The Bankruptcy System's Chapter 22 Recidivism Problem: How Serious is It?

Published date01 February 2015
Date01 February 2015
The Financial Review 50 (2015) 1–26
The Bankruptcy System’s Chapter 22
Recidivism Problem: How Serious is It?
Edward I. Altman
NYU Stern School of Business and NYU Salomon Center
Ben Branch
University of Massachusetts
This paper is adapted from the keynote address from the Eastern Finance Association’s
2014 meeting in Pittsburg, Pennsylvania. We highlight a recidivism problem: about 15% of
debtors who emerge as continuing entities under Chapter 11, or are acquired as part of the
bankruptcy process, ultimately file for bankruptcy protection again (18.25% when considering
only those firms which emerge as a continuing, independent entity). Weargue that the “Chapter
22” issue should not be dismissed by the bankruptcy community just because no interested
party objects during the confirmation hearing. Applying the Z”-Score model to a large sample
of Chapter 11 cases reveals highly different and significant expected survival profiles at
emergence. Credible distress prediction techniques can effectively predict the future success
of firms emerging from bankruptcyand be used by the bankruptcy court to assess the feasibility
Corresponding author: Isenberg School of Management, 121 Presidents Drive, University of Mas-
sachusetts, Amherst, MA 01003; Phone: (413) 545-5690; E-mail:
Max L. Heine Professor of Finance and Director of Fixed Income & Credit Markets Research Program,
NYU Stern School of Business and NYU Salomon Center, 44 West 4th Street, New York, NY 10012;
(212) 998-0709; E-mail: The original article was published in the Brooklyn J.
Corp. Fin. & Law in May 2014 (#8)-(2014). Professor Altman is indebted to the organizers and members
of the Barry L. Zaretsky Roundtable at the Brooklyn School of Law,November 18, 2013 for proposing and
participating in a discussion on “Avoiding Chapter 22-Predicting Success in Chapter” and to the Eastern
Finance Association for featuring a discussion of this type during Professor Altman’s keynote address at
the 50th Anniversary meeting in Pittsburgh,PA on April 11, 2014. The following article was motivated by
a discussion between Professors Altman and Branch at that meeting.
C2015 The Eastern Finance Association 1
2E. I. Altman and B. Branch/The Financial Review 50 (2015) 1–26
of the reorganization plan, a requirement mandated by the Bankruptcy Code. Branch reviews,
discusses, and critiques in this follow-up article to Altman’s original thesis.
Keywords: C hapter 11,Chapter 22, reorganization, feasibility, Z-Scores
JEL Classifications: G32, G38
1. Introduction
Ever since we first coined the phrase “Chapter 22” (Hotchkiss, 1992;
Altman, 1983), the U.S. bankruptcy community has been debating the fact that some
companies going through the Chapter 11 system need to refile soon after emerg-
ing. Note that 11 U.S.C. Clause 1129(a)(11) (2012) of the U.S. Bankruptcy Code
explicitly provides that: “confirmation of the plan is not likely to be followed by
the liquidation, or the need for further financial reorganization of the debtor or any
successor to the debtor under the plan, unless such liquidation or reorganization is
proposed in the plan.”
Hence, a “feasibility analysis” is one of the requirements for confirmation of
Chapter 11 plans of reorganization. We argue that the courts and restructuring pro-
fessionals should strongly consider utilizing statistical methodologies for predicting
corporate financial distress to complement the traditional feasibility analysis tests
now being used by restructuring specialists. We show that one such technique, the
Altman-Z-Score method, discriminates between firms that file for Chapter 11 at least
once after emergence compared to firms that do not suffer this recidivism event.
In a new study, Altman (2014a) updates and increases the sample size of firms
used to test his theory. He comments for the first time on the extent and frequencyof
Chapter 22, 33, and 44 filings in the United States, and provides some additional tests
(see Altman, Kant and Rattanaruengyot, 2009) about a number of relevant variables.
This paper, reviews his new findings, which set the stage for a more in-depth and
considered thesis.
When the debtor corporation refiles after it emerges, this bankruptcy constitutes
a reorganization failure, both in concept and in cost. This is due to the direct and
indirect costs of bankruptcies, estimated to be between 1% and 6% for direct costs
(e.g., by Warner, 1977; LoPucki and Kalin, 2001) and between 11% and 17% for
indirect costs, depending on the industry (Altman, 1984). The tradeoff between
bankruptcy costs and the tax benefits from additional debt is one of the cornerstones
for several generations of corporate financial theory.
Altman’s (1983) original thesis asserts that the likely refiling of an emerging
entity is not what the advisors or the court expect coming out of bankruptcy, and that
a fast, low cost, and reliable early warning system could greatly reduce the likelihood
of a refiling without materially adding to the costly nature of a long drawn-out
restructuring. See articles by McHugh, Michael and Shaked (1998), Lee (2001), Lee

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