Financial distress process Federal bankruptcy law Reorganization Liquidation - PowerPoint PPT Presentation

Slide1 l.jpg
1 / 31

  • Uploaded on
  • Presentation posted in: General

CHAPTER 24 Bankruptcy, Reorganization, and Liquidation. Financial distress process Federal bankruptcy law Reorganization Liquidation. What are the major causes of business failure?. Economic factors industry weakness poor location/product Financial factors too much debt

I am the owner, or an agent authorized to act on behalf of the owner, of the copyrighted work described.

Download Presentation

Financial distress process Federal bankruptcy law Reorganization Liquidation

An Image/Link below is provided (as is) to download presentation

Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author.While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server.

- - - - - - - - - - - - - - - - - - - - - - - - - - E N D - - - - - - - - - - - - - - - - - - - - - - - - - -

Presentation Transcript

Slide1 l.jpg


Bankruptcy, Reorganization,

and Liquidation

  • Financial distress process

  • Federal bankruptcy law

  • Reorganization

  • Liquidation

Slide2 l.jpg

What are the major causes

of business failure?

  • Economic factors

    • industry weakness

    • poor location/product

  • Financial factors

    • too much debt

    • insufficient capital

      Most failures occur because a number of factors combine to make the business unsustainable.

Slide3 l.jpg

Do business failures occur evenly over time?

  • A large number of businesses fail each year, but the number in any one year has never been a large percentage of the total business population.

  • The failure rate of businesses has tended to fluctuate with the state of the economy.

Slide4 l.jpg

What size firm, large or small, is more prone to business failure?

  • Bankruptcy is more frequent among smaller firms.

  • Large firms tend to get more help from external sources to avoid bankruptcy, given their greater impact on the economy.

Slide5 l.jpg

What key issues must managers

face in the financial distress process?

  • Is it a temporary problem (technical insolvency) or a permanent problem caused by asset values below debt obligations (insolvency in bankruptcy)?

  • Who should bear the losses?

  • Would the firm be more valuable if it continued to operate or if it were liquidated?


Slide6 l.jpg

  • Should the firm file for bankruptcy, or should it try to use informal procedures?

  • Who would control the firm during liquidation or reorganization?

Slide7 l.jpg

What informal remedies are available to firms in financial distress?

  • Informal reorganization

  • Informal liquidation

  • Why might informal remedies be preferable to formal bankruptcy?

  • What types of companies are most suitable for informal remedies?

Slide8 l.jpg

Informal Bankruptcy Terminology

  • Workout: Voluntary informal reorganization plan.

  • Restructuring: Current debt terms are revised to facilitate the firm’s ability to pay.

    • Extension: Creditors postpone the dates of required interest or principal payments, or both. Creditors prefer extension because they are promised eventual payment in full.


Slide9 l.jpg

  • Composition: Creditors voluntarily reduce their fixed claims on the debtor by either accepting a lower principal amount or accepting equity in lieu of debt repayment.

  • Assignment: An informal procedure for liquidating a firm’s assets. Title to the debtor’s assets is transferred to a third party, called a trustee or assignee, and then the assets are sold off.

  • Slide10 l.jpg

    Describe the following terms related to U.S. bankruptcy law:

    • Chapter 11: Business reorganization guidelines.

    • Chapter 7: Liquidation procedures.

    • Trustee:

      • Appointed to control the company when current management is incompetent or fraud is suspected.

      • Used only in unusual circumstances.


    Slide11 l.jpg

    • Voluntary bankruptcy: A bankruptcy petition filed in federal court by the distressed firm’s management.

    • Involuntary bankruptcy: A bankruptcy petition filed in federal court by the distressed firm’s creditors.

    Slide12 l.jpg

    What are the major differences

    between an informal reorganization

    and reorganization in bankruptcy?

    • Informal Reorganization:

      • Less costly

      • Relatively simple to create

      • Typically allows creditors to recover more money and sooner.


    Slide13 l.jpg

    • Reorganization in Bankruptcy

      • Avoids holdout problems.

      • Due to automatic stay provision, avoids common pool problem.

      • Interest and principal payments may be delayed without penalty until reorganization plan is approved.


    Slide14 l.jpg

    • Permits the firm to issue debtor in possession (DIP) financing.

    • Gives debtor exclusive right to submit a proposed reorganization plan for agreement from the parties involved.

    • Reduces fraudulent conveyance problem.

    • Cramdown if majority in each creditor class approve plan.

    Slide15 l.jpg

    What is a prepackaged bankruptcy?

    • New type of reorganization

      • Combines the advantages of both formal and informal reorganizations.

      • Avoids holdout problems

      • Preserves creditors’ claims

      • Favorable tax treatment.

    • Agreement to plan obtained from creditors prior to filing for bankruptcy.

    • Plan filed with bankruptcy petition.

    Slide16 l.jpg

    List the priority of claims in a

    Chapter 7 liquidation.

    • Secured creditors.

    • Trustee’s administrative costs.

    • Expenses incurred after involuntary case begun but before trustee appointed.

