Overview of Chapter 11 Bankruptcy Proceeding

1
(No Transcript)
2
Overview of Chapter 11 Bankruptcy Proceeding
Filing of Petition ----automatic stay
Operation of Business (Part VI) -- Managers
continue to operate firm (asDebtor in
Possession or DIP) -- Post-petition (Debtor
in Possession) financing -- Review of old
contracts
Recovery of assets and reranking of claims (Part
V) -- Recovery of assets through fraudulent
conveyance law, preferences etc. -- Re-ranking of
claims through equitable subordination etc.
Proposal, approval and confirmation of Chap. 11
plan of reorganization (Part IV)
3
Priority under Chapter 11

• Plan of reorganization must be confirmed by court
• Section 1129 - Requirements for confirming plan
• 2 methods under Section 1129
• a. Consensual - no valuation required
• b. Cram-down - valuation required

4

• Both consensual and cram-down plans require
  (after each claim/interest is put in a class
  with similar claims/interests, and there is a
  vote on the plan)
• that the following be satisfied
• 1129(a)(1)-(6) (9)-(10), (12)-(13) (see p.624)
• 1129(a)(7) best interests test
• W/r/t each impaired class of claims of interests
  (see Section 1124 next slide)
• (A) each holder of a claim or interest
• (i) has accepted the plan or
• (ii) will receive at least liquidation value
  entitled to
• under Sections 725 and 726 if debtor were
  liquidated
• under Chapter 7
• 1129(a)(11) feasibility requirement

5

• Section 1124 Impairment
• A class of claims or interests is impaired
  unless the plan
• (1) leaves unaltered the legal, equitable,
  and contractual
• rights of the claimholder or interest holder
• (2) notwithstanding any provision/law that
  entitles holder
• to receive accelerated payment after
  occurrence of a default
• (A) cures the default....
• (B) reinstates the maturity

6

• Consensual plan
• In addition, a consensual plan requires that the
  following be satisfied
• 1129(a)(8) w/r/t each class of claims or
  interests
• (A) such class has accepted the plan (see
  1126c,d) or
• (B) such class is not impaired under the plan
• 1126(c) a class of claims has accepted if
  creditors
• (1) holding at least 2/3 amount of claims
• (2) more than ½ of the claims
• 1126(d) a class of interests has accepted if
  equityholders
• holding at least 2/3 amount of interests

7
Cram-down plan

• In a cramdown plan, 1129(a)(8) need not be
  satisfied
• 1129(a)(8) w/r/t each class of claims or
  interests
• (A) such class has accepted the plan (see
  1126c,d) or
• (B) such class is not impaired under the plan
• Instead, must satisfy 1129(a)(1)-(7) (9)-(13)
  and
• 1129(b)(1) for classes that have not accepted
  and are impaired, the plan is
• fair and equitable (defined in 1129(b)(2),
  next slide) and
• does not unfairly discriminate

8

• Fair and equitable defined in 1129 (b) (2)
• (a) Secured creditors
• (i) (I) retain liens, to extent of allowed
  amount of claim
• (II) get deferred cash payments
• --- totalling allowed amount of the claim
• --- with a present value gt value of
  creditors interest in the collateral
• (ii) retain liens in proceeds, such that (i)
  or (iii) is satisfied or
• (iii) get indubitable equivalent of such
  claims
• (b) Unsecured creditors
• (i) get PV of allowed amount of their claim
  or
• (ii) junior claims and interests get 0
• (C) Equity holders get
• (i) fixed liquidation preference, redemption
  right or
• (ii) junior equity gets 0

9
XYZ Example background

• XYZ Corp
• Liabilities and Equity
• V? 1M in secured debt (due in 10 yrs)
• 1.2M in debentures (due in few months)
• Common stock
• XYZ defaults on debentures
• Debentureholders accelerate, bring suit
• Secured creditor accelerates because of
  cross-default clause

10
XYZ Reorganization Plan

• Secured creditor has maturity reinstated,
  interest will be paid will be paid missed
  interest payment, with compensation for delay
  
• Unsecured creditors will get 6 annual payments of
  300K each
• Common stockholders retain stock

