After five years of being courted, attorney Paul Aronzon earlier this month took the plunge and moved to the other side of the bankruptcy aisle by joining Beverly Hills investment bank Imperial Capital LLC.

Aronzon admits that he held off leaving Milbank, Tweed, Hadley, & McCloy LLP, where he co-chaired the law firm's financial restructuring group for 17 years, because he was concerned about joining the investment banking world.

"The time to make a change like this is when the market is quiet, before it turns, and you end up too busy to think about a change," Aronzon said, sitting in a sleek, windowed office on South Rodeo Drive. "Investment banks have not previously been focused on the restructuring business." That may be about to change.

Default rates on corporate debt are at their lowest levels in years, and hedge funds and private equity firms are still flooding the market with capital, but restructuring experts are anticipating a reversal. Many banks and law firms are preparing for the next cyclical downturn, anticipating a flurry of bankruptcy filings in 2007. That's particularly true if, as expected, the Federal Reserve continues its current policy of ratcheting up the federal funds rate to fight inflation.

Investment banks can play a pivotal role in a company's bankruptcy or turnaround by issuing high-yield debt or arranging a buyout, for example. They often like to recruit bankruptcy lawyers for they know a good deal about the bankruptcy process as well as the laws.

Earlier this month, Goldman Sachs & Co. hired another prominent bankruptcy lawyer, James Sprayregen, from Kirkland & Ellis to run its restructuring practice. Investment bank Lazard Freres has been one of the most active recruiters of bankruptcy lawyers, having previously lured away David Kurtz from Skadden Arps Slate Meagher & Flom's corporate restructuring group.

Irwin Gold, senior managing director and national co-director of Houlihan Lokey Howard & Zukin's financial restructuring group, wasn't surprised by Aronzon's move.

"You'll find a lot of people in restructuring have legal backgrounds," he said. "Some of these firms are gearing up for what people see as a raining down of distressed high-yield debt and restructurings."

"It's a numbers game," he continued. "There have been a lot of high-yield issuances and lower credit ratings and some companies have less financial flexibility. But until we get to that point, there isn't a lot of business to go around and many firms are planning for the long term.

Moody's Investors Service reported that the global speculative grade corporate default rate was at 1.8 percent at the end of January, down from 1.9 percent in 2005. But Moody's forecasts the default rate will rise to 3.3 percent by January 2007.

One big question is whether cheap capital will dry up.

"There's still a tremendous amount of liquidity in the capital markets and if banks get nervous, they sell off the loans at a discount, and then you're left with the parties that have bought corporate debt at a lower price point on the secondary market," said Fruman Jacobson, a partner who heads Sonnenschein Nath & Rosenthal LLP's national workout, reorganization and bankruptcy practice. "Rising interest rates will have an effect, but we first have to see some liquidity taken out of the marketplace."

Jacobson, who admits to having been tempted with offers from investment banks, said many firms are in the process of building their restructuring practices.

Law firms some of which have lost top bankruptcy guns to investment banks are finding themselves in a similar situation, making plans to deal with an anticipated rise in defaults.

Wayne Terry, partner in the bankruptcy practice at Mitchell Silberberg & Knupp LLP, said restructuring lawyers already on staff will get as busy as they want to be at last.

"Bankruptcy law and the quality of cases have been slow for years," Terry said. "If there is an upswing, it will be awhile before it gets absorbed."

Beefing Up

Imperial Capital, which competes most directly with investment bank Jefferies & Co., is on a hiring binge.

In April, Imperial acquired the San Francisco operations of Giuliani Capital Advisors LLC, and hired seven Giuliani executives to expand its restructuring practice. It also lured Timothy O'Connor, the former managing director of Jefferies' recapitalization and restructuring group, as managing director of investment banking in New York.

The goal, of course, is to be prepared when the high-yield market rebounds.

"Imperial Capital is probably the only firm on the West Coast that follows structured or distressed debt with written research," said Mary Ross Gilbert, a managing director and head of fixed income research at Imperial Capital.

Imperial specializes in the sales and trading of high-yield and distressed debt, bank debt, convertible bonds and equities. Its largest clients include hedge funds that are active purchasers of first and second lien debt.

Though Aronzon has been at the firm for only four months, he says he already has 10 deals and another four in the pipeline at a time where there is literally "no bankruptcy business to speak of."

Aronzon, a native of Los Angeles who takes pride in the fact that he graduated from California State University, Northridge, and Southwestern Law School, joined the firm in February as executive vice president heading up its restructuring advisory group. Among the cases he's worked on are Trump Casino Holdings LLC, Pacific Gas & Electric Co. and Delta Air Lines Inc.

Transitioning to another industry presents opportunities.

The biggest difference in his day-to-day job responsibilities is that Aronzon now is focused on business ideas and giving financial advice.

"As a lawyer, you give legal advice with a business focus, but you are not always permitted to participate directly in the decision-making process," he said. "As a banker, you not only participate directly in the business decisions concerning a financial restructuring, but you help shape them and lead their implementation."

In some ways, bankruptcy lawyers and investment bankers with a specialty in restructuring are like Siamese twins they see what the other does and are working with the other party, but not in the same shoes.

"Being able to do what an investment banker does, which is bring the different parties to the table, is different from a bankruptcy lawyer, who has the power of litigation," said Fruman at Sonnenschein. "I think it's actually kind of cool."

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