Alternative Exit and Restructuring Strategies: Reorganization and Liquidation

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Alternative Exit and Restructuring
StrategiesReorganization 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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Cross-Border Transactions
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Learning Objectives

• Primary Learning Objective To provide students
  with an understanding of alternative strategies
  for failing businesses
• Secondary Learning Objectives To provide
  students with 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

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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.

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Bankruptcy

• Applicable to failing firms
• A firm is technically insolvent if it is unable
  to pay its liabilities as they come due
• A firm is legally insolvent if a firms
  liabilities exceed the fair market value 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
• A firm not considered bankrupt until it or its
  creditors petition the federal bankruptcy court

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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

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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

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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
• Bankruptcy allows creditor firm to stop all
  principal and interest payments and prevents
  secured creditors from taking possession of their
  collateral
• U.S. Bankruptcy Code
• Chapter 11 deals with reorganization and provides
  for the debtor to remain in possession, unless
  court rules otherwise
• Chapter 7 deals with liquidation and defines
  priority in which creditors will be paid
• Chapter 15 addresses insolvency issues involving
  assets, lenders, and other parties in various
  countries

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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
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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

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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 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.

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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 trust1 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.

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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 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

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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 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
• 2United 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.
• .

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General Motors (GM) Bankruptcy

• Pre-Bankruptcy
  Bankruptcy Post-Bankruptcy

U.S. Canadian Operations1
Attractive Assets
New GM U.S. Canadian Operations3
Consolidated GM
Consolidated GM
All Other International Operations
Old GM Unattractive Assets2
All Other International Operations
1Only the U.S. and Canadian operations were
included in the GM bankruptcy filing. 2Old GM
contains the unattractive assets of the U.S. and
Canadian operations in a trust set up under the
protection of the bankruptcy court. These assets
are to be liquidated by a court-appointed
trustee, with the proceeds going to
creditors. 3New GM represents a new corporation
containing only the attractive assets held by the
U.S. and Canadian operations and primarily owned
by the U.S. and Canadian governments, a UAW
healthcare trust, and the creditors of Old GM
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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

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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 gt going concern or liquidation
  value, sell firm
• If going concern value gt sale or liquidation
  value, reach out of court settlement with
  creditors or seek bankruptcy protection under
  Chapter 11
• If liquidation value gt sale or going concern
  value, reach out of court settlement with
  creditors and liquidate or liquidate under
  Chapter 7

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Dodd-Frank Act of 2010 Orderly Liquidation
Authority (OLA)

• OLA Enables FDIC to seize and liquidate
  systemically significant firms
• Objectives To Ensure
• A speedy liquidation of systemically significant
  firms
• Losses are borne primarily by shareholders and
  creditors
• Losses to taxpayers are minimized and
• Firms management removed and may be subject to
  clawback.
• When used Request by Treasury secretary that
  FDIC be appointed receiver of a failing firm,
  subject to 2/3rds approval of boards of Fed and
  FDIC
• How used With FDIC as receiver,
• Debtor-in-possession (i.e., current management
  and board) is removed
• All contracts (including derivatives) may be
  terminated
• Claims must be resolved within 180 days
• Firm may be merged with or assets/liabilities
  transferred to another firm without shareholder
  or creditor approval
• Cost of liquidation funded by FDIC

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Discussion Questions

1. Why should corporate bankruptcy be considered a
   potential business strategy?
2. Under what circumstances is the bankruptcy 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 used to
   select the best option? Be specific.
4. When is a prepackaged bankruptcy an appropriate
   option?

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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