• XYZ Corp
• Liabilities and Equity
• V2M 1M in secured debt (due in 10 yrs)
• 1.2M in debentures (due in few months)
• Common stock

11
Questions on XYZ (p.30-32)

• B. Can secured creditor block plan?
• C. One of the 100 debentureholders holding 25 of
  debentures objects. Can she block the plan?
• E. If the secured creditor wants to block plan,
  can it invoke 1129(a)(7)?
• D. All debentureholders object. End of plan?
• Why is the PV of the promised payment important?
  If a 10 interest rate is used in calculating the
  value of the business, should that rate be used
  in discounting the 6 yearly payments?

12
Valuing Firms and Securities1

• Value of Firm
• Value of Firm PV of cash flow (adjusted for
  risk)
• Remember RiskyWar RR, etc.
• Securities are Claims on Firm Cash Flow
• Securities divide cash flow based on priority
• Debt paid first, equity paid second
• Debt less risky (lower discount rate)
• Different types of debt (secured, less risky
  lower discount rate unsecured, less riskyhigher
  discount rate)
• Different types of equity (preferred, common)
• Value of Securities Value of Firm
• Discount rate for Firm not Discount rate for
  Each Security

13
Valuing Firms and Securities2

• Example
• RiskyPeaceRR Peace Tension War
  2M 1M 0 (Per
  year, forever once state of world is known)
• 10 non risk adjusted discount rate
• 12 risk
  adjusted discount rate
• Expected Non-risk adjusted PV of Firm 10M
• Risk adjusted PV of Firm is 8.3M

14
Valuing Firms and Securities3

• Let us divide RiskyPeaceRRs cash flow by
  creating 2 securities
• RiskyPeaceRR debt
• RiskyPeaceRR equity
• Peace Tension War
• RiskyPeaceRR debt 1M 1M 0
• Non-adjusted PV
• 6.66M
• RiskyPeaceRR equity 1M 0 0
• Non-adjusted PV
• 3.33M

15
Valuing Firms and Securities4

• What do we know about how RR debt and equity
  discounted for risk?
• (1) discount rate for Debt (Rd) lt discount rate
  for Equity (Re)
• (2) Since risk adjusted value of RR is 8.3M,
  risk adjusted values of the Debt and Equity
  together must add to 8.3M (why?)
• (or) 666,000/(1 Rd) 330,000/(1 Re)
  1M/(1 12)

16
Trade Creditors and Unfair Discrimination
questions on p. 30-32

• (new) XYZ Corp has 3 creditors, each owed 1M
• 1m of bank debt that is superior to subordinated
  debentures
• 1m of subordinated debentures that are
  subordinated to bank debt
• 1m of trade debt (money owed to suppliers)

17

• Questions on XYZ Corp. pp 33-34
• A. Is the trade debt senior to the subordinated
  debentures? Does it share equally and ratably
  with the subordinated debentures? With the bank
  debt?
• C. Suppose XYZ is worth 990,000. The trustee
  proposes the following plan
• Bank 600K
• Trade 330K
• Subs 60K
• Seniors and subs consent. Trade objects.
• (1) Can plan be confirmed under 1129(a)(8)(A)?
• (2) Can plan be confirmed as fair and equitable
  under 1129(b)(2)(B)(i)? (B)(ii)?
• (3) Does the plan discriminate unfairly against
  the trade creditors?

18

• XYZ Co. questions on p.33-34
• D Same facts. The trustee proposes the
  following plan
• Bank 675k
• Trade 315k
• Trade objects. Seniors and subs consent.
• (1) Can plan be confirmed under 1129(a)(8)(A)?
• (2) Can plan be confirmed as fair and equitable
  under 1129(b)(2)(B)(i)? (B)(ii)?
• (3) Does the plan discriminate unfairly against
  the trade creditors?
• E. XYZ is worth 1.8 million
• Plan Bank 1 million
• Trade 750k
• Subs 50k
• Is anybody the victim of unfair discrimination?

