Distressed IB Flashcards
What is it called when a company ultimately resorts to a sale of all or substantially all of their operations?
An external restructuring transaction
What is insolvency?
When a Company runs out or is about to run out of cash ,or the financial wherewithall, to support its debt burden
What are the early warning indicators of insolvency?
1- downturn in operational performance (sales, margins, operating cash flow, growth in AR days receivable, decline in inventory turnover)
2- bond price - (relative to spread over treasury of other similarly rated bonds)
3-credit availability (liquidity section of MD&A in 10k; changes to credit agreements)
4- stock price (high equity/debt ratio implies that company can tap equity markets to enhance liquidity)
5- stock buybacks (major buyback programs at distressed prices could exacerbate liquidity problem)
6- Lawsuits
7- Fraud and accounting irregularities
The % of receivables and inventory in an ABL
The collateral formula
If assets < liabilities, should you have asset sales?
No. When Enterprise Value < Debt, selling assets to pay down debt will create a deeper equity shortfall. (if Company has $90 of assets and $100 of liabilities, then selling $50 of assets to pay down debt will increase the equity shortfall from 10% to 20%)
How are incumbent financing investment banks treated when seeking a mandate as a restructuring advisor?
Bankruptcy code prohibits retaining an investment bank that has underwritten the Company’s bonds in recent years (this bank has a blatant incentive to see its client avoid chapter 11 even if it’s in the Company’s best interest; also protects accounts you sold bonds to)
What are the 6 primary stakeholders in a distressed company? What are their goals in a distress situation?
1- Board of Directors - maximize recovery for shareholders and limit individual liability
2- Management - maximize equity value and keep their jobs
3- Secured lenders - keep borrower on a short-lease and maximize recovery over time
4- Bondholders - maximize recovery immediately or take over management of Company
5- Trade Creditors - maintaining its customers viability as a going concern and maximizing CASH recovery
6- Old Equity - prove out a valuation where equity is in the money; invest in high-risk / high-return strategies
What is the incentive for a Board of Directors to pursue Chapter 11?
Any good-faith board decisions made after a Chapter 11 filing are largely immune from liability scrutiny. Provisions for director releases and indemnity for directors can also be included when filing for Ch 11
The two most important things for a Board and Management to establish with key constituencies during a period of distress
Liquidity and Credibility
In most financially challenged situations, what should be the Board’s mantra?
- stabilize, (potentially) monetize, and then reorganize
- any different order would ensure materially worse results for the Board, Company, and non-bondholder constituencies
the “sunset provision” in a confidentiality agreement negotiated by the UCC
provides for a debtor to make public all non-public and material information given to the UCC if an agreement is not reached within a certain number of days
-such disclosure would allow the bondholders to trade with the public again
How does a trade creditor claim view its claim in bankruptcy?
While the trade has a claim of 100 cents on the dollar, its cost of that claim may be 50-90 cents, with the rest being a markup/profit. Thus, it can take a “haircut” on the face amount and still not “lose” anything more than anticipated profits
COD
- Cash on Delivery
- a trade term in which payment for goods is made on delivery. If the purchaser does not make payment when the good is delivered, then the good is returned to the seller.
CIA
- Cash in Advance
- a trade term in which the buyer must pay the seller before the goods are shipped
If inventory is purchased on credit when a Company knows it will need to file for Ch 11 after receiving the goods, what could happen?
corporate directors could be found liable for not doing business in good faith
Administrative Priority
+example
+reasoning
- post-petition claims that are senior to all pre-petition unsecured claims and generally only behind DIP financing and secured loans. These claims must be satisfied before the company can emerge from Ch 11
- example: trade claims generated after the bankruptcy petition
- encourages trade vendors and professionals to continue to do business with a company that has filed chapter 11)
Which companies fare far better in a Chapter 11 situation?
