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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 Appointment of Develop and Bankruptcy Debtor in Present Court Possession or Reorganization Court Trustee 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 1 Once 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 rule 5 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). 1 U. S. government agreed to forgive all but $9 billion of its $49. 5 billion in loans to GM 2 United 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 3 Ontario and Canadian governments agreed to forgive all but $1. 7 billon of their $9. 5 billion in loans to GM. 4 Bondholders agreed to forgive $27. 2 billion in GM debt. 5 Absolute 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. .
General Motors’ (GM) Bankruptcy Pre-Bankruptcy Post-Bankruptcy U. S. & Canadian Operations 1 Attractive Assets Consolidated GM “New GM: ” U. S. & Canadian Operations 3 Consolidated GM All Other International Operations “Old GM: ” Unattractive Assets 2 All Other International Operations 1 Only the U. S. and Canadian operations were included in the GM bankruptcy filing. 2”Old 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”
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 2/3 rds 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