19
Section 502

• Section 502
• (A) claim is allowed unless objected to
• (B) if objection, then court determines validity
  of claim, except that the claim will not be valid
  if
• (2) claim is for unmatured interest

20
Section 506 Secured Claims

• (A) (bifurcation into secured claims and
  unsecured claims)
• An allowed claim of a creditor secured by a
  lien on property
• .... is a secured claim to the extent of the
  value of the property, and is an unsecured
  claim to the extent the value of the property
  is less than the amount of the allowed claim.
  Such value will be determined in light of the
  purpose of the valuation and of the proposed use
  of the property. Rash case value replacement
  value
• (B) (entitlements of secured claims holders)
• holders of secured claims get interest,
  reasonable fees, costs, or charges under the loan
  agreement to the extent that the value of the
  collateral exceeds the amount of the secured claim

21
Dieglom Balance Sheet (year ending Dec. 31,
1999) Assets Liabilities and Sh.
Equity Current Assets Current
Liabilities 10M cash Bank debt due w/in 1
year 10M 1M A/R Trade accounts
payable 10M 1M inventory 12M
20M Plant and Equipment Long-term
debt 100M 7 senior deb (due 2001) 20M
Deprec. (52M) 3.5 mortgage (due 2009)
30M 14 subordin (due 2001)
30M 48M 70M Total
liabilities 90M Shareholder
equity (30M) total assets
60M total liab equity 60M
22
Dieglom - end of 1999
Results of Operations for 1999

• Plant has a scrap value of 5 M
• Replacement value of 10 M

23
Dieglom(questions on p. 39-42)

• 1. Is Dieglom worth 60m for purposes of
  reorganization? What factors might make it worth
  less? More?
• 2. Assume that the value is 50m, the result of
  discounting future cash flows to present value.
  The scrap value of the plant is 5m replacement
  value is 10m. How would you distribute value
  according to 1129(b) (assuming no consent to
  deviation, no nonimpairment)? Assume that the
  subs are subordinate to the seniors and only the
  seniors.

24
Dieglom(questions on p.39-42)

• 4(i) Will stockholders accept the plan?
• (ii-iii) If the firm declines in value, who
  loses? If it gains, who profits?
• (iv-v) If the value is 50m but the judge
  overvalues the firm, who profits? If the value
  is 50m but the judge undervalues the firm, who
  profits?

25
Dieglom(reinstatement questions based on p.42-45)

• Suppose that the appropriate discount rate for
  the mortgage bond is 10. Its stated interest
  rate is 3.5.
• 1. What is the PV of the bond if its terms are
  not altered in Chapter 11, as under 1124(2)? How
  do you figure it out?

26
Dieglom(reinstatement questions based on p.42-45)

• 2. What does the current plan (assume that the
  firm is properly valued at 50m) propose to give
  bondholders in PV terms?
• 3. Does 1124(2) or 1129(b) make the bondholders
  better off?
• 4. Who will propose reinstatement, and why?

27
Section 1129(a) (7)The Best Interests Test -
Questions based on p.45-47

• 1. What does 1129(a)(7) promise members of
  impaired classes in the proceeding?
• 2. Return to the Dieglom balance sheet. What
  would a liquidation sale yield? Who would get
  what?

28
Section 1129(a) (7)The Best Interests Test
-questions

• 3. Can anybody challenge under 1129(a)(7) the
  plan where mortgage bondholders are crammed down?
  
• 4. Can anybody challenge the plan under 1129(b)
  where the mortgage bonds are reinstated? See
  1129(b)(2)(A). Suppose bondholders can show that
  the liquidation value of plant is 14m.Would
  1129(a)(7) help?

29
Section 1129(a) (7)The Best Interests Test -
Questions

• 5. Suppose that the mortgage bondholders make a
  deal with the other creditors.
• They get a total (for both secured and unsecured
  claims) of 13m in cash/securities to avoid
  reinstatement, which they also think has a value
  of 12m.
• 2/3 of bonds, more than ½ bondholders, approve.
• 5a) Can a dissenting bondholder block the plan
  under
• 1129(a)(8)(A) or (B)?
• 5b) Under 1129(b)?
• 5c) Under 1129(a)(7)? What will this depend on?