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

2,000
Thousands

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

1,000
Assets ($Billions)

800

600

400

200

0
80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 12 14

Source: BankruptcyData.com, A Division of New Generation Research, Inc.

All Rights Reserved - Dr. Patrick Gaughan

Bankruptcies and Economic Declines
• Slower economies increase the number of
bankruptcies

All Rights Reserved - Dr. Patrick Gaughan

 Failure by Age of Business

Number of Years in Business Percentage (%)

One year or less 10.7
Two years 10.1
Three years 8.7
Total three years or less 29.5
Four years 7.8
Five years 7.0
Total five years or less 44.3
Total six to ten years 23.9
Total over ten years 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 Assets in $ mil. Date Filed
Lehman Brothers Holdings Inc. $691,063 9/15/2008
Washington Mutual, Inc. 327,913 9/26/2008
WorldCom, Inc. 103,914 7/21/2002
General Motors Corporation 91,047 6/1/2009
CIT Group Inc. 80,448 11/1/2009
Enron Corp. 65,503 12/2/2001
Conseco, Inc. 61,392 12/17/2002
Energy Future Holdings Corp. 40,970 4/29/2014
MF Global Holdings Ltd. 40,541 10/31/2011
Chrysler LLC 39,300 4/30/2009
Thornburg Mortgage, Inc. 36,521 5/1/2009
Pacific Gas & Electric Company 36,152 4/6/2001
Texaco, Inc. 34,940 4/12/1987
Financial Corp. of America 33,864 9/9/1988
Refco Inc. 33,333 10/17/2005
IndyMac Bancorp, Inc. 32,734 7/31/2008
Global Crossing, Ltd. 30,185 1/28/2002
Bank of New England Corp. 29,773 1/7/1991
General Growth Properties, Inc. 29,557 4/16/2009
Lyondell Chemical Company 27,392 1/6/2009

Source: BankruptcyData.com, A Division of New Generation Research, Inc.

All Rights Reserved - Dr. Patrick Gaughan

 Organization of the US Bankruptcy Law

Chapter Subject
1 General provisions and definitions
3 Case administration
5 Creditors, debtors, and estates
7 Liquidation
9 Bankruptcies of municipalities
11 Reorganization
13 Bankruptcies of individuals
15 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

All Rights Reserved - Dr. Patrick Gaughan

 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

All Rights Reserved - Dr. Patrick Gaughan

Duration of Chapter 11 Process
• New Generation Research
• 1982–2004: 16.4 months

All Rights Reserved - Dr. Patrick Gaughan

 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

All Rights Reserved - Dr. Patrick Gaughan

 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

All Rights Reserved - Dr. Patrick Gaughan

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
All Rights Reserved - Dr. Patrick Gaughan
 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
All Rights Reserved - Dr. Patrick Gaughan
 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

Bankruptcy Effective
Company Name Start Date Assets Industry Date Outcome Notes

CIT Group Inc. 11/01/09 $80,448,900,000 Banking & Finance 12/10/09 Emerged - Public (CIT)

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 Reorganized

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)

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”

All Rights Reserved - Dr. Patrick Gaughan

 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

All Rights Reserved - Dr. Patrick Gaughan

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
All Rights Reserved - Dr. Patrick Gaughan
 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

All Rights Reserved - Dr. Patrick Gaughan

 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

All Rights Reserved - Dr. Patrick Gaughan

 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

All Rights Reserved - Dr. Patrick Gaughan

 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

All Rights Reserved - Dr. Patrick Gaughan

 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

All Rights Reserved - Dr. Patrick Gaughan

 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

0
2003 2004 2005 2006 2007 2008

General Motors Stock Price

60
50
40
30
20
10
0
2003 2004 2005 2006 2007 2008

Source: Yahoo! Finance All Rights Reserved - Dr. Patrick Gaughan

 Sears Holdings Corp.: Sales
2005-2014
$60,000

$50,000

$40,000
Sales ($ mil.)

$30,000

$20,000

$10,000

$0
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Source: Value Line, January 30, 2015.

 Sears Holdings Corp.: # of Stores
2005-2014

4,500

4,000
Number of Stores

3,500

3,000

2,500

2,000

1,500

1,000

500

0
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Source: Value Line, January 30, 2015.

 Sears Holdings Corp.: Net Profits
2005 -2014
$2,000

$1,500

$1,000
Net Profits ($ mil.)

$500

$0

-$500

-$1,000
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Source: Value Line, January 30, 2015.

 Sears Holdings Corp.: Working Capital
2005 -2014

$6,000
Working Capital ($ mill.)

$5,000

$4,000

$3,000

$2,000

$1,000

$0
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Source: Value Line, January 30, 2015.