Reorganization plans in a chapter 11 case typically do not provide any meaningful recovery for pre-petition equity interests. This is as it should be, according to the rule of absolute priority; the going-concern value of a reorganized debtor is usually less than the sum of allowed pre-petition claims and post-petition liabilities, resulting in impairment for some classes of claimants—with equity interests standing last in line. Pre-petition equity interests may hope to receive a small percentage of the new equity of the reorganized debtor, or more typically, provides some potential recovery down the road if the debtor performs well post-emergence. More often than not, pre-petition equity-holders see no recovery at all for their interests. Academics have devoted many research papers to analyzing an observed market anomaly in which shares of a bankrupt company will continue to trade actively for value, usually nickels or dimes, long after the debtor has stated the unlikelihood that equity-holders will participate in any value recovery for their pre-petition interests under a reorganization plan.

How many chapter 11 cases can you recall where pre-petition equity interests received a substantial recovery under a debtor's reorganization plan? In one recent case, that of Carmike Cinemas, pre-petition preferred equity-holders came out whole from its reorganization in January 2002 while common equity interests salvaged a 22 percent stake in the reorganized company, with another 7.8 percent fully diluted stake reserved for Carmike's longtime president and CEO—who also was a 6.6 percent pre-petition common stockholder.

Carmike Cinemas is a Georgia-based motion picture theater operator that got caught up in the megaplex build-out frenzy that seduced, then trapped, most of the industry's large theater chains in the mid- to late-90s, resulting in the bankruptcy filings of six of the nation's 10 largest chains between 2000 and 2001. The saga and fallout of the megaplex build-out has been thoroughly chronicled. Unofficially begun by AMC Entertainment in 1995, the megaplex theater was an instant hit with moviegoers and soon supplanted multiplex theaters of the 80s and even older single-screen theaters as the venue of choice, especially among moviegoers under age 25. Stadium seating, digital stereo surround sound and up to 25 oversized screens appealed to audiences, while better screen management and concession economics were attractive to theater operators. Adopting a Field of Dreams strategy ("If you build it, they will come"), movie exhibitors raced to build these enormous structures. Financing was no problem, either; banks and other providers of capital were eager to lend on these projects, even at a construction cost of up to $1 million per screen in most urban and suburban markets. The number of U.S. movie screens increased by close to 35 percent to 37,400 between 1995 and 2000—about double the rate of increase in the first half of the decade. Unfortunately, movie attendance only increased by 12.6 percent over the same five-year period, and a slow box office in the summer of 2000 became the proverbial last straw for many theater operators. A restructuring of virtually the entire industry would ensue soon thereafter.

Carmike was among the top three motion picture exhibitors in the nation in the late-90s. It operated movie theaters in smaller, non-urban markets, and accordingly, averaged fewer average screens per theater (about five) than its big-city counterparts (anywhere from eight to 15). Carmike believed it was the sole exhibitor in 65 percent of its film licensing zones, according to its 1999 Form 10-K filing. Nonetheless, it too fully participated in the theater-replacement cycle, adding 20 percent more screens (net) between 1995 and 1999 to more than 2,800 screens, while reducing the number of theaters by 12 percent to 458 during the same period. What followed at Carmike (see Charts 1 and 2) was reflective of the sudden instability of the entire industry; operators aggressively built or expanded competing theaters in proximate locations, with total revenues and EBITDA increasing only marginally on a significantly larger asset base, much of which was debt-financed. Banks slowed and then stopped lending to the industry for such purposes, while projects in progress continued to consume cash flow. Widespread financial distress seemed all but inevitable, and was, in fact, predicted by certain industry analysts as early as the late-90s.

Carmike defaulted on certain financial covenants in its bank credit agreement in the quarter ended June 30, 2000, and was negotiating a waiver from its lenders when a $9.4 million interest payment became due on its $200 million 9.375 percent subordinated notes. The banks blocked the interest payment until an amendment to its credit agreement could be completed. The disappointing summer box office of 2000 caused operating results to weaken below plan, further complicating the company's negotiation with its banks. With no immediate prospects for a box office turnaround, unable to reach agreement on an amendment to its bank credit agreement and in default on its subordinated notes, Carmike filed for reorganization under chapter 11 on Aug. 8, 2000—by far the largest exhibitor to file at the time. Liabilities subject to compromise in its first quarter-end after filing were as follows:

The revolver and term loans were secured by liens on the personal property of the company. Furthermore, Carmike had issued $55 million of 5.5 percent Series A convertible preferred stock in November 1998, all of which was outstanding at the time of filing. There were also 11.3 million common shares outstanding, which had a market value of approximately $42 million two weeks prior to the filing.

During its 16 months in reorganization, Carmike leveraged the provisions of §365 of the Bankruptcy Code, rejecting some 136 unexpired theater leases representing approximately 28.5 percent of its theater base (but only 18 percent of its screens (see Table 2)), and modifying terms of another 35 leases. Further aiding Carmike's reorganization effort was a fortuitous box office comeback nationwide. Total box office receipts jumped 9.8 percent nationally in 2001 on a robust 4.7 percent increase in admissions.