Companies that enter Chapter 11 with a solution in hand (as opposed to companies that enter Ch 1 in order to find a solution)
What does Bankruptcy code allow regarding the issuance of public securities?
That a company may issue new public debt or equity without filing a registration statement with the SEC as part of a reorganization so long as the securities are:
A) issued or sold as part of a Plan of Reorganization and
(B) those securities are issued entirely in exchange for an existing claim against or interest in the debtor
What is an Involuntary Bankruptcy Proceeding?
- When creditors whose debt is in default file a petition against the debtor
- as opposed to an Voluntary Bankruptcy, where the Company files the petition
priming
- when the bankruptcy court carves up the pre-petition banks collateral and gives a senior slice to a new lender because existing lenders do not provide additional post-petition financing
- very bad for senior lenders and acts as incentive for them to provide DIP financing
What is “adequate protection”? How does it work?
- a special right for pre-petition secured lenders which prevents the value of their collateral from being dissipated in a bankruptcy
- example: in the case of priming, the court must find the pre-petition secured creditors to be fully covered by collateral both immediately after the senior slice of their collateral has been given to other lenders and on a continuing basis
The seniority of DIP financing
A super-priority administrative claim
The cram-down provisions of the bankruptcy code
- provides that as long as at least one impaired class accepts a plan, that plan can be imposed on all subordinate classes, provided that the subordinate class that objects gets more than it would in a liquidation AND is either made whole OR that no class junior to the objecting class gets anything
- a way to get around objections to form of recovery (equity vs debt) if debtor can prove securities are worth 100 cents
How does filing for bankruptcy provide the ability to bind together creditors
1) court can bind all holders within an impaired class, where actions require a vote from 2/3 of the aggregate claims and 1/2 of the individual voters (deals with small groups of holdouts)
2) allows cram down on objecting classes
What is a “cram-up”?
provides that as long as at least one junior impaired class accepts a plan, that plan can be imposed on all senior classes, provided that the senior class that objects gets more than it would in a liquidation AND is either made whole OR that no class junior to the accepting class gets anything
What claim does the counterparty of a rejected executory contract have in a bankruptcy?
An unsecured pre-petition claim
What are preferences? How are they handled in a bankruptcy?
Preferences - if a constituency receives benefits from the company (such as prepetition paydowns of debt debt or granting of collateral to backstop debt in the period leading up to bankruptcy
If benefits occurred within 90 days before bankruptcy for third parties or a year for insiders, the transactions would be reviewed by the court for possible return of the preferences to the estate. The transaction would be viewed as a preference if the recipient obtained more value than it would have in a hypothetical Ch 7 liquidation
How does filing for bankruptcy help the debtor with M&A?
Pre-bankruptcy sales could can be challenged by the sellers creditors for fraudulent conveyance, making the buyer subject to substantial liabilities or penalties. While an asset sale in Ch 11 let’s court give buyer an unquestionably clean title
Fraudulent Conveyance
Occurs if a company transfers an asset to a third party under circumstances where both:
(1) the consideration it receives for the asset is subsequently considered to be inadequate AND
(2) the company was insolvent before the transaction, or the transaction itself renders the company insolvent
- occurs regardless of whether actual fraud was involved
How are tax gains often created by restructuring a company? What is the situation called? How is it dealt with?
- referred to as a COD “cancellation of indebtedness”
- When a downward revaluation of the Company results in a value differential between the New consideration given by the company and the face amount of the original debt
- can be offset by NOLs so long as Section 382 of the IRC isn’t triggered
Section 382
Of the Internal Revenue Code
-restricts companies ability to use NOLs After a change of control (defined as stockholders owning more than 5% each of the Company having traded more than 50% of the Company’s stock in the past 3 years)
-would result in payment of a tax gain on a cancellation of indebtedness, rather than an
Offset against NOLs. NOLs would then be limited to annual usage equal to federal long term tax exempt rate x new equity market cap
How can an entity acquire back-door control of a company?
