Bankruptcy

Topic-Review Tutorial
AGENDA

13 October 2012 | Corporate Governance and Restructuring

01 What is financial distress? & Bankruptcy of GM

02 How do firms change as they enter financial distress?

03 Cost and benefits of financial distress

04 Influence of Stakeholders on Bankruptcy Outcome

05 GM Reorganization
Introduction

What is financial distress?

Financial distress

Financial distress Insolvency Bankruptcy Liquidation

Insufficient cash to pay Unable to pay debts Court supervised Court supervised selling
obligations when they are due setting to rewrite of assets
contracts
Without leverage poor Cash and flow Converting assets into
performance would insolvency cash and distribution of
not lead to financial proceeds through
distress claimants

Without leverage poor

Information problem
How to obtain reliable data about
the type of insolvency

Conflict about resolving distress, as

different ways distribute wealth
differently
Creditors

Shareholders

Managers
Bankruptcy of GM

Fast Facts
Founded in 1908 by William Durant
After great performance in the 90s , GM went financially vulnerable
Until the automotive crisis in 2008-2009 owned more than 20 companies in car manufacturing business
Resolutions
Financial distress is resolved in an environment of imperfect
information and conflict of interests

Workouts Chapter 11 Chapter 7 Bail-outs

Private negotiations for debt Protection from creditors Sale of the assets and Bail out with debt is preferable,
restructuring auctioning higher incentives and
monitoring for managers

More likely for companies which Automatic stay for the Preferred by creditors Performed by governments for
have concentrated debt management(debtor-in- economically significant
possession) companies

More accepted in Europe and Expensive and complex Difficulties with evaluation of Necessity in order to prevent
Japan than in US the firm greater socioeconomic failures

Incentives for management to Significant discounts when fire

propose a reorganization plan sales are performed
Stakeholders Interests During Financial Distress
Equity Holders
Excessive risk taking
Distribution of dividends (violation of APR)
Incentive to claim the firm is insolvent solely
on a FLOW
Formal right to replace the board and
management
Deviations from absolute priority
Mostly interrested in firm value

Creditors Management/Board
Liquidation as a priority Tendency to give a better image of the
They want their initial investment back company than it really is
Ally with the most infuencial group of
Incentives to claim the firm is insolvent on a
claimholders
stock basis.
Deviation of priority
May prefer less risky strategy to preserve value
Choosing a lower leverage structure or less
risky
investments

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How do firms change
as they enter financial
distress?
How do firms in financial distress differ from healthy firms?
PRIOR

Distressed Firms
Distressed firms are significantly more levered
than industry median by year -7

By the year prior to filing the total debt to total

asset ratio of distressed firms exceeds the
industry median ratio by 0.28

Suffer decline in operating performance (4

years before filling bankruptcy)
How firms change as they enter financial distress?

Distressed Firms
Very high management and board turnover

Conflicts between the interests of stakeholders

Creditors gain control

Assets are redeployed

Boards fiduciary duties expand to both equity

and debt
TWO TYPES OF
FIRMS IN DISTRESS
.

FINANCIALLY
DISTRESSED FIRMS
Higher leverage
Problems in repaying debt
Viable going-concern values
OPERATIONALLY
DISTRESSED FIRMS
Low operating performance
Disputable going-concern
values
Leverage might be low
TYPES OF FIRMS IN DISTRESS
RESOLUTION
.

