distress 3
TRANSCRIPT
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Introduction to troubled-debtrestructuring
Corporate Restructuring
Tim Thompson
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Distressed Firm
Workout
Chapter 11(outside option)
No Chapter 11 filing
Prepackaged Ch. 11
Chapter 11
Reorganization
Chapter 7
Liquidation
(outside option)
Auction
or sale
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Focus of lecture Firm already in distress
defined as not able to make debt payments
as they come due
Choices Renegotiate contracts with creditors out of court (workout)
Renegotiate contracts with creditors in court (Chapter 11)
Allow the firm to be liquidated by court appointed trustee(Ch 7)
Chapter 11 court may order the company be sold to highestbidder
Most focus will be on large firms, usually publicly held
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Insolvency Troubled debt restructuring methods
needed because firm is insolvent
I.e., it can not meet its obligations asthey come due.
This is not the legal definition
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Causes of insolvency Bad luck
Economic conditions
Competitive position eroded
Firm specific factors
Bad strategy
Bad execution -- mismanagement Fraud
Overlevered the company
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Effect of insolvency Have to recontract with creditors
get parties to agree to reorganization liabilities, ownership, control
or liquidate
Recontracting can be settled out of court
Workouts/private reorganizations
Or, in court
Chapter 11 (reorg) or Chapter 7 (liquidation)
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Main effect of reorganizations Restructure terms on debt
reduce interest payments/principal amounts
Extend maturity
Substitute equity (or equiv.) for debt
What if V is very large?
Could be that have too little cash flow, but goodvalue, could offer BH more value, but paid later
Not the usual situation
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What is optimal choice if managers are
value maximizing?
Is the firm worth more as a goingconcern? with its own strategy bought out by another firm
Or is it worth more liquidated?
What is size of the pie and how is it tobe sliced? Tough question on bothcounts!
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Watch out for incentives on all sides!
Creditors Race to the top
Dont want firm to go into Ch. 11 In Ch. 11, want you to liquidate inefficiently
Shareholders Stay out of Ch 11
In Ch 11, want ongoing firm
Managers Depends on what their position looks like
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Chapter 11 is not first choiceAlmost all large, publicly traded firms
attempt to workout debt beforeentering Chapter 11
Why do firms attempt a workout?
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Workouts less expensive than
Chapter 11 Gilson, John and Lang (GJL) studied
NYSE AMEX firms doing workouts and
Ch. 11s in 80s Legal and professional fees higher in Ch 11
Avg length of Ch 11 is longer, especiallywhen workout included exchange offer
In workout, only deal with claims indefault*
In Ch 11, all claims
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Problems with Ch. 11
Legal/professional fees have priority overother claims, so less incentive to get it done
Management by judges Major decisions: file application with court, notify
creditors -- file complaints
Judges legal requirements
claimholders must receive at least what theyd get inliquidation, company not in danger of going bankruptagain (near future)
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Advantages to DIP of Chapter
11 New issued debt higher priority than
pre-petition debt
Interest on pre-petition unsecured debtstops accruing
Automatic stay from creditors
Easier to get reorg plan acceptedbecause of voting rules
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Why does firm go to Chapter 11?
Creditor holdouts (and advantages above)
In workout, have to get all participatingcreditors to agree
Bondholders have incentive to free ride onthe settlement
Try to trap the free riders by making theexchanged bonds higher priority, shorter maturity
Problem worse with public debt, morecomplex debt
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LTV decision Judge Burton Lifland
Bondholders who tendered in previousexchange offer were entitled to claim equalto market value of new bonds
Non exchanging bondholders entitled to
claim equal to face value of debt Makes holdout problem worse
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Rights of management in Ch
11 DIP (debtor in possession) has
exclusive right to file first reorg plan
for 120 days
typically extended, sometimes for years
Large management turnover in both
workouts and Ch 11sAlso, reputation issues
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Tax disadvantage to voluntary
restructuring Tax Reform Act of 1986
More difficult to preserve NOL
carryforwards Hard to avoid paying tax on income from
forgiveness of debt
Revenue Reconciliation Act of 1990 newly exchanged bonds trading at a
discount to face value, the firm must bookthe difference as taxable income
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Prepackaged bankruptcy
Hybrid of workouts and Chapter 11s Firm files Chapter 11
But files reorg plan at the same time(agreed to with secured creditorsinformally beforehand)
Can hurry up the Ch 11 process
Not a sure thing!
