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
Course Layout: M&A & Other
Restructuring Activities
Part I: M&A
Environment
Part II: M&A
Process
Part III: M&A
Valuation &
Modeling
Part IV: Deal
Structuring &
Financing
Part V:
Alternative
Strategies
Motivations for
M&A
Business &
Acquisition
Plans
Public Company
Valuation
Payment &
Legal
Considerations
Business
Alliances
Regulatory
Considerations
Search through
Closing
Activities
Private
Company
Valuation
Accounting &
Tax
Considerations
Divestitures,
Spin-Offs &
Carve-Outs
Takeover Tactics
and Defenses
M&A Integration
Financial
Modeling
Techniques
Financing
Strategies
Bankruptcy &
Liquidation
Cross-Border
Transactions
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
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.
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 firm’s 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
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 firm’s 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
• 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
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 debtor’s 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 courtsupervised 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
Chrysler’s 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
.
General Motors’ (GM) Bankruptcy
Pre-Bankruptcy
U.S. &
Canadian
Operations1
Bankruptcy
Attractive
Assets
Consolidated
GM
“New GM:”
U.S. &
Canadian
Operations3
Consolidated
GM
All Other
International
Operations
1Only
Post-Bankruptcy
“Old GM:”
Unattractive
Assets2
All Other
International
Operations
the U.S. and Canadian operations were included in the GM bankruptcy filing.
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.
3”New 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”
2”Old
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 firm’s 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
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
Firm’s 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
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?
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 firm’s options are to merge with another firm,
reach an out-of-court voluntary settlement with creditors,
or file for Chapter 11 bankruptcy protection