第三十一章财务困境

ExecutiveSummaryThischapterdiscussesfinancialdistress,privateworkouts,andbankruptcy.Afirmthatdefaultsonarequiredpaymentmaybeforcedtoliquidateitsassets.Moreoften,adefaultingfirmwillreorganize.Financialrestructuringinvolvesreplacingoldfinancialclaimswithnewonesandtakesplacewithprivateworkoutsorlegalbankruptcy.ChapterOutline31.1WhatisFinancialDistress?31.2WhatHappensinFinancialDistress?31.3BankruptcyLiquidationandReorganization31.4PrivateWorkoutorBankruptcy:WhichisBest?31.5PrepackagedBankruptcy31.6SummaryandConclusions31.1WhatisFinancialDistress?Asituationwhereafirm’soperatingcashflowsarenotsufficienttosatisfycurrentobligationsandthefirmisforcedtotakecorrectiveaction.Financialdistressmayleadafirmtodefaultonacontract,anditmayinvolvefinancialrestructuringbetweenthefirm,itscreditors,anditsequityinvestors.InsolvencyStock-baseinsolvency;thevalueofthefirm’sassetsislessthanthevalueofthedebt.AssetsDebtEquitySolventfirmDebtAssetsEquityInsolventfirmDebtNotethenegativeequityInsolvencyFlow-baseinsolvencyoccurswhenthefirmscashflowsareinsufficienttocovercontractuallyrequiredpayments.ContractualobligationsInsolvency$FirmcashflowCashflowshortfalltimeTheLargestU.S.BankruptciesFirmLiabilities($m)BankruptcyDateTexaco$21,6031987ExecutiveLifeInsurance14,5771991MutualBenefitLife13,5001991Campeau9,9471990FirstCapitalHoldings9,2911991BaldwinUnited9,0001983ContinentalAirlines(II)6,2001990LomasFinancial6,1271989Macy’s5,300199231.2WhatHappensinFinancialDistress?Financialdistressdoesnotusuallyresultinthefirm’sdeath.FirmsdealwithdistressbySellingmajorassets.Mergingwithanotherfirm.Reducingcapitalspendingandresearchanddevelopment.Issuingnewsecurities.Negotiatingwithbanksandothercreditors.Exchangingdebtforequity.Filingforbankruptcy.ReorganizeandemergeMergewith

anotherfirmLiquidation83%10%7%WhatHappensinFinancialDistressFinancial

distressFinancial

restructuringNofinancial

restructuring49%51%Legalbankruptcy

Chapter11Private

workout47%53%Source:KarenH.Wruck,“FinancialDistress:ReorganizationandOrganizationalEfficiency,”JournalofFinancialEconomics

27(1990),Figure2.SeealsoStuartC.Gilson;KoseJohn,andLarryN.P.Lang,“TroubledDebtRestructurings:AnEmpirical

StudyofPrivateReorganizationinFirmsinDefaults,”JournalofFinancialEconomics27(1990);andLawrenceA.Weiss,

“BankruptcyResolution:DirectCostsandViolationofPriorityClaims,”JournalofFinancialEconomics27(1990).ResponsestoFinancialDistressThinkofthetwosidesofthebalancesheet.AssetRestructuring:Sellingmajorassets.Mergingwithanotherfirm.ReducingcapitalspendingandR&Dspending.FinancialRestructuring:Issuingnewsecurities.Negotiatingwithbanksandothercreditors.Exchangingdebtforequity.Filingforbankruptcy.31.3BankruptcyLiquidationandReorganizationFirmsthatcannotmeettheirobligationshavetwochoices:liquidationorreorganization.Liquidation(Chapter7)meansterminationofthefirmasagoingconcern.Itinvolvessellingtheassetsofthefirmforsalvagevalue.Theproceeds,netoftransactionscosts,aredistributedtocreditorsinorderofpriority.Reorganization(Chapter11)istheoptionofkeepingthefirmagoingconcern.Reorganizationsometimesinvolvesissuingnewsecuritiestoreplaceoldones.BankruptcyLiquidationStraightliquidationunderChapter7usuallyinvolves:Apetitionisfiledinafederalcourt.Thedebtorfirmcouldfileavoluntarypetitionorthecreditorscouldfileaninvoluntarypetitionagainstthefirm.Atrustee-in-bankruptcyiselectedbythecreditorstotakeovertheassetsofthedebtorfirm.Thetrusteewillattempttoliquidatethefirm’sassets.Aftertheassetsaresold,afterpaymentofthecostsofadministration,moneyisdistributedtothecreditors.Ifanymoneyisleftover,theshareholdersgetit.BankruptcyLiquidation:PriorityofClaimsThedistributionoftheproceedsofliquidationoccursaccordingtothefollowingpriority:Administrationexpensesassociatedwithliquidation.Unsecuredclaimsarisingafterthefilingofaninvoluntarybankruptcypetition.Wagesearnedwithin90daysbeforethefilingdate,nottoexceed$2,000perclaimant.Contributionstoemployeebenefitplansarisingwith180daysbeforethefilingdate.Consumerclaims,notexceeding$900.Taxclaims.Securedandunsecuredcreditors’claims.Preferredstockholders’claims.Commonstockholders’claims.APRExampleSupposetheB.O.DrugCo.decidestoliquidateunderChapter7.Assumethattheliquidationvalueis$2.7million.Bondsworth$1.5millionaresecuredbyamortgageonthecorporateheadquartersbuilding,whichissoldfor$1million.$200,000isusedtocoveradministrativecostsandotherclaims—afterpayingthis,$2.5millionisavailabletopaycreditors.Theonlyproblemisthattheunpaiddebtis$4million.APRExampleUnderAPR,allcreditorsarepaidbeforeshareholders,andthemortgagebondholdersarefirstinline.Thetrusteeproposesthefollowingdistribution:TypeofClaimPriorClaimCashReceivedUnderLiquidationMortgageBonds$1,500,000$1,500,000SubordinatedDebentures$2,500,000$1,000,000CommonStock$10,000,000$0Total$14,000,000$2,500,000BankruptcyReorganization:Chapter11Atypicalsequence:Avoluntarypetitionoraninvoluntarypetitionisfiled.Afederaljudgeeitherapprovesordeniesthepetition.Inmostcasesthedebtorcontinuestorunthebusiness.Thefirmisgiven120daystosubmitareorganizationplan.Creditorsandshareholdersaredividedintoclasses.Requiresonlyapprovalby1/2ofcreditorsowning2/3ofoutstandingdebtAfteracceptancebythecreditors,theplanisconfirmedbythecourt.Paymentsincash,property,andsecuritiesaremadetocreditorsandshareholders.ReorganizationExampleSupposetheB.O.DrugCo.decidestoreorganizeunderChapter11.Assumethatthe“goingconcern”valueis$3millionanditsbalancesheetisshown.Assets$3,000,000Liabilities:

