ExecutiveSummaryThischapterdiscussesfinancialdistress,privateworkouts,andbankruptcy.Afirmthatdefaultsonarequiredpaymentmaybeforcedtoliquidateitsassets.Moreoften,adefaultingfirmwillreorganize.Financialrestructuringinvolvesreplacingoldfinancialclaimswithnewonesandtakesplacewithprivateworkoutsorlegalbankruptcy.ExecutiveSummaryThischapterChapterOutline31.1WhatisFinancialDistress?31.2WhatHappensinFinancialDistress?31.3BankruptcyLiquidationandReorganization31.4PrivateWorkoutorBankruptcy:WhichisBest?31.5PrepackagedBankruptcy31.6SummaryandConclusionsChapterOutline31.1WhatisFi31.1WhatisFinancialDistress?Asituationwhereafirm’soperatingcashflowsarenotsufficienttosatisfycurrentobligationsandthefirmisforcedtotakecorrectiveaction.Financialdistressmayleadafirmtodefaultonacontract,anditmayinvolvefinancialrestructuringbetweenthefirm,itscreditors,anditsequityinvestors.31.1WhatisFinancialDistresInsolvencyStock-baseinsolvency;thevalueofthefirm’sassetsislessthanthevalueofthedebt.AssetsDebtEquitySolventfirmDebtAssetsEquityInsolventfirmDebtNotethenegativeequityInsolvencyStock-baseinsolvencInsolvencyFlow-baseinsolvencyoccurswhenthefirmscashflowsareinsufficienttocovercontractuallyrequiredpayments.ContractualobligationsInsolvency$FirmcashflowCashflowshortfalltimeInsolvencyFlow-baseinsolvencyTheLargestU.S.BankruptciesFirmLiabilities($m)BankruptcyDateTexaco$21,6031987ExecutiveLifeInsurance14,5771991MutualBenefitLife13,5001991Campeau9,9471990FirstCapitalHoldings9,2911991BaldwinUnited9,0001983ContinentalAirlines(II)6,2001990LomasFinancial6,1271989Macy’s5,3001992TheLargestU.S.Bankruptcies31.2WhatHappensinFinancialDistress?Financialdistressdoesnotusuallyresultinthefirm’sdeath.FirmsdealwithdistressbySellingmajorassets.Mergingwithanotherfirm.Reducingcapitalspendingandresearchanddevelopment.Issuingnewsecurities.Negotiatingwithbanksandothercreditors.Exchangingdebtforequity.Filingforbankruptcy.31.2WhatHappensinFinancialReorganizeandemergeMergewith

