Deck 17: Alternative Exit and Restructuring Strategies:

Question 1

Financial buyers (both hedge funds and private equity investors) clearly are motivated by the potential profit they can make by buying distressed debt. Their actions may have both a positive and negative impact on parties to the bankruptcy process. Identify how parties to Hostess bankruptcy may have been helped or hurt by the actions of the hedge funds and private equity investors.

Answer 1

Hedge funds and other investor groups provide liquidity in the distressed debt and equity markets by enabling those creditors and shareholders desirous of selling their claims on the failing firm to cash out. Moreover, these financial investors may provide a more vigorous competitive bidding environment during any auction that might be held as a result of the bankruptcy process. Finally, the presence of financial buyers may expedite the process for transferring the failing firm's assets into the hands of those who can manage them more efficiently. However, the focus of financial investors on short-term profits may force the debtor firm's trustee to rush the development of a reorganization plan to create a viable firm, resulting in a plan that is unacceptable to the bankruptcy court judge and a majority of other creditors. As a result, Chapter 7 or a 363 sale may be viewed as the only viable options.

Question 2

types of businesses are most appropriate for Chapter 11 reorganization, Chapter 7 liquidation, or a Section 363 sale? What factor(s) drove Hostess into a Section 363 sale?

Answer 2

Although intended to give firms time to restructure, whether a business is likely to be successful in Chapter 11 in part depends on the type of business and the circumstances under which it seeks the protection of the bankruptcy court. For example, a firm may be technically insolvent but still have sufficient cash flow to meet its immediate liquidity requirements; consequently, such firms may be able to survive the length of time often required to hammer out a reorganization plan among the various parties to the bankruptcy. In contrast, a firm may be solvent but illiquid due to deteriorating cash flow. Such firms may be good candidates for Chapter 7 if it is deemed that their assets are likely to maintain their value during the bankruptcy process but that they have insufficient cash flow to meet if even minimal working capital requirements.
Chapter 7 liquidations appear to be as costly in terms of legal expenses and related fees, as well as the time required to complete the proceedings, as Chapter 11 reorganization. However, studies show that Chapter 11 reorganization allows creditors to recover relatively more of their claims than under liquidation. In liquidation, bankruptcy professionals, including attorneys, accountants, and trustees, often end up with the majority of the proceeds generated by selling the assets of the failing firm.
Time is the critical factor in choosing a 363 sale. For firms whose asset values and cash flow are deteriorating rapidly, a highly controlled and accelerated bankruptcy may be the only answer. In these instances, a Section 363 sale may be most appropriate.
Hostess was forced into a 363 sale due to a lack of time (and perhaps will) to reorganize. Running out of cash, with both management and labor at loggerheads due to a lack of trust, and wanting to capitalize on an emotional outpouring of nostalgia and media coverage for the brand, Hostess's creditors needed a quick exit to preserve whatever asset value remained. As configured, the business' problems did not appear fixable and lenders were looking for a way to recover as much of what they were owed as possible. A 363 sale offered such an option because of the rapidity of the auction process and the likelihood of getting the highest values for the assets.

Question 3

Hostess's assets were sold in a 363 auction. Such auctions attract both strategic and financial bidders. Which party tends to have the greater advantage: the strategic or financial bidder? Explain your answer.

Answer 3

Strategic buyers are by definition interested in buying a business and integrating it into their existing operations because they perceive significant synergy. Acquisitions out of bankruptcy often provide a means of acquiring valuable assets free and clear of all liens at a significant discount from their book value. In contrast, financial buyers such as hedge funds rely on their ability to buy heavily discounted distressed debt and to subsequently acquire the firm's assets through a credit bid in which their claims are valued at face value rather than what they actually paid. This gives financial buyers the ability to set the initial bid a relatively high level which may discourage some bidders.
Whether the strategic or financial buyer has an advantage in the auction process usually depends on which party is better able to execute its strategy. The strategic buyer's advantage is dependent on their ability to accurately assess, value, and realize expected synergies. As explained elsewhere in this book, each of these activities involves significant challenges. While financial buyers also run a risk of overpaying for the debt, their fortunes are heavily impacted by circumstances often beyond their control. If the firm is truly in a free fall, the value of the assets may deteriorate very rapidly limiting the ability of the financial buyer to recovery their initial investment when they subsequently try to sell the assets they have acquired in the auction.

Question 4

are the primary objectives of the bankruptcy process? Speculate as to why this process may have failed in reorganizing Hostess Brands?

Question 5

Financially distressed firms also affect communities in which they are located in terms of increasing unemployment and eroding the tax base.

Question 6

4 Describe the probable trend in financial returns to shareholders of firms that emerge from bankruptcy. To what do you attribute these trends? Explain your answer.

Question 7

Reforms in creditor rights tend to increase the availability and reduce the cost of credit in countries where court enforcement is quick and fair.