Mortgagebonds$1,500,000

Subordinated debentures$2,500,000

Equity-$1,000,000ReorganizationExampleThefirmhasproposedthefollowingreorganizationplan:OldSecurityOldClaimNewClaimUnderReorganizationMortgagebonds$1,500,000 $1,500,000Subordinateddebentures$2,500,000 $1,000,000ReorganizationExampleAndadistributionofnewsecuritiesunderanewclaimwiththereorganizationplan:OldSecurityNewClaimUnderReorganizationMortgagebonds$1,000,000in9%subordinateddebentures$500,000in11%subordinateddebenturesSubordinateddebentures$1,000,000in8%preferredstock$500,000incommonstockAbsolutePriorityRuleinPracticeTheAPRstatesthatseniorclaimsarefullysatisfiedbeforejuniorclaimsreceiveanythingDeviationsfromAPR

EquityholdersExpectation:NopayoutReality:Payoutin81%ofcasesUnsecuredcreditorsExpectation:FullpayoutaftersecuredcreditorsReality:Violationin78%ofcasesSecuredcreditorsExpectation:FullpayoutReality:Fullpayoutin92%ofcasesReasonsforAPRViolationsCreditorswanttoavoidtheexpenseoflitigation.Debtorsaregivena120-daywindowofopportunitytocausedelayandharmvalue.Managersoftenownequityanddemandtobecompensated.Theyareinchargeforatleastthenext120days.Bankruptcyjudgeslikeconsensualplans(theydon’tclogthecourtcalendarwithappeals)andpressurepartiestocompromise.Vultures“Vultures”aremoneymanagersthatspecializeinthesecuritiesofdistressedanddefaultedcompanies.Therearebetween50and60institutionvulturespecialists,activelymanagingover$25billionin1998.Distresseddebtinvestorshavetargetannualratesofreturnof20–25percent.Althoughsomeyearsarebetterthanothers,theoverallannualrateofreturnfrom1978-1997hasbeenabout12percent—similartojunkbondsbutlessthanthestockmarket.31.4PrivateWorkoutorBankruptcy:WhichisBest?Bothformalbankruptcyandprivateworkoutsinvolveexchangingnewfinancialclaimsforoldfinancialclaims.Usuallyseniordebtisreplacedwithjuniordebtanddebtisreplacedwithequity.Whentheywork,privateworkoutsarebetterthanaformalbankruptcy.Complexcapitalstructuresandlackofinformationmakeprivateworkoutslesslikely.31.4PrivateWorkoutorBankruptcy:WhichisBest?AdvantagesofBankruptcyNewcreditisavailable-"debtorinpossession"or"DIP"debt.Discontinuedaccrualofinterestonpre-bankruptcyunsecureddebt.Anautomaticstayprovision.Taxadvantages.Requiresonlyapprovalby1/2ofcreditorsowning2/3ofoutstandingdebt.DisadvantagesofBankruptcyAlongandexpensiveprocess.Judgesarerequiredtoapprovemajorbusinessdecisions.Distractiontomana