employees in Chapter 11 typically receive bonuses and other incentives to make sure the auction goes smoothly.
In Chapter 7, the liquidation is handled by an impartial trustee whose fees are set by the federal bankruptcy code.
"The idea behind a Chapter 11 liquidation is to have an orderly disposition of the company's assets with the help of management instead of a fire sale on the courthouse steps," said William Zewadski, a Tampa, Fla. attorney who specializes in bankruptcy issues for the American Bar Association. "But sometimes the (management) just wants to try to milk the company's assets one last time."
That's what some major investors in Quokka Sports believe happened when managers at the San Francisco-based company decided to file for Chapter 11 in April.
Under management's initial bankruptcy plan, 15 employees would have received a total of $239,243 in bonuses for staying on the job to help shepherd the liquidation process. Four other employees, including former CEO Alvaro Saralegui, also wanted to split a 15 percent commission on the proceeds from the company's liquidation.
U.S. Bankruptcy Judge Thomas Carlson nixed the proposed bonuses and commissions amid investor protests that Quokka never should have been allowed to file for Chapter 11. Quokka's Chapter 11 "represents little more than an attempt by ... management to dip one last time into a trough that already has been depleted over the last year," the investors said in a brief seeking to convert the case to Chapter 7.
Bankruptcy Trustee Linda Ekstrom Stanley also argued that Quokka's case should be converted to a Chapter 7, but Carlson denied the request in August.
Quokka's decision to file Chapter 11 reflected management's belief that its remaining assets would fetch substantially more money if key employees supervised the auction process, said Tobias Keller, Quokka's bankruptcy attorney. But the liquidation didn't live up to expectations.
Chapter 11 "did not work well with Quokka," Keller said. "In retrospect, it could have been a Chapter 7. The problem is that you have to make a decision (on which chapter to file) before you know how things will turn out."
Intira, a Pleasanton-based Web hosting service, fared better under a Chapter 11 liquidation, said Keller, whose firm handled the case. Heading into bankruptcy, Intira hoped to raise $2 to $3 million for its assets, which cost more than $100 million, Keller said. The auction fetched roughly $8 million, Keller said.
Many dot-com executives liquidating their companies under Chapter 11 are just trying to line their pockets, said David Fidler, an attorney who represented Quokka's investors.
"It's not like there are a lot of other employment opportunities out there for these guys," Fidler said.
San Francisco-based Standard Media, publisher of the now-defunct Industry Standard, irked creditors by agreeing to pay 5 percent of its liquidation proceeds to three executives: founder John Batelle; Anne-Marie McGowan, chief operating officer; and Jonathan Weber, the magazine's editor-in-chief.
The company's attorneys argued that the trio provided critical knowledge and services in the Chapter 11 liquidation, but Standard Media's committee of unsecured creditors questioned the need for the so-called "success fee."
The 5 percent fee "may be a disguised 'golden parachute' payment to these individuals, completely unrelated to service in connection with the sale," the committee wrote in a legal brief.
The September auction, held a month after Standard Media's Chapter 11 bankruptcy filing, raised $1.4 million. Business 2.0 publisher AOL Time Warner paid $500,000 for a list of the Industry Standard's subscribers and International Data Group, Standard Media's biggest shareholder, bought the Standard's Web site and other assets for $900,000.
Chapter 11 advocates say the process doesn't cost the estate much and might even save money because a trustee inevitably would have to hire contractors to help oversee the process. The best candidates for these contracting jobs frequently are the former employees of the bankrupt company.
"In bankruptcy, you want to keep around the people who are most capable of selling the assets," Keller said. "If you do Chapter 7, a lot of the engineers that understand the assets might be gone for good."
© Copyright 2001 The Associated Press