INTERVIEW: Taking It to the Brink

Attorney and bankruptcy authority Ken Klee says business troubles will get worse before they get better.

Staff Reporter

Soon after graduating cum laude from Harvard Law School in 1974, Ken Klee went to Washington. There, as associate counsel to the House Judiciary Committee, Klee was thrust into a job that would shape the course of his career: helping draft the 1978 Bankruptcy Code.

From there, Klee has proven adept in legal, political and academic circles. He is often involved in the biggest and most complicated cases, such as the 1985 Texaco Inc. bankruptcy (representing legal adversary Pennzoil), and from 1995 to 1997 as special counsel to debtors in the case of Barneys New York.

In 1999, Klee and two colleagues left Stutman Treister & Glatt, where he had been since 1980, to form Klee Tuchin Bogdanoff & Stern LLP. Since 1979, Klee also has taught at UCLA Law School. He has written numerous scholarly articles and has continued to advise lawmakers on bankruptcy matters, including a 1994 mission to China to assist in the writing of Chinese bankruptcy laws.

Question: Business bankruptcies are at record levels. Will they continue to rise?

Answer: I think 2002 is going to surpass 2001 and 2000. We're in an upswing for business bankruptcies. That's being exacerbated by Sept. 11. Whereas before Sept. 11 you had industry specific downturns in places like health care, retailing, power, sub-prime lending now you've got general economic malaise.

Q: Do you concur with those who predict a recovery by mid-2002?

A: I think they're overly optimistic and by the way, I hope they're right, but I don't see it happening. You look for the bright spots, and you have to ask yourself, "What's going to drive a recovery?" The Fed is pushing on a string. They've got interest rates as low as they've been in 40 years, so where's it coming from? I see a lot of restructuring work, a lot of de-levering and restructuring in business operations.

Q: How are wealthy individuals going to fare?

A: Some are going to skate through this and others are going to fall through a hole in the ice. There are a lot of wealthy individuals that made their wealth by betting on dot-coms and they did not get out. Other people were more diversified and they are sitting on the sidelines, but they are not going to cause the recovery. They're going to help fund a recovery when there's an underlying business reason to do so.

Q: What specific problems do companies face over the near term?

A: There are basically three types of problems that businesses have. One is outmoded technology. They can be an old, low-tech business like (San Diego-based) Anacomp Inc., which we just put through a prepackaged bankruptcy convert last month. But a lot of people say the dot-coms have this problem, too. They started an idea and it didn't work, because ultimately they didn't have a product that could make money.

Second, you have businesses that are struck by a cyclical lack of demand. They've had high demand before, they're going to have high demand again, but now the demand falls off and they've got to have massive layoffs and retrenchment to go through that cycle.

Q: What's the third type of problem?

A: Banks essentially behave like sheep. They move in a herd. If it's fashionable to lend somewhere, they throw a bunch of money at it. If it's fashionable to go somewhere else, they pull all the money out. So liquidity can be a huge problem if banks sour on a particular industry and all of the sudden they refuse to renew revolving lines of credit, refuse to work out covenants that bust.

Q: What are the industries that banks are shutting out right now?

A: I'd rather not put a finger on that. But if you look at things like hospitals, or some of the private physicians' groups, it's no secret that the banks have pulled their support.

Q: What other activities are we seeing from distressed companies?

A: A lot of bondholder restructuring. Lots of people with notes trying to restructure them or convert debt to equity, just do it out of court, roll it up through Chapter 11 in a pre-package.

Q: When you look out over the economy, what's your biggest fear?

A: There is a non-trivial scenario where things could get so bad that people start defaulting on commercial paper and everybody who's got their money in a money market account all of a sudden realizes that it's not worth the dollar that they thought it was.

The financial services industry has attracted money from federally insured bank accounts over to money market accounts, and people think the money market's good as gold. Of course, the big institutions are going to do whatever they can to stand behind their money market funds. But there comes a point, if you have a lot more Enrons, where the pressure on these funds is going to be such that some fund is going to break. And if that happens, people could try to pull money out of these funds. They could create a terrible downward spiral. I don't think that's going to happen, but if it does, I don't think life in America will ever be the same.

Q: What about more likely scenarios?

A: I think the recent allure for junk bonds, particularly on the part of some of the major retirement funds, is going to get increasing scrutiny. I would expect stories in the papers in 2003 and 2004 to be focusing on how could this prestigious university take its retirement funds and put X percent into junk bonds, which wound up producing nothing.

Q: Who else is vulnerable?

A: Undermining of the solvency of public institutions is one concern. If it's universities, that's a big concern. If it's retirement funds for teachers, steelworkers, or any other kind of union, now you've got a much bigger problem. What you're seeing in a microcosm in Enron, where the captive employees had company stock in their 401(k)s and it went down to near zero. Take that problem and multiply it to 100 million people.

Q: Where have you put your money?

A: I do have some friends on Wall Street who are in cash. And I don't mean money markets. I mean cash. But I have maintained a diversified portfolio of stocks and bonds. I still have my money in money markets. I haven't taken it and put it under the mattress. I think things are going to turn around, but there are some scenarios out there that are, I think, a lot scarier than most people realize.

Q: Do you support pending changes to the Bankruptcy Code?

A: I hope economic malaise prevents Congress from enacting them, because to me the bill is nonsensical. It's sort of like saying, "If we close the door to the hospitals people won't have the flu." People are going to be in economic difficulty even if there were no bankruptcy laws, period. So I would look at the responsibility that the lending community should take in extending credit to people who don't have the ability to repay it.

Q: Is there as much abuse of the code as people say?

A: No, I don't think there is. You see a few cases where a high-profile movie star or athlete or politician files for bankruptcy and comes out with a mansion in Florida or Texas. It's the cases of the rich and famous that get the attention. But most people who file are unwed mothers, people who have medical situations, people who have lost their jobs, had a spouse die, been divorced.

Q: What can be done to fix the problems that do exist?

A: There are three things that could be done without totally revamping the bankruptcy system. No. 1, you could go after the homestead exemption (on debtor's private residence), which is unlimited in four states, and put a cap on it of $250,000 or $100,000 or whatever. No. 2, prevent re-filings. A lot of the people who abuse the bankruptcy system file multiple times. Allow people to file a second time, but if you do, you don't get a lot of these benefits and protections unless you can show the judge that you deserve it. And the third thing is to put limits on the ability to reaffirm debts, because a lot of people in bankruptcy reaffirm debts that they shouldn't be reaffirming, and it's leaving them in financial difficulty going forward.

Kenneth N. Klee
Title: Founding Partner
Organization: Klee Tuchin Bogdanoff & Stern LLP
Born: 1949, Los Angeles
Education: A.B., Stanford, 1971; J.D., Harvard, 1974
Career Turning Point: Working for the House Judiciary Committee immediately after law school
Most Admired Person: Moses
Personal: Married, with two sons, ages 26 and 24

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