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Bankruptcy,Bankruptcy,
Reorganization, andReorganization, and
LiquidationLiquidation
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Agenda
Financial distress process
Federal bankruptcy law (Undang-undang No. 37tentang Kepailitan dan Penundaan Kewajiban Pembayaran Utang
) Reorganization
Liquidation
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What are the major causesof business failure?
Economic factors
industry weakness
poor location/product
Financial factors
too much debt
insufficient capitalMost failures occur because a number offactors combine to make the businessunsustainable.
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Do business failures occur evenly over
time?
A large number of businesses fail each
year, but the number in any one year hasnever been a large percentage of the totalbusiness population.
The failure rate of businesses has tendedto fluctuate with the state of the economy.
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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 fromexternal sources to avoid bankruptcy,given their greater impact on the
economy.
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What key issues must managers
face in the financial distress process?
Is it a temporary problem (technicalinsolvency) or a permanent problem
caused by asset values below debtobligations (insolvency in bankruptcy)?
Who should bear the losses?
Would the firm be more valuable if it
continued to operate or if it wereliquidated?
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Should the firm file for bankruptcy, orshould it try to use informal procedures?
Who would control the firm duringliquidation or reorganization?
PT Mandala Airlines mengajukan permohonan penundaan
kewajiban pembayaran utang (PKPU) untuk merestrukturisasi
kembali bisnis perusahaannya melalui Pengadilan Negeri
Jakarta pusat dan terdaftar dengan nomor
01/PKPU/2011/PN.Niaga.Jkt.Pst.
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What informal remedies are available
to firms in financial distress?
Informal reorganization
Informal liquidation
Why might informal remedies bepreferable to formal bankruptcy?
What types of companies are most
suitable for informal remedies?
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Informal Bankruptcy Terminology
Workout: Voluntary informalreorganization plan.
Restructuring: Current debt terms are
revised to facilitate the firms ability to pay. Extension: Creditors postpone the dates of
required interest or principal payments, orboth. Creditors prefer extension because they
are promised eventual payment in full.
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Composition: Creditors voluntarily reducetheir fixed claims on the debtor by eitheraccepting a lower principal amount oraccepting equity in lieu of debt repayment.
Assignment: An informal procedure forliquidating a firms assets. Title to thedebtors assets is transferred to a thirdparty, called a trustee or assignee, andthen the assets are sold off.
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Describe the following terms related to
U.S. bankruptcy law:
Chapter 11: Business reorganizationguidelines.
Chapter 7: Liquidation procedures.
Trustee:
Appointed to control the company whencurrent management is incompetent or fraudis suspected.
Used only in unusual circumstances.
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Voluntary bankruptcy: Abankruptcy petition filed in federalcourt by the distressed firms
management.
Involuntary bankruptcy: Abankruptcy petition filed in federal
court by the distressed firmscreditors.
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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.
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Reorganization in Bankruptcy
Avoids holdout problems.
Due to automatic stay provision, avoidscommon pool problem.
Interest and principal payments may be
delayed without penalty untilreorganization plan is approved.
(More...)
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Permits the firm to issue debtor inpossession (DIP) financing.
Gives debtor exclusive right to submit a
proposed reorganization plan foragreement from the parties involved.
Reduces fraudulent conveyance problem.
Cramdown if majority in each creditorclass approve plan.
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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 creditorsprior to filing for bankruptcy.
Plan filed with bankruptcy petition.
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List the priority of claims in a
Chapter 7 liquidation.
Secured creditors.
Trustees administrative costs.
Expenses incurred after involuntary casebegun but before trustee appointed.
Wages due workers within 3 months prior
to filing.
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Unpaid contributions to employeebenefit plans that should have been paidwithin 6 months prior to filing.
Unsecured claims for customer deposits. Taxes due.
Unfunded pension plan liabilities.
General (unsecured) creditors. Preferred stockholders.
Common stockholders.
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Liquidation Illustration Data
(millions of $)
Creditor Claims:Accounts payable $10.0Notes payable 5.0
Accrued wages 0.3Federal taxes 0.5State and local taxes 0.2First mortgage 3.0Second mortgage 0.5
Subordinated debentures* 4.0$23.5
*Subordinated to notes payable.
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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.
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Priority Distribution
(millions of $)
Creditor ClaimDistributionUnsatisfiedAccrued wages $0.3 $0.3 $0.0Federal taxes 0.5 0.5 0.0
Other taxes 0.2 0.2 0.0First mortgage 3.0 2.5 0.5Second mortgage 0.5 0.0 0.5
$4.5 $3.5 $1.0
Notes: (1) First mortgage receives entire proceeds from sale offixed assets, leaving $0 for the second mortgage.
(2) $16.5 - $3.5 = $13.0 remains for distribution to general
creditors.
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General Creditor Distribution
(millions of $)Remaining Initial Final Percent
Creditor GC Claim Distrib.a Amountb Received
Accounts payable $10.0 $6.500 $6.500 65.0%
Notes payable 5.0 3.250 5.000 100.0
Accrued wages 0.0 0.300 100.0Federal taxes 0.0 0.500 100.0
Other taxes 0.0 0.200 100.0
First mortgage 0.5 0.325 2.825 94.2
Second mortgage 0.5 0.325 0.325 65.0
Sub. deb. 4.0 2.600 0.850 21.2
$20.0 $13.000 $16.500
a. Pro rata amount = $13/$20 = 0.65.b. Includes priority distribution and $1.75 transfer from subordinated
debentures.
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Other Motivations for Bankruptcy
Normally, bankruptcy is motivated byserious current financial problems.
However, some companies have usedbankruptcy proceedings for otherpurposes:
To break union contracts
To hasten liability settlements
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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 alivetoo long, leaving little for creditors when
liquidation does occur. Companies in bankruptcy can hurt other
companies in industry.
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MDA to predict bankruptcy
Recent business failures
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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 enteredinto the model to assess the likelihood offuture bankruptcy.
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MDA Illustration
Assume you have the following 1997 datafor 12 companies:
Current ratio
Debt ratio
Six of the companies (marked by Xs) wentbankrupt in 1998 while six (marked bydots) remained solvent.
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Current Ratio
Debt Ratio
.. .
.
. .X
X
X
X
X
X
Discriminant Boundary
Bankrupt
Firms
Solvent
Firms
(More...)
= Solvent
X = Bankrupt
.
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The discriminant boundary, or Z line,statistically separates the bankrupt andsolvent companies.
Note that two companies have beenmisclassified by the MDA program: Onebankrupt company falls on the solvent (left)side and one solvent company falls on the
bankrupt (right) side.
(More...)
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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.
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Using MDA To Predict Bankruptcy
Suppose Firm Shas 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.
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Some Final Points
The most well-known bankruptcyprediction model is Edward Altmans fivefactor model.
Suchmodels tend to work relatively well,but only for the near term.
The more similar the historical sample tothe firm being evaluated, the better theprediction.
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