There are no doubts that there are benefits to Chapter 11. Creditors who properly manage the threat of Chapter 11 can wrest control of a company from incompetent management and still work with equity holders. Then there are the management teams who live in a world of reality and file voluntarily, thereby establishing a working relationship with the secured creditors.

Sadly what often happens is the creditors have to wait for the company to fall flat on its face before they can we told you so and then seize the company through court. Contrary to popular belief, no bank or creditor wants to take a company into bankruptcy. Bankruptcy brings certain advantages to the senior secured creditors but these advantages are essential to putting the company back on its feet or to make the senior secured creditors partially whole. Another upside is: House cleaning. You can clear out the knuckleheads who drove the company into bankruptcy and put the right people in charge. The downsides of bankruptcy are many; ranging from damaged reputations to short changing/cheating suppliers and wiping out equity holders.

I will be the first to say that there have been times when the incompetence of management has left me thinking that bankruptcy would put the company out if its misery and spare the customers, creditors from more pain and misery. The great thing about the free market is that the customers are great indicators. Customers will not do business with junk companies. In the case of telephone companies, customers file complaints with the public service commissions (public utility commissions in some states).

The more and more I think about it, the more I am convinced that Fairpoint needs to file. Every horror story you hear just scares the heck out of me. Frankly, I am questioning management’s ability to see the company through this rough time. Who in the world ignores an auditor’s report? Remember they ignored the auditor’s report.

The creditors of Fairpoint may opt for a bankruptcy filing for the following reasons:

1. Chapter 11 provides protection from unsecured creditors, suppliers who are owed money, and other bill collectors.
2. Chapter 11 enables the company to seek debtor-in-possession (DIP) financing which can be used for working capital.
3. Chapter 11 essentially buys breathing room for the company while it develops a plan for reorganization
4. Chapter 11 puts overall control of the company under the secured creditors of Fairpoint, thereby increasing the chances of a saving the company from incompetent management. It would be better for management to cooperate with secured creditors in order to avoid a filing but often management cannot realize it is the source of all the problems.

The risks and downsides of a Fairpoint bankruptcy filing are:

1. Debtor (Fairpoint) Management is placed under enormous strain and is not capable of completing the restructuring
2. Potential loss of corporate customers
3. Corporate reputation is damaged within the business community; suppliers’ bills are unpaid, unsecured creditors lose their investments, and equity holders lose everything.
4. Employee layoffs are often the result of a bankruptcy
5. Service quality may degrade
6. All current and future network upgrades are placed on hold indefinitely

A bankruptcy filing may be what is needed to save Fairpoint. However, a Chapter 11 can be avoided if management agrees to all conditions set by the senior secured creditor(s) of Fairpoint, which may include removal of all management. Such an agreement will require support from the largest equity holders who may control the board. Fairpoint equity holders have very little choice in the matter because once Fairpoint files (voluntarily or not) the senior secured creditors of Fairpoint will control the company and the equity holders’ shares will be worthless.