Carmike emerged from chapter 11 on Jan. 31, 2002. Its reorganization plan valued the company at $585 million, significantly larger than its implied enterprise value about 15 months earlier when its subordinated notes traded at a fraction of face value. Fresh-start reporting could not be adopted because Carmike's reorganization value exceeded the sum of its allowed claims and post-petition liabilities, and its reorganization plan did not result in a change in ownership as defined by Statement of Position 90-7. The company's reorganization value was allocated in the following manner:

• Holders of pre-petition bank claims of approximately $254 million were satisfied in full from Carmike's exit facility;
• Holders of $154 million of pre-petition 9.375 percent subordinated notes received a like amount of seven-year replacement notes bearing interest at 10.375 percent;
• General unsecured creditors received 100 percent of their allowed claims in cash and interest-bearing five-year notes;
• All outstanding pre-petition common shares were cancelled and replaced with 10 million authorized new shares of common stock, allocated as follows:
  • 26.6 percent to certain holders of $46 million of pre-petition 9.375 percent subordinated notes. These holders were two directors of the company or their indirect affiliates, who previously disclosed they had purchased these securities at significant discounts to face value in open market transactions in October 2000.
  • 41.2 percent to the holders of its Series A preferred stock
  • 22.2 percent to holders of pre-petition Class A and B common stock
  • 10.0 percent was reserved for future issuance to senior management.

Carmike's shares closed at $18 on its first day of trading post-emergence, a slight premium to the estimated value of the equity in its reorganization plan. Despite the dilution suffered by pre-petition common equity interests, the market value of their 2.2 million new common shares was $40 million—essentially unchanged from its value in the month preceding the chapter 11 filing. The pre-petition Series A preferred shareholders came out even better; their 4.1 million shares of new equity were worth $74 million on day one—20 percent more than the sum of their original $55 million investment made only 18 months prior to the chapter 11 filing plus $7 million in unpaid dividends. Carmike's share price has since increased 55 percent from its emergence 20 months ago, largely due to a record-shattering $9.5 billion box office nationally in 2002 (a 13.2 percent increase) that has lifted movie exhibitor share prices well off their cyclical lows. Former preferred-stock holders have now seen their converted $55 million investment more than double in value notwithstanding Carmike's bankruptcy.

Carmike's ability to reject undesirable theater leases at a definable, manageable cost under §502(b)(6) of the Code created significant value for the debtor's estate, which accrued largely to recipients of its newly issued common stock. Of course, one could argue that these recipients took on sizeable risk by accepting equity in a reorganized Carmike, but this is debatable. Improved operating results were all but assured once Carmike had eliminated its oldest, poorest performing assets via the bankruptcy process. The operating risk in its remaining portfolio was substantially mitigated, especially since the industry's build-out craze was stopped dead in its tracks in early 2002. Unlike retailers that are perpetually exposed to myriad business risks and consumer fads, motion picture exhibitors share fewer of these concerns and enjoy a far more predictable aggregate demand curve. Hollywood's total box-office gross hasn't experienced a down year since 1991. Competing theater operators offer their customers an identical product at the same price (per locality) in similar settings. Ironically, the industry's passing crisis was self-inflicted—with the supply of new screens far outstripping any reasonable expectation of growth in ticket sales based on historical or demographic trends—yet utterly unavoidable due to the pressure on operators to upgrade their theater circuits. With nearly 30 percent of its theaters now excised, Carmike's total revenues are marginally higher than in 1999 or 2000 on a much smaller asset base, and EBITDA margins immediately jumped to nearly 20 percent from about 18 percent in the year prior to its bankruptcy. One new theater has been constructed in the last two years.

It is noteworthy that nearly every creditor group involved in the Carmike bankruptcy essentially came out (or will come out) whole, with the possible exception of landlords holding the 136 leases that were rejected. Yes, they received the full value of their allowed lease-rejection claims, but as we all know, the Code limits a landlord's allowed claim in bankruptcy relative to the present value of a tenant's remaining future obligations under a rejected lease. Moreover, these landlords got saddled with older, smaller theaters, many of which were unleasable as such and would have to be reconfigured for alternative uses or demolished.

Within 16 months of Carmike's bankruptcy filing, Regal Cinemas, Edwards Theatres, United Artists Theatre Co., GC Cinemas and Loews Cineplex had all filed for reorganization under chapter 11 as well. All but one were acquired out of bankruptcy by financial buyers (GC was purchased by another operator, AMC Entertainment), each of whom made good use of the provisions of §365 to shed undesirable properties as a propelling strategy of their reorganization. One could reasonably contend that the successful restructuring of the movie exhibition industry would not have occurred without the lease-rejection and claims-allowance provisions of the Code for unexpired leases that, like it or not, allowed theater operators to avoid paying much of the economic cost of their aggressive strategies. But perhaps none did it as extensively as Carmike Cinemas, which enabled certain pre-petition equity interests to emerge unscathed. It's almost enough to elicit sympathy for landlords.