FINANCIALLY
DISTRESSED FIRMS
More likely to emerge as an
independent company
More likely to be restructured
out-of-court
Dispersed debt concentration
hampers out-of-court
restructuring Chapter 11
OPERATIONALLY
DISTRESSED FIRMS
More likely to be liquidated
No financial change can save
these distressed firms
More likely to file for Chapter
11
 General
Motors

Sales gradually going down since 2000

Rapidly loosing share in all important markets
Failure to respond to market change and trends
Endlessly bureaucratic
High operational costs and employee compensations
Dispersed debt ($27bn in notes)

GM filed under Chapter 11

Cost and benefits of
financial distress
Cost of Financial Distress

Direct Cost Indirect Costs Reputation Loss

Management Turnover and Fire-sales of assets

Compensation
Benefits of Financial Distress

Event that triggers changes

Improved operating performance

Benefits of Financial Distress

Event that triggers changes

Improved operating performance

Restructuring
Benefits of Financial Distress

Event that triggers changes Organizational changes

Improved operating performance Debtor-in-Possession financing (Chapter 11)

Restructuring

Changes in governance and management

Influence of Stakeholders
on Bankruptcy Outcome

Imperfect information & conflicts of

interest.
Potential to distort investment incentives.
Actions of Stakeholders All Affect Bankruptcy Outcome

Shareholders Creditors/Banks

Bankruptcy
Outcome

Mangement
Legal
Institution/
Court

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Actions of Stakeholders All Affect Bankruptcy Outcome

Equity Holders Debt Holders

Formal right to replace the board and the Lower investments and a less risky strategy
management
May reduce the firms liquidity
Right to vote on a reorganization plan
Creditor controls also entails firms to be limited
Tend toward the continuation of the firms to raising additional funds.
operations
Control over the bankrupt firms through DIP
loans covenants.
Banks:
Imposing covenants as an important governance
mechanism
Play a role in the firms decision structure when
financially distressed

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Actions of Stakeholders All Affect Bankruptcy Outcome

Management/ Board Legal/Government/Court

Stakeholders severely limited by formal law and

Desire to reach a rapid consensual plan
courts.

Taking only shareholders into account :

Firm in financial distress/bankruptcy loses the
-Delayed filing, right to make certain decision choices without
-Asset substitution legal approvement.
-Increased risk taking
-failure to liquidate poorly performing assets Provide the interested parties to object

Forced to undertake value increasing

organizational changes

Amount of time spent on tackling financial

distress
Firm distress can also reduce the demand of the
firms product. And incrzease production costs
Hard to apply liquidation strategy in some cases. (P.437 WRUCK).

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Outcome of Stakeholders on Bankruptcy

Final Outcome

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GM Reorganization

Pre-packaged Chapter 11 filling

GM files for bankruptcy reorganization,
In conjunction with the bankruptcy filing, the US
government provides a $30.1 billion debtor-in-
possession loan.
GM Reorganization
The plan for General Motors' bankruptcy involved:
Cutting costs
Auction off the companys assets in a section 363 sale:
- Sold their entire stake in the Hummer and the entire brands Saturn and Saab
Cessation of brands Pontiac and Goodwrench
All operational assets and trademarks of GM were transferred, as a part of pre-packaged Chapter 11, to Vehicle
Acquisition Holdings LLC which assumed the name General Motors Company and GM exited bankruptcy.

Brands Debt Ownership US plants Employees

GM Buick, Cadillac, Chevrolet,

GMC, Holden, Opel,
US $94.7 B Common shareholders 47 91000
Vauxhall, Saturn, Hummer,
Saab, Pontiac

NEW GM Buick, Cadillac, Chevrolet,

GMC, Holden, Opel,
US $17 B U.S. (60.8%), Canada
(11.7%), unions VEBA
34 68500
Vauxhall fund (17.5%) and the
unsecured bondholders
of old GM (10% )
Reorganization decisions

Delivery in
Time

Contact

Debt structure Asset structure

Info

Produce

Concentrated debt(e.g. Dispersed debt(e.g.

bank loans) public debt)
- Private workout
- Disruptive Intangible preferred
- Easier negotiations - Value more likely to
- Time consuming assets
- Less costly be destroyed in
- Hold out
- Quicker process Bankruptcy
- Costly

Private workout Court involvement

Sorting out efficient from inefficient firms, on
information basis
Thank you for your attention!
Questions?