'Reasonably High' Chance BP Files for Bankruptcy

There is a reasonably high chance that BP could file for Chapter 11 bankruptcy in the next few years, or even months, and the result would be an "absolute horror" for the government, according to a bankruptcy expert.

Peter S. Kaufman, the President of investment bank Gordian Group and head of the firm's Restructuring and Distressed M&A practice, told me that if he had BP's ear, "I'd advise them to explore the option of bankruptcy." If he had the government's ear, he'd tell them to stop berating the company to the point where BP would find it appealing to use bankruptcy to limit its liabilities.

The specter of Chapter 11 bankruptcy terrifies Gulf residents because it could allow BP to delay, or even avoid, paying billions of dollars to businesses and individuals affected by the Gulf spill. The chapter is specifically for companies in temporary financial trouble who can reemerge as viable if they receive new funding, cancel burdensome contracts and delay, restructure, or wall off repayment obligations.

I spoke with Kaufman about the possibility of a BP bankruptcy yesterday. Here is an edited transcript of our conversation yesterday, which includes further clarifications from an email follow-up with Kaufman this morning:

Let's say you're advising BP. What would you tell them to do?

I'd advise them to explore the option of bankruptcy. I only know BP from public information. BP has a lot of cash and the ability to generate huge amounts of cash. But remember, just because BP can pay claims doesn't mean they should, or that they will, given that their primary obligation is to their shareholders.

Bankruptcy laws are designed to help companies rehabilitate themselves. What I'm suggesting here is that BP is or ought to be analyzing the possibility of insolvency proceedings, and the pros and cons of doing so. Now understand, this would be an absolute horror for the U.S. government. If BP succeeds in putting a wall around its Gulf liabilities, payment on those claims fall to the U.S. government or they're not paid.

What would a BP bankruptcy look like?

It could work a lot of different ways. They could cut loose BP America and it could be BP America that files for bankruptcy. My presumption is that it's BP America that's responsible for the spill. They can wall off the non-BP America assets from the Gulf -- which is about 50% of the company's net value --and try to reorganize BP America. That's likely to take a very long time, and BP would not make good on its promise for the 20 billion [in the escrow fund].

Or they could file all of BP, and do so in London. Wonder how well-received our government and legitimate Gulf claimants would fare in a British insolvency court?

Now let's say you're advising the U.S. government on dealing with BP. What actions do you take now to keep BP from filing for bankruptcy to limit its exposure to liabilities?

I would start with the same analysis BP is undertaking. Perform the same analyses BP is performing about various bankruptcy strategies and figuring out how its assets and liabilities match up structurally, and how to shift assets from one entity to another. Develop judgments about potential outcomes from those bankruptcy strategies. Develop views on total costs that BP might face. We need to be able to anticipate where and how BP is going and then plan courses of action designed both to blunt and address BP's potential strategies.

In short, I would want to have a very good understanding of what BP could do. My thinking now is that BP America could file here or they could file the whole thing in London. Why should they continue to get berated by this country, pay $20 billion [via the escrow fund] and still face an unlimited liability for not only civil, but also for criminal charges, if there's a better way for the company?

It would be a mistake, in my judgment, to view BP as a political piñata that can be beat around the head repeatedly without consequences. It's not reasonable to expect BP to pay unlimited liabilities and face criminal charges, and the United States needs to understand the size of the gun BP can pull.

I see the case for exploring the bankruptcy option. But what are some reasons they shouldn't file for Chapter 11?

If BP makes the calculated decision that the amount of damages they'll have to pay doesn't warrant the money, time, risk, hassle of going through solvency proceedings, they won't do it.

In short: if both sides fully understand the alternatives and options available to everyone around the table, that should lead to a global resolution and settlement. Otherwise, it will be rampant litigation and BP could pull some very unpleasant surprises. I should not want to see the United States surprised and unprepared.