Chapter Twelve
Restructuring
in Bankruptcy
Patrick A. Gaughan
Mergers, Acquisitions, and Corporate Restructurings
John Wiley & Sons, 6th Edition, 2015
All Rights Reserved - Dr. Patrick Gaughan
Chapter 11 Bankruptcy
• Two main forms of Bankruptcy in the U.S.:
• Chapter 7 – liquidation
• Chapter 11 – reorganization
• The chapters refer to the sections of the
U.S. bankruptcy law
All Rights Reserved - Dr. Patrick Gaughan
Total Bankruptcies Filed, 1980–2014
2,500
Thousands
2,000
1,500
1,000
500
0
80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14
Shaded regions indicate recession.
Sources: BankruptcyData.com, New Generation Research & Administrative Office of the United States Courts
All Rights Reserved - Dr. Patrick Gaughan
Chapter 11 Bankruptcies Filed, 1980-2014
30,000
25,000
20,000
15,000
10,000
5,000
0
80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14
Sources: BankruptcyData.com, New Generation Research, Administrative Office of the U.S. Courts
All Rights Reserved - Dr. Patrick Gaughan
Assets of Public Companies Filing for Bankruptcy, 1980-2014
1,400
1,200
Assets ($Billions)
1,000
800
600
400
200
0
80
82
84
86
88
90
92
94
96
98
00
02
Source: BankruptcyData.com, A Division of New Generation Research, Inc.
All Rights Reserved - Dr. Patrick Gaughan
04
06
08
10
12
14
Bankruptcies and Economic Declines
• Slower economies increase the number of
bankruptcies
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Failure by Age of Business
Number of Years in Business
One year or less
Two years
Three years
Total three years or less
Four years
Five years
Total five years or less
Total six to ten years
Total over ten years
Percentage (%)
10.7
10.1
8.7
29.5
7.8
7.0
44.3
23.9
31.8
100.0
Source: The Dun & Bradstreet Corporation, Business Failure Record, 1997.
All Rights Reserved - Dr. Patrick Gaughan
Largest U.S. Public Bankruptcies
Company
Lehman Brothers Holdings Inc.
Washington Mutual, Inc.
WorldCom, Inc.
General Motors Corporation
CIT Group Inc.
Enron Corp.
Conseco, Inc.
Energy Future Holdings Corp.
MF Global Holdings Ltd.
Chrysler LLC
Thornburg Mortgage, Inc.
Pacific Gas & Electric Company
Texaco, Inc.
Financial Corp. of America
Refco Inc.
IndyMac Bancorp, Inc.
Global Crossing, Ltd.
Bank of New England Corp.
General Growth Properties, Inc.
Lyondell Chemical Company
Assets in $ mil.
$691,063
327,913
103,914
91,047
80,448
65,503
61,392
40,970
40,541
39,300
36,521
36,152
34,940
33,864
33,333
32,734
30,185
29,773
29,557
27,392
Source: BankruptcyData.com, A Division of New Generation Research, Inc.
All Rights Reserved - Dr. Patrick Gaughan
Date Filed
9/15/2008
9/26/2008
7/21/2002
6/1/2009
11/1/2009
12/2/2001
12/17/2002
4/29/2014
10/31/2011
4/30/2009
5/1/2009
4/6/2001
4/12/1987
9/9/1988
10/17/2005
7/31/2008
1/28/2002
1/7/1991
4/16/2009
1/6/2009
Organization of the US Bankruptcy Law
Chapter
1
3
5
7
9
11
13
15
Subject
General provisions and definitions
Case administration
Creditors, debtors, and estates
Liquidation
Bankruptcies of municipalities
Reorganization
Bankruptcies of individuals
U.S. trustees system
All Rights Reserved - Dr. Patrick Gaughan
Sections of U.S. Bankruptcy Law Most
Relevant to Corporations
• Chapter 7: Liquidation
• For the more distressed corporations
• Here they sell off their assets according to the
Absolute Priority Rule
• Chapter 11: Reorganization
• This has become a creative tool of corporate
finance
• Companies that face difficult and inflexible
agreement may consider this tool as a way out
of them
All Rights Reserved - Dr. Patrick Gaughan
Time Line of Key Events and Dates in a
Chapter 11 Reorganization
1. Filing of the Chapter 11 petition
2. Filing a schedule of assets and liabilities
3. Bar date
4. Filing a reorganization plan and disclosure statement
5. Hearing on the disclosure statement
6. Voting on the plan
7. Plan confirmation hearing
8. Effective date of plan/distribution of new claims under the plan
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Benefits of Chapter 11
• Tends to work better for larger companies
than smaller ones
• The expenses of bankruptcy get spread out
over a larger quantity of revenues at large
companies
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Duration of Chapter 11 Process
• New Generation Research
• 1982–2004: 16.4 months
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Reorganization Plan
• Part of a larger document – Disclosure
Statement
• It is the plan for how the company is going
to be changed to become more viable in the
future
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Reorganization Process
• Exclusivity Period: during this time period
only the debtor in possession can file a plan
• This can be extended for cause
• Bankruptcy Abuse Prevention & Consumer
Protection Act of 2005 – placed a limit of
18 months on the exclusivity period
• If the creditors reject the plan that can do
their own after the exclusivity period ends
All Rights Reserved - Dr. Patrick Gaughan
Financing during Chapter 11
• The debtor in possession can get debt
financing while Ch 11
• Various distressed lenders specialize in such
financing
• These lenders may require that the company