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).ReorganizeandemergeMergewitResponsestoFinancialDistressThinkofthetwosidesofthebalancesheet.AssetRestructuring:Sellingmajorassets.Mergingwithanotherfirm.ReducingcapitalspendingandR&Dspending.FinancialRestructuring:Issuingnewsecurities.Negotiatingwithbanksandothercreditors.Exchangingdebtforequity.Filingforbankruptcy.ResponsestoFinancialDistres31.3BankruptcyLiquidationandReorganizationFirmsthatcannotmeettheirobligationshavetwochoices:liquidationorreorganization.Liquidation(Chapter7)meansterminationofthefirmasagoingconcern.Itinvolvessellingtheassetsofthefirmforsalvagevalue.Theproceeds,netoftransactionscosts,aredistributedtocreditorsinorderofpriority.Reorganization(Chapter11)istheoptionofkeepingthefirmagoingconcern.Reorganizationsometimesinvolvesissuingnewsecuritiestoreplaceoldones.31.3BankruptcyLiquidationanBankruptcyLiquidationStraightliquidationunderChapter7usuallyinvolves:Apetitionisfiledinafederalcourt.Thedebtorfirmcouldfileavoluntarypetitionorthecreditorscouldfileaninvoluntarypetitionagainstthefirm.Atrustee-in-bankruptcyiselectedbythecreditorstotakeovertheassetsofthedebtorfirm.Thetrusteewillattempttoliquidatethefirm’sassets.Aftertheassetsaresold,afterpaymentofthecostsofadministration,moneyisdistributedtothecreditors.Ifanymoneyisleftover,theshareholdersgetit.BankruptcyLiquidationStraightBankruptcyLiquidation:PriorityofClaimsThedistributionoftheproceedsofliquidationoccursaccordingtothefollowingpriority:Administrationexpensesassociatedwithliquidation.Unsecuredclaimsarisingafterthefilingofaninvoluntarybankruptcypetition.Wagesearnedwithin90daysbeforethefilingdate,nottoexceed$2,000perclaimant.Contributionstoemployeebenefitplansarisingwith180daysbeforethefilingdate.Consumerclaims,notexceeding$900.Taxclaims.Securedandunsecuredcreditors’claims.Preferredstockholders’claims.Commonstockholders’claims.BankruptcyLiquidation:PrioriAPRExampleSupposetheB.O.DrugCo.decidestoliquidateunderChapter7.Assumethattheliquidationvalueis$2.7million.Bondsworth$1.5millionaresecuredbyamortgageonthecorporateheadquartersbuilding,whichissoldfor$1million.$200,000isusedtocoveradministrativecostsandotherclaims—afterpayingthis,$2.5millionisavailabletopaycreditors.Theonlyproblemisthattheunpaiddebtis$4million.APRExampleSupposetheB.O.DrAPRExampleUnderAPR,allcreditorsarepaidbeforeshareholders,andthemortgagebondholdersarefirstinline.Thetrusteeproposesthefollowingdistribution:TypeofClaimPriorClaimCashReceivedUnderLiquidationMortgageBonds$1,500,000$1,500,000SubordinatedDebentures$2,500,000$1,000,000CommonStock$10,000,000$0Total$14,000,000$2,500,000APRExampleUnderAPR,allcredBankruptcyReorganization:Chapter11Atypicalsequence:Avoluntarypetitionoraninvoluntarypetitionisfiled.Afederaljudgeeitherapprovesordeniesthepetition.Inmostcasesthedebtorcontinuestorunthebusiness.Thefirmisgiven120daystosubmitareorganizationplan.Creditorsandshareholdersaredividedintoclasses.Requiresonlyapprovalby1/2ofcreditorsowning2/3ofoutstandingdebtAfteracceptancebythecreditors,theplanisconfirmedbythecourt.Paymentsincash,property,andsecuritiesaremadetocreditorsandshareholders.BankruptcyReorganization:ChaReorganizationExampleSupposetheB.O.DrugCo.decidestoreorganizeunderChapter11.Assumethatthe“goingconcern”valueis$3millionanditsbalancesheetisshown.Assets$3,000,000Liabilities:

Mortgagebonds$1,500,000

Subordinated debentures$2,500,000

Equity-$1,000,000ReorganizationExampleSupposeReorganizationExampleThefirmhasproposedthefollowingreorganizationplan:OldSecurityOldClaimNewClaimUnderReorganizationMortgagebonds$1,500,000 $1,500,000Subordinateddebentures$2,500,000 $1,000,000ReorganizationExampleThefirmReorganizationExampleAndadistributionofnewsecuritiesunderanewclaimwiththereorganizationplan:OldSecurityNewClaimUnderReorganizationMortgagebonds$1,000,000in9%subordinateddebentures$500,000in11%subordinateddebenturesSubordinateddebentures$1,000,000in8%preferredstock$500,000incommonstockReorganizationExampleAndadiAbsolutePriorityRuleinPracticeTheAPRstatesthatseniorclaimsarefullysatisfiedbeforejuniorclaimsreceiveanythingDeviationsfromAPR

