Chapter_16_Bankruptcy_and_Liquidation M nd A.ppt

7/29/2019 Chapter_16_Bankruptcy_and_Liquidation M nd A.ppt

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Alternative Exit and

Restructuring Strategies:

Reorganization and Liquidation


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What is important is not adding more

years to life but more life

to your years.

Doug Fields


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Learning Objectives

Primary Learning Objective: To provide anunderstanding of alternative strategies for failingbusinesses

Secondary Learning Objectives: To provide an

understanding of:- Criteria for choosing strategy for failing firms

Process for filing for bankruptcy, voluntary andinvoluntary settlements inside and outside of court, andvoluntary and involuntary liquidation


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Rule of Law andCorporate Asset Allocation

The smooth functioning of capital markets requires rapid and fair resolutionof disputes involving the legal rights of borrowers and lenders

Studies show that borrowing costs are lower and access to credit easier incountries which enforce credit rights.

Total cost of financial distress (i.e., inability to meet financial obligations)includes the following:

--Employee layoffs--Firm under-investment

--Eroding community tax base and blight

--Customer dissatisfaction with declining product quality and increasingdelivery times

--Delayed payments to suppliers (including lenders)

--Higher borrowing costs

--Declining shareholder value

Bankruptcy plays key role in minimizing these costs by providing a processfor resolving these issues in a timely manner.


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BUSINESS FAILUREBusiness failure refers to a company ceasing operations following its inability to make

a profit or to bring in enough revenue to cover its expenses. A profitable business can fail ifit does not generate adequate cash flowto meet expenses.

Businesses can fail as a result of:

wars,

recessions,

high taxation,

high interest rates,

excessive regulations,

poormanagement decisions,

insufficient marketing,

inability to compete with other similar businesses, or a lack of interest from the public inthe business's offerings.

TECHNICAL INSOLVENCY- IT ARISES WHEN A FIRM IS unable to pay its liabilities

& LEGAL INSOLVENCY: it occurs when a firms liabilities exceed the fair market valve of

its assets Designed to

--Protect failing firms from lawsuits by its creditors until decision made to shut-down or tocontinue operating the firm--Provide creditors with an efficient means of recovering what they are owed
http://en.wikipedia.org/wiki/Profit_(accounting)http://en.wikipedia.org/wiki/Revenuehttp://en.wikipedia.org/wiki/Cash_flowhttp://en.wikipedia.org/wiki/Warhttp://en.wikipedia.org/wiki/Recessionhttp://en.wikipedia.org/wiki/Taxhttp://en.wikipedia.org/wiki/Interest_ratehttp://en.wikipedia.org/wiki/Regulationhttp://en.wikipedia.org/wiki/Managementhttp://en.wikipedia.org/wiki/Marketinghttp://en.wikipedia.org/wiki/Marketinghttp://en.wikipedia.org/wiki/Managementhttp://en.wikipedia.org/wiki/Regulationhttp://en.wikipedia.org/wiki/Interest_ratehttp://en.wikipedia.org/wiki/Taxhttp://en.wikipedia.org/wiki/Recessionhttp://en.wikipedia.org/wiki/Warhttp://en.wikipedia.org/wiki/Cash_flowhttp://en.wikipedia.org/wiki/Revenuehttp://en.wikipedia.org/wiki/Profit_(accounting)


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Example of business failures

Some companies which had undergone buisiness failure in 2012

SeaFrance

Comet Group

Malv Hungarian Airlines Portsmouth F.C.

Rangers F.C.

Daffy's

JJB Sports PLC Hostess Brands

Fashion Bug
http://en.wikipedia.org/wiki/SeaFrancehttp://en.wikipedia.org/wiki/Comet_Grouphttp://en.wikipedia.org/wiki/Mal%C3%A9v_Hungarian_Airlineshttp://en.wikipedia.org/wiki/Portsmouth_F.C.http://en.wikipedia.org/wiki/Rangers_F.C.http://en.wikipedia.org/wiki/JJB_Sportshttp://en.wikipedia.org/wiki/Hostess_Brandshttp://en.wikipedia.org/wiki/Fashion_Bughttp://en.wikipedia.org/wiki/Fashion_Bughttp://en.wikipedia.org/wiki/Hostess_Brandshttp://en.wikipedia.org/wiki/JJB_Sportshttp://en.wikipedia.org/wiki/Rangers_F.C.http://en.wikipedia.org/wiki/Portsmouth_F.C.http://en.wikipedia.org/wiki/Mal%C3%A9v_Hungarian_Airlineshttp://en.wikipedia.org/wiki/Mal%C3%A9v_Hungarian_Airlineshttp://en.wikipedia.org/wiki/Mal%C3%A9v_Hungarian_Airlineshttp://en.wikipedia.org/wiki/Comet_Grouphttp://en.wikipedia.org/wiki/SeaFrance