file Ch 11 as a precondition to get such
financing
• These creditors may get put ahead of other
creditors in the payment of claims on
liquidation
All Rights Reserved - Dr. Patrick Gaughan
Criteria for DIP Financing
• DIP lenders are given a priority over other
creditors
• Really need to have good collateral –
valuable assets which lenders can use as
security
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Approval of the Reorganization Plan
• Each class of creditors has to approve the plan by
½ in # and 2/3 in $ amount
• Trustee may hire firm to handle the voting process
– e.g., Bankruptcy Services LLC
• Serve as solicitation and tabulation agent for secured
creditors
• Classes: e.g., secured vs. unsecured creditors
• There may be subclasses with these groups
• Cramdown: if a given class does not approve the
plan but others do the court may force agreement
through a cramdown
• Court only needs to show that the non-agreeing class
will get via the plan what they would have gotten in
liquidation
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Confirmation of Plan
• Voting: Each class of creditors has to
approve the plan by ½ in # and 2/3 in $
amount
• Hearing: an actual hearing is held
• Notice of Hearing: published in major
publications like Wall Street Journal and
NY Times
All Rights Reserved - Dr. Patrick Gaughan
Recent Trends in Treatment of Junior
Creditors
• In some Ch 11 bankruptcies senior creditors have
been allocated some monies for junior or
unsecured creditors so as to get them to not try to
hold up or slow down the Ch 11 approval process
• They slow down the process by filing lawsuits alleging
management mismanagement and demand damages
• This can slow down approval of a plan
• Process is called gifting
• Examples: Sirva, Inc., Avado Brands, and Wickes
Furniture Co.
• Sirva, Inc., filed Ch 11 in February 2008
• They are parent company of Allied Van Lines
• Lenders agreed to give unsecured creditors 25 cents on dollar
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Prepackaged Bankruptcy
• This is where the debtor in possession
reaches advance agreement with creditors
• 1st major Prepack: Crystal Oil Co 1986
All Rights Reserved - Dr. Patrick Gaughan
Largest Prepackaged Bankruptcy Filings
Company Name
Bankruptcy
Start Date Assets
CIT Group Inc.
11/01/09
$80,448,900,000 Banking & Finance
Charter Communications, Inc.
03/27/09
$13,882,000,000 Telecommunications 12/01/09 Emerged - Public (CCMM)
Home Holdings, Inc.
01/15/98
$7,593,000,000 Insurance
Station Casinos, Inc.
07/28/09
$5,831,636,000 Hotel & Gaming
06/17/11 Emerged - Private; n/k/a Station Casinos LLC
Southland Corp., (The)
10/24/90
$3,438,760,000 Retail
03/05/91 Reorganized
Dex One Corporation (2013)
03/17/13
$2,835,418,000 Publishing
04/30/13 Emerged - Public (DXM)
Houghton Mifflin Harcourt Publishing Co.
05/21/12
$2,680,000,000 Publishing
06/22/12 Emerged - Private
MGM Holdings Inc. (Metro-Goldwyn-Mayer
Inc.)
11/03/10
$2,673,772,000 Entertainment
12/21/10 Emerged - Private
Masonite Corporation
03/16/09
$2,660,052,000 Manufacturing
06/09/09 Emerged - Public (MASWF)
Trans World Airlines, Inc. (1995)
06/30/95
$2,495,210,000 Aviation
08/23/95 Emerged - Public (TWA)
Industry
Effective
Date
Outcome Notes
12/10/09 Emerged - Public (CIT)
Reorganized
Source: BankruptcyData.com, A Division of New Generation Research, Inc.
All Rights Reserved - Dr. Patrick Gaughan
Benefits of a Prepackaged Bankruptcy
• Shorter time spent in bankruptcy
• Save money and loss of business
• Tashjain, Lease & McConnell 1996 – pre-packs
spent less time in bankruptcy but more time in
pre-filing negotiations
• Less of a holdout problem that is associated
with voluntary agreements
• The bankruptcy process that follows “keeps the
parties honest”
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Types of Prepacks
• Pre-Voted: the vote is held before the filing
• Results filed with the bankruptcy petition
• Post-Voted: voting process overseen by the
bankruptcy court after the filing
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Ch 11 as Means to Facilitate a Sale of the
Company
• A company may find it can’t sell itself due
to certain undesirable attributes such as high
debt or other burdensome contracts
• Buyers may say that they would acquire the
target if the target could fix these problems
through the Ch 11 process
• Ex: Fortunoff 2008
• In its bankruptcy filing it revealed it had a
stalking horse bidder but the bidder required
a Ch 11 filing
• Buyers get assets free and clear from liens
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Stalking Horse Bidders
• This is a bidder who may make a first bid
• The bidder may require some protections if
it is outbid
• These protections may provide compensation to
the stalking horse bidder if outbid
• Like a break-up fee
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Workouts
• Workouts: negotiated agreements between
debtors and creditors outside of the
bankruptcy process
• Extension: where payments are extended
longer
• Composition: where payment amount is
reduced
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Workouts (cont.)
