Bankruptcy

•Bankruptcy can be a creative corporate finance tool. Reorganization through the bankruptcy process can in certain instances provide unique benefits that are unattainable through other means.
•Clearly, bankruptcy is a drastic step that is only pursued when other more favorable options are unavailable. A bankruptcy filing is an admission that a company has in some way failed to achieve certain goals.

Bankruptcy Overview

The Bankruptcy Act of 1978 (the Bankruptcy Code) is the main bankruptcy law of the United States. It organizes bankruptcy laws into eight odd-numbered chapters.



Economic Failure

•Economic failure is the more ambiguous. For example, economic failure could mean that the firm is generating losses; that is, revenues are less than costs.
•However depending on the users and the context, economic failure could also mean that the rate of return on investment is less than the cost of capital. It could also mean that the actual returns earned by a firm are less than those that were forecast.

Financial Failure

•Financial failure is less than ambiguous than economic failure. Financial failure means that a company cannot meet its current obligations as they come due. The company does not have sufficient liquidity to satisfy its current liabilities.

Causes of Business Failure

•The three most common factors of business failure were economic factors, such as weakness in the industry; financial factors, such as inefficient capitalization; and weaknesses in managerial experience, such as insufficient managerial knowledge.




•Research analysis shows that 10.7% of businesses failed in one year or less. Just under one-third of the companies were in business for three years or less, where as 44.3% existed up to five years.



Causes of Financial Distress

•Financial distress and bankruptcy have been linked to many of the highly leveraged deals that took place in the 1980’s.
•Studies have been conducted of a study of 29 leveraged recapitalizations that took place between 1984 and 1988. They defined leveraged recapitalizations as transactions that use proceeds from new debt obligations to make payouts to shareholders. The results show that 31% of the firms that completed leveraged recapitalizations encountered financial distress.

Chapter 11 Reorganization

•The purpose of the reorganization section (Chapter 11) of the Bankruptcy Code is to allow a reorganization plan to be developed that will allow the company to continue to operate. This plan will contain the changes in the company that its designers believe are necessary to convert it to a profitable entity.
•If a plan to allow the profitable operation of the business cannot be formulated, the company may have to be liquidated, with its assets sold and the proceeds used to satisfy the company’s liabilities.

Benefits of Chapter 11 Process for the Debtor



Chapter 7 - Liquidation

•Liquidation is a distressed firm’s most drastic alternative, and it is usually pursued only when voluntary agreement and reorganization cannot be successfully implemented. In a liquidation, the company’s assets are sold and the proceeds are used to satisfy claims, priority as follows:











Last modified: Tuesday, August 14, 2018, 8:43 AM