EquityholdersExpectation:NopayoutReality:Payoutin81%ofcasesUnsecuredcreditorsExpectation:FullpayoutaftersecuredcreditorsReality:Violationin78%ofcasesSecuredcreditorsExpectation:FullpayoutReality:Fullpayoutin92%ofcasesAbsolutePriorityRuleinPracReasonsforAPRViolationsCreditorswanttoavoidtheexpenseoflitigation.Debtorsaregivena120-daywindowofopportunitytocausedelayandharmvalue.Managersoftenownequityanddemandtobecompensated.Theyareinchargeforatleastthenext120days.Bankruptcyjudgeslikeconsensualplans(theydon’tclogthecourtcalendarwithappeals)andpressurepartiestocompromise.ReasonsforAPRViolationsCredVultures“Vultures”aremoneymanagersthatspecializeinthesecuritiesofdistressedanddefaultedcompanies.Therearebetween50and60institutionvulturespecialists,activelymanagingover$25billionin1998.Distresseddebtinvestorshavetargetannualratesofreturnof20–25percent.Althoughsomeyearsarebetterthanothers,theoverallannualrateofreturnfrom1978-1997hasbeenabout12percent—similartojunkbondsbutlessthanthestockmarket.Vultures“Vultures”aremoneym31.4PrivateWorkoutorBankruptcy:WhichisBest?Bothformalbankruptcyandprivateworkoutsinvolveexchangingnewfinancialclaimsforoldfinancialclaims.Usuallyseniordebtisreplacedwithjuniordebtanddebtisreplacedwithequity.Whentheywork,privateworkoutsarebetterthanaformalbankruptcy.Complexcapitalstructuresandlackofinformationmakeprivateworkoutslesslikely.31.4PrivateWorkoutorBankru31.4PrivateWorkoutorBankruptcy:WhichisBest?AdvantagesofBankruptcyNewcreditisavailable-"debtorinpossession"or"DIP"debt.Discontinuedaccrualofinterestonpre-bankruptcyunsecureddebt.Anautomaticstayprovision.Taxadvantages.Requiresonlyapprovalby1/2ofcreditorsowning2/3ofoutstandingdebt.DisadvantagesofBankruptcyAlongandexpensiveprocess.Judgesarerequiredtoapprovemajorbusinessdecisions.Distractiontomanagement.“Holdout”bystockholders.31.4PrivateWorkoutorBankru31.5PrepackagedBankruptcyPrepackagedBankruptcyisacombinationofaprivateworkoutandlegalbankruptcy.Thefirmandmostofitscreditorsagreetoprivatereorganizationoutsidetheformalbankruptcy.Aftertheprivatereorganizationisputtogether(prepackaged)thefirmfilesaformalbankruptcyunderChapter11).Themainbenefitisthatitforcesholdoutstoacceptabankruptcyreorganization.Offersmanyoftheadvantagesofaformalbankruptcy,butismoreefficient.31.5PrepackagedBankruptcyPre31.6SummaryandConclusionsFinancialdistressisasituationwhereafirm’soperatingcashflowisnotsufficienttocovercontractualobligations.Financialrestructuringcanbeaccomplishedwithaprivateworkoutorformalbankruptcy.CorporatebankruptcyinvolvesChapter7liquidationorChapter11reorganization.AnessentialfeatureoftheU.S.Bankruptcycodeistheabsolutepriorityrule(APR).Ahybridofaprivateworkoutandformalbankruptcyisprepackagedbankruptcy.31.6SummaryandConclusionsFi生活中的辛苦阻撓不了我對生活的熱愛。1月-231月-23Monday,January2,2023人生得意須盡歡，莫使金樽空對月。22:49:0122:49:0122:491/2/202310:49:01PM做一枚螺絲釘，那里需要那里上。1月-2322:49:0122:49Jan-2302-Jan-23日復一日的努力只為成就美好的明天。22:49:0122:49:0122:49Monday,January2,2023安全放在第一位，防微杜漸。1月-231月-2322:49:0122:49:01January2,2023加強自身建設，增強個人的休養。2023年1月2日10:49下午1月-231月-23精益求精，追求卓越，因為相信而偉大。02一月202310:49:01下午22:49:011月-23讓自己更加強大，更加專業，這才能讓自己更好。一月2310:49下午1月-2322:49January2,2023這些年的努力就為了得到相應的回報。2023/1/222:49:0122:49:0102January2023科學，你是國力的靈魂；同時又是社會發展的標志。10:49:01下午10:49下午22:49:011月-23每天都是美好的一天，新的一天開啟。1月-231月-2322:4922:49:0122:49:01Jan-23相信命運，讓自己成長，慢慢的長大。2023/1/222:49:01Monday,January2,2023愛情，親情，友情，讓人無法割舍。1月-232023/1/222:49:011月-23謝謝大家！生活中的辛苦阻撓不了我對生活的熱愛。12月-2212月-22ExecutiveSummaryThischapterdiscussesfinancialdistress,privateworkouts,andbankruptcy.Afirmthatdefaultsonarequiredpaymentmaybeforcedtoliquidateitsassets.Moreoften,adefaultingfirmwillreorganize.Financialrestructuringinvolvesreplacingoldfinancialclaimswithnewonesandtakesplacewithprivateworkoutsorlegalbankruptcy.ExecutiveSummaryThischapterChapterOutline31.1WhatisFinancialDistress?31.2WhatHappensinFinancialDistress?31.3BankruptcyLiquidationandReorganization31.4PrivateWorkoutorBankruptcy:WhichisBest?31.5PrepackagedBankruptcy31.6SummaryandConclusionsChapterOutline31.1WhatisFi31.1WhatisFinancialDistress?Asituationwhereafirm’soperatingcashflowsarenotsufficienttosatisfycurrentobligationsandthefirmisforcedtotakecorrectiveaction.Financialdistressmayleadafirmtodefaultonacontract,anditmayinvolvefinancialrestructuringbetweenthefirm,itscreditors,anditsequityinvestors.31.1WhatisFinancialDistresInsolvencyStock-baseinsolvency;thevalueofthefirm’sassetsislessthanthevalueofthedebt.AssetsDebtEquitySolventfirmDebtAssetsEquityInsolventfirmDebtNotethenegativeequityInsolvencyStock-baseinsolvencInsolvencyFlow-baseinsolvencyoccurswhenthefirmscashflowsareinsufficienttocovercontractuallyrequiredpayments.ContractualobligationsInsolvency$FirmcashflowCashflowshortfalltimeInsolvencyFlow-baseinsolvencyTheLargestU.S.BankruptciesFirmLiabilities($m)BankruptcyDateTexaco$21,6031987ExecutiveLifeInsurance14,5771991MutualBenefitLife13,5001991Campeau9,9471990FirstCapitalHoldings9,2911991BaldwinUnited9,0001983ContinentalAirlines(II)6,2001990LomasFinancial6,1271989Macy’s5,3001992TheLargestU.S.Bankruptcies31.2WhatHappensinFinancialDistress?Financialdistressdoesnotusuallyresultinthefirm’sdeath.FirmsdealwithdistressbySellingmajorassets.Mergingwithanotherfirm.Reducingcapitalspendingandresearchanddevelopment.Issuingnewsecurities.Negotiatingwithbanksandothercreditors.Exchangingdebtforequity.Filingforbankruptcy.31.2WhatHappensinFinancialReorganizeandemergeMergewith