• Benefits: cost savings and more flexibility for the
debtor
• Less business loss (less likely customers will cease
doing business
• Also less likely suppliers will cut off shipments
• No stigma of being bankrupt
• Reduced expenses that would normally be incurred in
bankruptcy
• Drawbacks: may be hard to get all creditors to
agree
• Holdout problem
All Rights Reserved - Dr. Patrick Gaughan
Workouts and Bankruptcy
• Many companies that do voluntary debt
restructurings end up in bankruptcy anyway
• Gilson, John, and Lang (1990) found out
that 52.7% of the voluntary restructurings
over period 1978–1987 ended up in
bankruptcy
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Multiple Reorganizations
• This is where a company has filed Ch 11
more than one time
• Ex: Continental Airlines
• Filed at different times due to different reasons
• 1st Time: 9/23/83
• Reason: U.S. Economy in Recession
• 2nd Time: 12/03/90
• Reason: Kuwait war caused fuel prices to rise
dramatically
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Mergers after Ch 11
• 2004: Northwest and Delta filed for Ch 11
• 2007: Both companies emerged from Ch 11
• April 2008: they announced a merger
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Liquidation
• This option is pursued when the continued
operation will only worsen the company’s
financial position and where reorganization
will not help
• It is possible this is pursued after
reorganization was tried
All Rights Reserved - Dr. Patrick Gaughan
Absolute Priority Rule for Payment
of Claims in Liquidation
•
•
•
•
•
•
•
•
•
•
•
Secured creditors (If the amount owed exceeds the proceeds from the
sale of the asset, the remainder becomes an unsecured claim.)
Bankruptcy administrative costs
Postpetition bankruptcy
Wages of workers owed for three months before the filing (limit
$2,000 per employee)
Employee benefit plan contributions owed for six months before the
filing (limit $2,000 per employee)
Unsecured customer deposits (limit $900)
Federal, state, and local taxes
Unfunded pension liabilities (limit is 30% book value of preferred and
common equity; any remainder becomes an unsecured claim)
Unsecured claims
Preferred stockholders (up to the par value of their stock)
Common stockholders
All Rights Reserved - Dr. Patrick Gaughan
U.S. Automakers & Labor
• The big 3 U.S. automakers have the highest
cost labor force
• Ex: Ford and GM pay $30 per hour in
wages and $30 per hour in benefits
• Honda with U.S. plants pay $15 per hour
and employees contribute to their own
health benefits
All Rights Reserved - Dr. Patrick Gaughan
Should U.S. Automakers File Ch 11?
• Seems to work for airlines
• Airlines like Delta and Continental file Ch
11 and do not lose customers
• Would this work for car makers
• Two businesses are very different
• Airlines are a short-term services business
• Consumers buy a ticket and rely on the
government to regulate safety
• No long-term commitment
All Rights Reserved - Dr. Patrick Gaughan
Autos & Ch 11 (cont.)
• Buying a car is a long-term commitment
• Service: Consumers wonder will the
automaker be there to provide parts and
service for the life of the car
• Warranty: Will they be able to honor the
warranty
• Resale: If the company goes under and
liquidates how will this affect resale values
• These concerns make one wonder would
sales dramatically drop if file Ch 11
• If so this would mean the end of the companies
All Rights Reserved - Dr. Patrick Gaughan
Ford Stock Price
20
15
10
5
0
2003
2004
2005
2006
2007
2008
General Motors Stock Price
60
50
40
30
20
10
0
2003
Source: Yahoo! Finance
2004
2005
2006
2007
All Rights Reserved - Dr. Patrick Gaughan
2008
Sears Holdings Corp.: Sales
2005-2014
$60,000
$50,000
Sales ($ mil.)
$40,000
$30,000
$20,000
$10,000
$0
2005
2006
2007
Source: Value Line, January 30, 2015.
2008
2009
2010
2011
2012
2013
2014
Sears Holdings Corp.: # of Stores
2005-2014
4,500
Number of Stores
4,000
3,500
3,000
2,500
2,000
1,500
1,000
500
0
2005
2006
2007
Source: Value Line, January 30, 2015.
2008
2009
2010
2011
2012
2013
2014
Sears Holdings Corp.: Net Profits
2005 -2014
$2,000
Net Profits ($ mil.)
$1,500
$1,000
$500
$0
-$500
-$1,000
2005
2006
2007
2008
Source: Value Line, January 30, 2015.
2009
2010
2011
2012
2013
2014
Sears Holdings Corp.: Working Capital
2005 -2014
Working Capital ($ mill.)
$6,000
$5,000
$4,000
$3,000
$2,000
$1,000
$0
2005
2006
2007
Source: Value Line, January 30, 2015.
2008
2009
2010
2011
2012
2013
2014