Why do Ch 11 at all?
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Deviations from AbsolutePriority in Troubled Debt
Restructuring
Corporate Restructuring
Tim Thompson
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AbsolutePriority
In typical corporate finance treatments ofdefault, assumed that claimants of the firm
will be paid according to absolute priority First, secured claimants
Administrative claims
Employee claims
Customer claims
Tax claims
Unsecured creditors, then equity
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Deviations from APR common
Kaiser, Chap. 11, documents manypapers describing deviations from APR Both in Chapter 11 and in workouts Typically, equity and unsecured
debtholders receive more than should,more senior claims receive less than
should Equity receives more in workouts than in
Chapter 11
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Do markets expect APR
deviations? Generally, yes.
Kaisers Chapter 11 suggests that debtmarkets do not seem to anticipate theeventual APR violations, but most of theliterature suggests that markets do, in
fact, incorporate these violations intopricing.
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Betker (1996) Show table
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If markets efficient, do
deviations from APR matter? Still matter, because the noise in how much
you would get/lose due to violations leads to
inefficient investments in time to find out how large deviations will be
in time and effort to limit/increase size ofdeviations
in increases in rates/onerous covenants when youissue debt
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LoPucki and Whitford (1990)
Managers act more in their owninterests than in equity interests, so
understanding the distinction isimportant on case by case basis.
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Recovery rates How much do bankers/bondholders get
back of their original investment in
Chapter 11 reorganizations?
What is relation between recovery ratesand seniority/security?
What is relation between recovery ratesand public/private/banks?
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Altman evidenceAverage recovery rate approx. 40%
Recovery rate defined as the price one
month after default occurred divided bypar value
1991 36.0%
1990 23.4%
1989 38.3%
1988 43.6%
1987 75.9%
1986 34.5%
1985 45.9%
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Altman: rec. rates by priority 1985-1991 Averages
Type of debt Recovery rate
Secured 60.51%
Senior 52.28%
Senior subordinated 30.70%
Subordinated (cash pay) 27.96%
Subordinated (PIK) 19.51%
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Recovery rates in Eastern Airlines Secured debt with sufficient collateral 100%
Secured debt, insufficient collateral 11.75% First equip cert 100%
12.75% Second equip cert 60% 13.75% Third equip cert 6%
Accrued interest on secured debt 57%
Capital lease obligations 100%
Unsecured debt P
BGC pension claims 15% Manufacturers sub notes 11%
Conv Sub Debs 6%
Healthcare claims 8%
Stock 0%
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Kaiser notes, Franks and
Torous Table 12.2 Percentage recovery rates
by creditor class
exchanges, Chap. 11, and prepacks
Conclusions: Recovery rates higher in workouts than Chapter
11s
Prepacks more like workouts
Pre-solicited somewhat higher than pre-negotiated
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Kaiser notes, Franks and
Torous Table 12.5, form of compensation
workouts v. Chapter 11s
Conclusions: Cash larger part of distribution in Ch. 11
Bank debt reduced in chapter 11, becomes senior debt
Junior debt and preferred receive equity, both methods
Equity is larger part of distribution in Ch. 11
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Loss in value at Eastern Weiss and Wruck
Table 2 Total recover by fixed claimants and equity at
resolution of bankruptcy, $2,005.5 million.
At filing of Chapter 11, total estimated marketvalue of equity plus different measures of debt,around $4 billion
Loss of approx. $2 billion in value in Chap 11 argue was not due to industry conditions
Direct costs were $114 million only.
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What was problem? Uncertainty about going concern v.
liquidate
Judge allowed managers to useproceeds of asset sales to fundcontinued operations (at substantial op
losses) Some venue shopping?