Question

Recently a large regulated utility which supplied natural gas to residential customers filed for bankruptcy because managers had incorrectly predicted a large increase in the price of natural gas and a large decrease in price occurred. Prior to bankruptcy, they had locked in suppliers to very long contracts, thinking the price would move up. At the time of the filing, this company was still viable but decided to file early to keep from draining the resources of the company. a. Is it ethical to use bankruptcy in this manner? b. Who benefited and who lost? Can you think of other business or personal situations that might result in a rash of bankruptcy filings if rapid inflation or deflation occurs?

Answer 1

a. In my opinion, it was unethical on the part of managers to file for an early bankruptcy even when the company was still viable because the price as calculated could have gone either way and the managers shouldn't have relied so much on their judgment to enter into financial obligations. Also, considering that residential customers depend on the company it should be able to work through the losses rather than just filing for bankruptcy. Bankruptcy, in my opinion, should be the last option when nothing works out. The company at first should try to negotiate with the suppliers for deferring their payments so that it could meet its obligations rather than going for an easy out by filing for bankruptcy. Bankruptcy altogether extinguishes the chances of a company ever becoming a viable entity even when it files for bankruptcy under Chapter 11 (reorganization of business) because of the loss of confidence in the company among investors, creditors, suppliers, and customers.

b. In this case, only the managers of the company benefitted because they got an easy out rather than facing the burden of their moral and financial obligations. On the other hand, the investors, the suppliers, the creditors and the customers were the ones to lose as a result of this decision. Since investors basically the stockholders might end up with pennies for their dollars or nothing at all, the creditors may end up with less amount than what they had invested, the suppliers may also have to bare a cut in their earnings and the customers fail to get natural gas at the reduced price as the company might go out of business.

c. During inflation, the interest rates increase especially for the floating rate home loans this might result in homeowners defaulting the payments of their debt as was the case with the US Financial crisis. This might lead to a string of bankruptcies being filed by homeowners unable to pay their increased debt obligations and at the same time buying them some time on their foreclosures. This bankruptcy law is abused by many homeowners in Los Angeles where this practice is quite rampant. Deflation, on the other hand, can drive companies like natural gas suppliers as the case was in the present question, Airline companies in case of a decline in prices of air tickets followed by no increase in demand, etc out of business.