Alternative Exit and Restructuring Strategies: Reorganization and Liquidation

What is important is not adding more years to life but more life to your years.
Doug Fields

Learning Objectives
Primary Learning Objective: To provide an

understanding of alternative strategies for failing businesses Secondary Learning Objectives: To provide an understanding of: Criteria for choosing strategy for failing firms
Process for filing for bankruptcy, voluntary and

involuntary settlements inside and outside of court, and voluntary and involuntary liquidation

Rule of Law and Corporate Asset Allocation

The smooth functioning of capital markets requires rapid and fair resolution

of disputes involving the legal rights of borrowers and lenders Studies show that borrowing costs are lower and access to credit easier in countries 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 increasing delivery times --Delayed payments to suppliers (including lenders) --Higher borrowing costs --Declining shareholder value Bankruptcy plays key role in minimizing these costs by providing a process for resolving these issues in a timely manner.

BUSINESS FAILURE
Business 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 if it does not generate adequate cash flow to 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 in the 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 to continue operating the firm --Provide creditors with an efficient means of recovering what they are owed

Example of business failures

Some companies which had under gone 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

Voluntary Reorganization Outside of Bankruptcy Court

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

investment
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 which

debtor 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

Voluntary Liquidation Outside of Bankruptcy Court

If creditors conclude

insolvent firms situation cannot be reorganized, liquidation may be only course of action If insolvent firm is willing to accept liquidation and all creditors agree, legal proceedings not necessary Creditors normally prefer liquidations to avoid lengthy and costly litigation

Reorganization and Liquidation in 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 and

owners would reach agreement on plans to reorganize rather than liquidate insolvent firms, offerings.

Procedures for Reorganizing in Bankruptcy

Filing with the Bankruptcy Court

Appointment of Debtor in Possession or Court Trustee

Develop and Present Reorganization Plan

Acceptance of Reorganization Plan by All Parties

Payment of Court Approved Expenses

Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA)

Pre-BAPCPA:
Debtor in possession (DIP) had exclusive right for first 120 days to file a

reorganization 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 to

win 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 times amount paid to non-management employees

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 as court 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 shareholders own less than 50 percent of firm. In bankruptcy, debtor may claim NOLs. So-called pre-negotiated bankruptcies differ in that actual votes or agreements to vote have not yet been reached with the majority of creditors, although agreement has been reached with those creditors deemed critical to the process.

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 popular

ways 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 to dispose of any assets not included in the plan.

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 protect value. Unlike typical bankruptcies, firms may emerge in 30-60 days.
Initial prospective buyer sets the initial purchase price and terms and

negotiates a break-up or topping fee to be paid if it is not the successful bidder. 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 the

period 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 secured

creditors

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 other

consisting 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, and bondholders (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 Mopar brands. Ownership distribution of the new company is as follows: UAW's VEBA (55%), Fiat (20% growing to 35% once certain milestones achieved); the US Government (8%), and the Canadian government (2%). Absolute priority rule5 may have been violated in that the UAW received for its pension 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 GM 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 dividends 3Ontario 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.
2United
.

Liquidation in Bankruptcy
If the bankruptcy court determines reorganization not feasible, failing firm

may 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

Choosing Appropriate Restructuring Strategy: 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 seek bankruptcy protection under Chapter 11 If liquidation value > sale or going concern value, reach out of court settlement with creditors and liquidate or liquidate under Chapter 7

Discussion Questions
1. 2.

3.

4.

Why should corporate bankruptcy be considered a potential business strategy? Under what circumstances is the bankruptcy court likely to decide that a failing firm should be liquidated? What are the primary options available to a failing firm? What criteria should be used to select the best option? Be specific. When is a prepackaged bankruptcy an appropriate option?

Things to Remember
Bankruptcy process supports smooth functioning of

capital markets by protecting creditor and debtor rights Generally offers best chance for owners to recover a portion of their investment Bankruptcy allows creditor firm to stop all principal and interest payments and prevents secured creditors from taking 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