    • Wages due workers within 3 months prior to filing.


    Slide17 l.jpg

    • Unpaid contributions to employee benefit plans that should have been paid within 6 months prior to filing.

    • Unsecured claims for customer deposits.

    • Taxes due.

    • Unfunded pension plan liabilities.

    • General (unsecured) creditors.

    • Preferred stockholders.

    • Common stockholders.

    Liquidation illustration data millions of l.jpg

    Liquidation Illustration Data(millions of $)

    Creditor Claims:

    Accounts payable$10.0

    Notes payable5.0

    Accrued wages0.3

    Federal taxes0.5

    State and local taxes0.2

    First mortgage3.0

    Second mortgage0.5

    Subordinated debentures* 4.0


    *Subordinated to notes payable.


    Slide19 l.jpg

    Proceeds from liquidation:

    From current assets$14.0

    From fixed assets* 2.5

    Total receipts$16.5

    *All fixed assets pledged as collateral to mortgage holders.

    Priority distribution millions of l.jpg

    Priority Distribution(millions of $)

    Creditor ClaimDistributionUnsatisfied

    Accrued wages$0.3$0.3$0.0

    Federal taxes0.50.50.0

    Other taxes0.20.20.0

    First mortgage3.02.50.5

    Second mortgage 0.5 0.0 0.5


    Notes:(1)First mortgage receives entire proceeds from sale of

    fixed assets, leaving $0 for the second mortgage.

    (2)$16.5 - $3.5 = $13.0 remains for distribution to general


    Slide21 l.jpg

    General Creditor Distribution (millions of $)

    Remaining Initial Final Percent

    Creditor GC ClaimDistrib.aAmountbReceived

    Accounts payable$10.0$6.500$6.50065.0%

    Notes payable5.03.2505.000100.0

    Accrued wages0.00.300100.0

    Federal taxes0.00.500100.0

    Other taxes0.00.200100.0

    First mortgage0.50.3252.82594.2

    Second mortgage0.50.3250.32565.0

    Sub. deb. 4.0 2.600 0.85021.2


    aPro rata amount = $13/$20 = 0.65.

    bIncludes priority distribution and $1.75 transfer from subordinated debentures.

    Slide22 l.jpg

    Other Motivations for Bankruptcy

    • Normally, bankruptcy is motivated by serious current financial problems.

    • However, some companies have used bankruptcy proceedings for other purposes:

      • To break union contracts

      • To hasten liability settlements

    Slide23 l.jpg

    Some Criticisms of Bankruptcy Laws

    • Critics contend that current (1978) bankruptcy laws are flawed.

    • Too much value is siphoned off by lawyers, managers, and trustees.

    • Companies that have no hope remain alive too long, leaving little for creditors when liquidation does occur.

    • Companies in bankruptcy can hurt other companies in industry.

    Chapter 24 extension l.jpg

    Chapter 24 Extension

    • MDA to predict bankruptcy

    • Recent business failures

    What is mda and how can it be used to predict bankruptcy l.jpg

    What is MDA, and how can it be used to predict bankruptcy?

    • Multiple discriminant analysis (MDA) is a statistical technique similar to multiple regression.

    • It identifies the characteristics of firms that went bankrupt in the past.

    • Then, data from any firm can be entered into the model to assess the likelihood of future bankruptcy.

    Mda illustration l.jpg

    MDA Illustration

    • Assume you have the following 2003 data for 12 companies:

      • Current ratio

      • Debt ratio

    • Six of the companies (marked by Xs) went bankrupt in 2004 while six (marked by dots) remained solvent.


    Slide27 l.jpg

    Current Ratio

    Discriminant Boundary


















    Debt Ratio

    = Solvent

    X = Bankrupt


    Slide28 l.jpg

    • The discriminant boundary, or Z line, statistically separates the bankrupt and solvent companies.

    • Note that two companies have been misclassified by the MDA program: One bankrupt company falls on the solvent (left) side and one solvent company falls on the bankrupt (right) side.


    Slide29 l.jpg

    • Assume the equation for the boundary line is

    Z = -2 + 1.5(Current ratio) - 5.0(Debt ratio).

    • Furthermore, if Z = -1 to +1, the future of the company is uncertain. If Z > 1, bankruptcy is unlikely; if Z < -1, bankruptcy is likely to occur.

    Slide30 l.jpg

    Using MDA To Predict Bankruptcy

    • Suppose Firm S has CR = 4.0 and DR = 0.40. Then,

    Z = -2 + 1.5(4.0) - 5.0(0.40) = +2.0,

    and firm is unlikely to go bankrupt.

    • Suppose Firm B has CR = 1.5 and DR = 0.75. Then,

    Z = -2 + 1.5(1.5) - 5.0(0.75) = -3.5,

    and firm is likely to go bankrupt.

    Some final points l.jpg

    Some Final Points

    • The most well-known bankruptcy prediction model is Edward Altman’s five factor model.

    • Such models tend to work relatively well, but only for the near term.

    • The more similar the historical sample to the firm being evaluated, the better the prediction.

  • Login