Through the purchase of a controlling portion of a distressed company’s unsecured debt
What is a Stalking Horse?
A “lead bidder” that provides a minimum price that a debtor would receive for its assets in a bankruptcy auction sale
By entering into agreement, stalking horse forgoes opportunity to buy asset at a lower price if there isn’t a lot of interest at the auction. In return, it often gets over-bid protection, break up fees and ability to negotiate a favorable definitive purchase agreement.
Absolute priority rule
-section 1129 of Bankruptcy Code
Provides that there is a cascading waterfall of value starting with the most senior creditor class and that no more junior creditor can be paid unless the class senior to them receives a 100% recovery
Why should old equity receive something meaningful when restructuring?
+methods of providing it
1) old equity still could have economic value even if it is out of the money
2) old equity generally controls the board and restructuring process at the outset of negotiations and should still negotiate to support the equity
Options
- modest % of equity outright
- larger ownership position through slug of warrants
- can provide cash to buy back ownership in company
A going concern
A company continuing its business as an operating entity. (And therefore being valued as a cash generating enterprise)
If a company is unable to continue “as a going concern”, it may have to liquidate
What is a liquidation analysis?
Assumes company shuts its doors to stop cash drain and all remaining assets would be disposed of grouch auctions, other sales, and attempts to collect on receivables
What are typically excluded from eligible receivables?
What would drive the Advance Rate?
- overdue payments
- excessively high concentrations of receivables with a single customer or industry
- market conditions
- whether customers in certain industries attempt to refuse payments to bankrupt companies (i.e. Auto manufacturers claiming defects)
An overline
The opposite of a reserve in a borrowing base
Allows company to borrow in excess of the borrowing base for a while
A quick proxy for cost of capital
If the terminal multiple could be calculated as 1/(cost of capital - growth rate), then cost of capital would equal
=1/multiple + growth rate
What are three usual targets of fraudulent conveyance litigation and under what circumstances?
-Groups that obtained some benefit prior to bankruptcy
1) Secured lenders that received paydowns or collateral grants
2) stockholders that received dividends
3) third parties that have bought assets from the company
4) parent companies receiving debt with a guaranty from an operating subsidiary that doesn’t receive any of the issuance
What concepts are in the definition of insolvency per the bankruptcy code?
1- the value of assets being below the value of liabilities
2-the company being unable to pay debts as they become due
3- the company being left with unreasonably small capital with which to conduct their business
If a plaintiff wins a fraudulent conveyance lawsuit against a buyer of the bankrupt company’s assets, what would happen?
the buyer would have to contribute funds to the estate representing at least part of the difference between what the buyer paid at the time of the transaction and what the business was later determined to have been worth at the time of the sale
What is equitable subordination?
the power of the bankruptcy court to examine the behavior of the company’s constituencies to see if their actions adversely or unfairly affected the estate. If so, the court can subordinate the party’s claim to other party’s at the same level of seniority
-Ex a creditor taking steps to advantage itself unfairly relative to other creditors could have its claim subordinated to those other creditors
What is a “technical default”? What is it’s impact?
- A default under a loan agreement related to a breach of a financial covenant or other such promise
- gives secured lenders the right to call their loans, but in practice, it gives them the ability to approve or disapprove of the company’s course of action AND block interest payments to subordinated debt
- NOT A PAYMENT DEFAULT
What is a “market test” in restructuring?
When buyers compete with internal reorganization plan values in a sale process
Which party typically provides the PSA in a distressed situation? Why?
The seller
(1) time is saved
(2) key issues important to the seller are highlighted
(3) competing bids are more easily compared (because the buyers are at least starting from the same agreement)
What is a “MAC” clause?
A Material Adverse Change Clause
-allows a buyer to drop out of the deal if a major problem emerges with the sellers business or prospects
What is an IPOR?