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Voluntary Reorganization Outside ofBankruptcy Court

Generally offers best chance for owners to recover a portion of theirinvestment

Usually initiated by debtor firm by requesting relief from creditors

Such relief often consists of the following:

An extension: Creditors agree to lengthen period during whichdebtor firm can repay its debt. May also include a temporary

suspension of both interest and principal repayments

A composition: Creditors agree to settle for less than the full

amount they are owed

Debt for equity swap: Creditors surrender a portion of their claims

in exchange for an ownership position in the firm

O


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Voluntary Liquidation Outsideof Bankruptcy Court

If creditors concludeinsolvent firms situationcannot be reorganized,liquidation may be onlycourse of action

If insolvent firm is willing toaccept liquidation and allcreditors agree, legalproceedings not necessary

Creditors normally preferliquidations to avoid lengthyand costly litigation

R i ti d Li id ti


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Reorganization and Liquidationin Bankruptcy

In absence of out-of-court voluntary settlement, debtor

firm may seek protection from creditors by petitioning the

bankruptcy court or

be forced into bankruptcy by its creditors

When a debtor firm files the petition- voluntary

When creditors do the filing- involuntary

The 1978 law also broadened the conditions

Intent of making bankruptcy code less rigid: creditors andowners would reach agreement on plans to reorganizerather than liquidate insolvent firms, offerings.


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Procedures for Reorganizingin Bankruptcy

Filing with theBankruptcyCourt

Appointment ofDebtor inPossession orCourt Trustee

Develop andPresentReorganizationPlan

Acceptance

of

ReorganizationPlan by AllParties

Payment ofCourtApprovedExpenses


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Bankruptcy Abuse Prevention and ConsumerProtection Act of 2005 (BAPCPA)

Pre-BAPCPA:

Debtor in possession (DIP) had exclusive right for first 120 days to file areorganization plan before creditors could submit their own plan

Court could at its discretion provide extensions beyond 120 days

Leases could be extended indefinitely as long as payments made

Post-BAPCPA:

Caps DIP exclusivity period at 18 months with an additional 2 months towin creditors acceptance of reorganization plan, effectively giving DIP a

maximum of 20 months before creditors can submit their plan

Good cause lease extensions limited to 90 days

Payments to management employees cannot be more than 10 timesamount paid to non-management employees


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Pre-Packaged Bankruptcies

Debtor negotiates reorganization plan with major creditors well in

advance of filing for Chapter 11 Actual votes for a reorganization plan may already have taken place

prior to the filing

Subsequent Chapter 11 reorganization averages a few months ascourt only has to approve the plan

Minority creditors may be required to accept the plan by the court Debtor may lose NOLs if out of court settlement reached in which

creditors exchange their debt for equity and original shareholdersown less than 50 percent of firm. In bankruptcy, debtor may claimNOLs.

So-called pre-negotiated bankruptcies differ in that actual votes oragreements to vote have not yet been reached with the majority ofcreditors, although agreement has been reached with those creditorsdeemed critical to the process.


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Buying Assets from a Firm in Chapter 11

Provides opportunity to acquire valuable assets free and

clear of liabilities. Many Chapter 11 proceedings undertaken to facilitate the

sale of a debtors assets or ongoing business.

3 ways to buy assets from a firm in bankruptcy

As part of a court approved plan of reorganization;

From a post-confirmation liquidating trust;1 or

Under Section 363 of the U.S. Bankruptcy Code

So-called 363 sales have become increasingly popularways of selling assets when time is critical

1Once approval of the Chapter 11 plan of reorganization has been confirmed by the court, such trusts are established todispose of any assets not included in the plan.


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Section 363 Bankruptcy

Section of the U.S. Bankruptcy Code allowing a firm to enter a court-

supervised sale of assets (usually at auction) as the best means to protectvalue. Unlike typical bankruptcies, firms may emerge in 30-60 days.