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).ReorganizeandemergeMergewitResponsestoFinancialDistressThinkofthetwosidesofthebalancesheet.AssetRestructuring:Sellingmajorassets.Mergingwithanotherfirm.ReducingcapitalspendingandR&Dspending.FinancialRestructuring:Issuingnewsecurities.Negotiatingwithbanksandothercreditors.Exchangingdebtforequity.Filingforbankruptcy.ResponsestoFinancialDistres31.3BankruptcyLiquidationandReorganizationFirmsthatcannotmeettheirobligationshavetwochoices:liquidationorreorganization.Liquidation(Chapter7)meansterminationofthefirmasagoingconcern.Itinvolvessellingtheassetsofthefirmforsalvagevalue.Theproceeds,netoftransactionscosts,aredistributedtocreditorsinorderofpriority.Reorganization(Chapter11)istheoptionofkeepingthefirmagoingconcern.Reorganizationsometimesinvolvesissuingnewsecuritiestoreplaceoldones.31.3BankruptcyLiquidationanBankruptcyLiquidationStraightliquidationunderChapter7usuallyinvolves:Apetitionisfiledinafederalcourt.Thedebtorfirmcouldfileavoluntarypetitionorthecreditorscouldfileaninvoluntarypetitionagainstthefirm.Atrustee-in-bankruptcyiselectedbythecreditorstotakeovertheassetsofthedebtorfirm.Thetrusteewillattempttoliquidatethefirm’sassets.Aftertheassetsaresold,afterpaymentofthecostsofadministration,moneyisdistributedtothecreditors.Ifanymoneyisleftover,theshareholdersgetit.BankruptcyLiquidationStraightBankruptcyLiquidation:PriorityofClaimsThedistributionoftheproceedsofliquidationoccursaccordingtothefollowingpriority:Administrationexpensesassociatedwithliquidation.Unsecuredclaimsarisingafterthefilingofaninvoluntarybankruptcypetition.Wagesearnedwithin90daysbeforethefilingdate,nottoexceed$2,000perclaimant.Contributionstoemployeebenefitplansarisingwith180daysbeforethefilingdate.Consumerclaims,notexceeding$900.Taxclaims.Securedandunsecuredcreditors’claims.Preferredstockholders’claims.Commonstockholders’claims.BankruptcyLiquidation:PrioriAPRExampleSupposetheB.O.DrugCo.decidestoliquidateunderChapter7.Assumethattheliquidationvalueis$2.7million.Bondsworth$1.5millionaresecuredbyamortgageonthecorporateheadquartersbuilding,whichissoldfor$1million.$200,000isusedtocoveradministrativecostsandotherclaims—afterpayingthis,$2.5millionisavailabletopaycreditors.Theonlyproblemisthattheunpaiddebtis$4million.APRExampleSupposetheB.O.DrAPRExampleUnderAPR,allcreditorsarepaidbeforeshareholders,andthemortgagebondholdersarefirstinline.Thetrusteeproposesthefollowingdistribution:TypeofClaimPriorClaimCashReceivedUnderLiquidationMortgageBonds$1,500,000$1,500,000SubordinatedDebentures$2,500,000$1,000,000CommonStock$10,000,000$0Total$14,000,000$2,500,000APRExampleUnderAPR,allcredBankruptcyReorganization:Chapter11Atypicalsequence:Avoluntarypetitionoraninvoluntarypetitionisfiled.Afederaljudgeeitherapprovesordeniesthepetition.Inmostcasesthedebtorcontinuestorunthebusiness.Thefirmisgiven120daystosubmitareorganizationplan.Creditorsandshareholdersaredividedintoclasses.Requiresonlyapprovalby1/2ofcreditorsowning2/3ofoutstandingdebtAfteracceptancebythecreditors,theplanisconfirmedbythecourt.Paymentsincash,property,andsecuritiesaremadetocreditorsandshareholders.BankruptcyReorganization:ChaReorganizationExampleSupposetheB.O.DrugCo.decidestoreorganizeunderChapter11.Assumethatthe“goingconcern”valueis$3millionanditsbalancesheetisshown.Assets$3,000,000Liabilities:

Mortgagebonds$1,500,000

Subordinated debentures$2,500,000

Equity-$1,000,000ReorganizationExampleSupposeReorganizationExampleThefirmhasproposedthefollowingreorganizationplan:OldSecurityOldClaimNewClaimUnderReorganizationMortgagebonds$1,500,000 $1,500,000Subordinateddebentures$2,500,000 $1,000,000ReorganizationExampleThefirmReorganizationExampleAndadistributionofnewsecuritiesunderanewclaimwiththereorganizationplan:OldSecurityNewClaimUnderReorganizationMortgagebonds$1,000,000in9%subordinateddebentures$500,000in11%subordinateddebenturesSubordinateddebentures$1,000,000in8%preferredstock$500,000incommonstockReorganizationExampleAndadiAbsolutePriorityRuleinPracticeTheAPRstatesthatseniorclaimsarefullysatisfiedbeforejuniorclaimsreceiveanythingDeviationsfromAPR

EquityholdersExpectation:NopayoutReality:Payoutin81%ofcasesUnsecuredcreditorsExpectation:FullpayoutaftersecuredcreditorsReality:Violationin78%ofcasesSecuredcreditorsExpectation:FullpayoutReality:Fullpayoutin92%ofcasesAbsolutePriorityRuleinPracReasonsforAPRViolationsCreditorswanttoavoidtheexpenseoflitigation.Debtorsaregivena120-daywindowofopportunitytocausedelayandharmvalue.Managersoftenownequityanddemandtobecompensated.Theyareinchargeforatleastthenext120days.Bankruptcyjudgeslikeconsensualplans(theydon’tclogthecourtcalendarwithappeals)andpressurepartiestocompromise.ReasonsforAPRViolationsCredVultures“Vultures”aremoneymanagersthatspecializeinthesecuritiesofdistressedanddefaultedcompanies.Therearebetween50and60institutionvulturespecialists,activelymanagingover$25billionin1998.Distresseddebtinvestorshavetargetannualratesofreturnof20–25percent.Althoughsomeyearsarebetterthanothers,theoverallannualrateofreturnfrom1978-1997hasbeenabout12percent—similartojunkbondsbutlessthanthestockmarket.Vultures“Vultures”aremoneym31.4PrivateWorkoutorBankruptcy:WhichisBest?Bothformalbankruptcyandprivateworkoutsinvolveexchangingnewfinancialclaimsforoldfinancialclaims.Usuallyseniordebtisreplacedwithjuniordebtanddebtisreplacedwithequity.Whentheywork,privateworkoutsarebetterthanaformalbankruptcy.Complexcapitalstructuresandlackofinformationmakeprivateworkoutslesslikely.31.4PrivateWorkoutorBankru31.4PrivateWorkout