- Internal Plan of Reorganization
- AKA “a standalone plan”
- a plan that can only be effected in a Ch 11 setting that does not require new equity financing or involve the sale of substantially all the debtors assets
The primary difference between an in-court and out-of-court restructuring
1) control (no judge in out-of-court)
2) holdouts (no ch 11 to bind all members of a class of creditors)
3) protection for officers/directors (less in out-of-court)
4) contingent claims (can be compromised in-court but no mechanism to deal with claims in out-of-court)
5) organization (in Ch 11, company needs to formally organize its creditors)
What is an “out of court stretch out”?
when a company may not be able to repay its banks or its trade on the original terms, so they ask for more time in exchange for transaction fees/increased interest rates/ grants of collateral interest / etc
What is a “pre-pack”?
- A pre-packaged plan of reorganization
- established as a path to an out-of-court exchange offer, in which creditors choose to exchange their bonds for new consideration (stock/bond/cash). If those electing are greater than the minimum tender condition (e.g. 90-95%), than the company can pursue the out-of-court path. If the minimum isn’t reached, then each creditors favorable election would count as a vote toward bankruptcy restructuring and if 67% of the bonds and 50% of the creditors voted in favor, then the pre-pack could be effected in Ch 11
- solicitation of notes is pursuant to SEC regulations
- creditors are legally bound to plan
What is a “pre-negotiated plan”?
when a company and its major creditor constituencies agree in principal on a restructuring plan and agree to implement it in Ch 11
-faster than pre-pack and creditors are not legally bound to plan
A company’s emergence from bankruptcy is dependent on receiving exit financing that will permit it to:
1) operate post ch 11
2) replace credit facilities that must be addressed per terms of the IPOR (i.e DIP)
3) have sufficient cash to sprinkle over creditors (especially trade creditors)
4) pay administrative claims
What are the disclosure statement and attendant plan?
-similar to offering documents; contain the requisite information required for creditors and interest holders to make a decision as to how to vote for a plan of reorganzation
What is the “best interests of creditors requirement”?
the bankruptcy code requirement that creditors are receiving more than they would in a liquidation
what forms the “Accepting Interest Holders Class”?
For a class of interest holders to accept a plan under Ch 11, in excess of 50% of the share in each such class must approve
what is an allowed claim? what are the other types of claims?
A claim that has:
1- been timely filed (by the bar date)
2- been agreed to in amount by the debtor and creditor
- if the amount has not been agreed to, its referred to as a “disputed” claim
- disallowed - a claim excluded from the estate
“chapter 22”
a term to refer to companies that return to Ch 11 once they fail after being reorganized the first time
in order for a Plan of Reorganization to be followed, it must first be ________ by the bankruptcy court
confirmed
consent solicitation
when a company with widely traded public debt seeks an approval to change or amend the terms or nature of their debt
a “credit bid”
a lenders use of a secured claim in lieu of cash in a section 363 auction
an examiner
appointed by the court with powers to pursue an investigation if the court is faced with questions regarding inappropriate conduct from one or more constituencies
foreclosure
steps taken by lender to seize the collateral underlying their loans
an indenture
the contract between a company and th ehoders of its bonds
release
a release from ligation claims frequently granted pursuant to the Plan of Reorganization or through an out-of-court plan
section 341 hearing
an organization meeting early in a bankruptcy case involving unsecured creditors, the US Trustee and the company
What is a “section 363 sale”?
an exception under bankruptcy code that allows a debtor to auction assets if the assets value is sinking fast or the company cannot afford the cash burn through the consummation of the plan
-allows the court to give buyers assurances regarding clean title
what is the role of the U.S. Trustee?
works in conjunction with the bankruptcy court to appoint members of the UCC and supervise fee applications submitted by professionals
work fees
requested by senior lenders to reimburse them for the costs of additional diligence prior to extending a company additional funds
a Potemkin village
something built solely to deceive others into thinking that a situation is better than it really is
-origin facke portable villages built only to impress Empress Catherin during her journey to Crimea