Initial prospective buyer sets the initial purchase price and terms andnegotiates a break-up or topping fee to be paid if it is not the successfulbidder. Often referred to as a stalking horse, initial bidder may conceal the

actual buyer.

Credit bids occur when secured creditors propose to buy the assets. Such

bidders can bid up to the amount of the debt owed before offering any cash.

Opponents of sale have 10-20 days to file written objections; although theperiod may be shortened to a few days by the bankruptcy judge.

Requirements: Bankruptcy judge must decide if

Negotiations concerning sale must be conducted at an arms length

Sale in best interests of all stakeholders

Purchaser acting in good faith

Bankruptcy judge decides how sale proceeds distributed among securedcreditors


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Examples of 363 Sales from Chapter 11 General Motors sale of selected assets in 2009:

GM split into two companies, one containing the good assets and the otherconsisting of the remaining assets. The new GM consists of 4 brands:

Chevrolet, GMC, Buick, and Cadillac. Ownership distribution in the new company is as follows: U.S. government

(60%)1, UAW (17.5%)2, Ontario and Canadian governments (12.5%)3, andbondholders (10%).4

Chryslers sale of most of its assets in 2009: Chrysler LLC sold to a new company managed by Fiat that will operate as

Chrysler Group LLC, consisting of the Chrysler, Jeep, Dodge and Moparbrands.

Ownership distribution of the new company is as follows: UAW's VEBA (55%),Fiat (20% growing to 35% once certain milestones achieved); the USGovernment (8%), and the Canadian government (2%).

Absolute priority rule5 may have been violated in that the UAW received for itspension obligations (an unsecured claim) a much higher ownership stake than

the value of the cash received by secured creditors (i.e., $.29 on the dollar).

1U.S. government agreed to forgive all but $9 billion of its $49.5 billion in loans to GM2United Auto Workers (UAW) agreed to forgive $20 billion GM had pledged to start the Voluntary Employee Beneficiary Association (VEBA) and

received $2.5 billion in cash and $6.5 billion in preferred stock paying $585 million in annual dividends3Ontario and Canadian governments agreed to forgive all but $1.7 billon of their $9.5 billion in loans to GM.4Bondholders agreed to forgive $27.2 billion in GM debt.5Absolute priority rule in the federal bankruptcy code states that no unsecured creditor can receive an interest in a reorganized firm before secured

creditors are paid in full or are paid a fair distribution.

.


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Liquidation in Bankruptcy

If the bankruptcy court determines reorganization not feasible, failing firmmay be forced to liquidate

Priority in which claims are paid (per Chapter 7 of U.S. Bankruptcy Code) Past due property taxes

Secured creditors up to proceeds of the sale of pledged assets

Legal fees

Expenses incurred after involuntary case begun but before trustee

appointed Wages not to exceed $2000 per worker

Unpaid employee benefit plan contributions up to $2000

Unsecured customer deposits of $900 or less

Income taxes owed federal, state, or local governments

Under-funded pension liabilities up to 30% of the firms book value Unsecured creditors

Preferred shareholders, up to par value of their stock

Common shareholders, paid out of remaining funds

Ch i A i t R t t i


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Choosing Appropriate RestructuringStrategy: Failing Firms

Choice heavily influenced by the following: Going concern value of debtor firm Sale value of debtor firm Liquidation value of debtor firm

Implications: If sale value > going concern or liquidation value, sell

firm If going concern value > sale or liquidation value, reach

out of court settlement with creditors or seekbankruptcy protection under Chapter 11

If liquidation value > sale or going concern value, reachout of court settlement with creditors and liquidate orliquidate under Chapter 7


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Discussion Questions

1. Why should corporate bankruptcy beconsidered a potential business strategy?

2. Under what circumstances is thebankruptcy court likely to decide that a

failing firm should be liquidated?3. What are the primary options available to a

failing firm? What criteria should be usedto select the best option? Be specific.

4. When is a prepackaged bankruptcy anappropriate option?


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Things to Remember

Bankruptcy process supports smooth functioning ofcapital markets by protecting creditor and debtor rights

Generally offers best chance for owners to recover aportion of their investment

Bankruptcy allows creditor firm to stop all principal andinterest payments and prevents secured creditors fromtaking possession of their collateral

A failing firms options are to merge with another firm,

reach an out-of-court voluntary settlement with creditors,or file for Chapter 11 bankruptcy protection


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Chapter_16_Bankruptcy_and_Liquidation M nd A.ppt

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