Question 8

9 In recent years, hedge funds have engaged in so-called "loan-to-own" pre-bankruptcy investments in which they acquire debt from distressed firms at a fraction of face value. Subsequently, they move the company into Chapter 11 intent upon converting the acquired debt to equity in a firm with sharply reduced liabilities. The hedge fund also provides DIP financing to further secure its interest in the business. The emergence from Chapter 11 is typically accomplished under section 363 (k) of the bankruptcy code which gives debtors the right to bid on the firm in a public auction sale. During the auction, the firm's debt is valued at face rather than market value, effectively discouraging any other bidders other than the hedge fund which acquired the debt prior to bankruptcy at distressed levels. Without competitive bidding, there is little chance of generating additional cash for the general creditors. How might this be viewed as an abuse of the Chapter 11 bankruptcy process?

Question 9

might the way in which Hostess Brands Inc. grew have contributed to its eventual financial distress?

Question 10

3 What are the primary options available to a failing firm? What criteria might the firm use to select a particular option? Be specific.

Question 11

Automotive emerged from Chapter 11 protection in mid-2008. The firm obtained exit
financing consisting of $110 million revolving credit facility, a $50 million European first-lien term loan, and an $84 million U.S. second-lien loan. The reorganization plan specifies how some portion of the proceeds of these loans would be used. What do you believe might be typical stipulations in reorganization plans for using such funds? Be specific.

Question 12

2 Although most companies that file for bankruptcy do so because of their deteriorating financial position, companies increasingly are seeking bankruptcy protection to avoid litigation and hostile takeovers. Give examples of how bankruptcy can be used to avoid litigation.

Question 13

Comment on the fairness of the 363 auction process to Hostess shareholders, lenders, employees, communities, government, etc. Be specific.

Question 14

Hostess Brands Inc.

Question 15

capital markets to function smoothly, disputes involving the legal rights of all participants (both debtors and creditors) need to be resolved quickly and equitably by the courts.

Question 16

8 What are the primary factors contributing to business failure? Be specific.

Question 17

1 Why would creditors make concessions to a debtor firm? Give examples of common types of concessions made?

Question 18

6 On June 25, 2008, JHT Holdings, Inc., a Kenosha Wisconsin-based package delivery service, filed
for bankruptcy. The firm had annual revenues of $500 million. What would the firm have to demonstrate for its petition to file for bankruptcy to be accepted by the bankruptcy court?

Question 19

10 American Home Mortgage Investments, a major U.S. mortgage lender, filed for Chapter 11 bankruptcy in late 2008. The company indicated that it chose this course of action because it represented the best means of preserving the firm's assets. W.L. Ross and Company agreed to provide the firm $50 million in debtor in possession financing to meet its anticipated cash needs while in Chapter 11. Comment on the statement that bankruptcy provides the best means of asset preservation. Why would W.L. Ross and Company lend money to a firm that had just filed for bankruptcy?

Question 20

Identify at least two financial or non-financial variables that have been shown to affect firm
defaults and bankruptcies? Explain how each might affect the likelihood the firm will default or seek Chapter 11 protection?

Question 21

Credit ratings provided by Moody's and Standard & Poor's are highly reliable indicators of a firm's degree of financial distress.

Question 22

A firm is not bankrupt or in bankruptcy until it files or its creditors file a petition for reorganization or liquidation with the federal bankruptcy courts.

Question 23

A workout is an arrangement conducted inside of bankruptcy court by a debtor and its creditors for payment or re-scheduling of payment of the debtor's obligations.

Question 24

A debt-for-equity swap occurs when the distressed firm's shareholders are willing to surrender a portion of their ownership for debt in the firm.

Question 25

A debt-for-equity swap occurs when creditors surrender a portion of their claims on the firm in exchange for an ownership position in the firm.

Question 26

The debtor firm often initiates the voluntary settlement process, because it generally offers the best chance for the current owners to recover a portion of their investments either by continuing to operate the firm or through a planned liquidation of the firm.

Question 27

By law, corporate liquidation can only be conducted outside of the U.S. bankruptcy court.

Question 28

firm is said to be bankrupt once it defaults on a bond payment.

Question 29

A debt extension occurs when creditors agree to lengthen the period during which the debtor firm can repay its debt.

Question 30

If the creditors conclude that the insolvent firm's situation cannot be resolved, liquidation may be the only acceptable course of action.

Question 31

A composition is an agreement in which creditors agree to settle for less than the full amount they are owed.

Question 32

Large companies often have a difficult time achieving out-of-court settlements because they usually have hundreds of creditors.

Question 33

If a creditor is owed a large amount of money, it could become a major or even the controlling shareholder in the reorganized firm.

Question 34

Bankruptcy is a state-level legal proceeding designed to protect the technically or legally insolvent firm from lawsuits by its creditors until a decision can be made to shut down or to continue to operate the firm.

Question 35

If the insolvent firm is willing to accept liquidation, legal proceedings are not necessary, regardless of what the creditors think.

Question 36

term financial distress could apply to a firm unable to meet its obligations or to a specific security on which the issuer has defaulted.

Question 37

Increasingly, distressed companies are choosing to restructure inside of bankruptcy court, rather than reaching a general agreement with creditors before seeking Chapter 11 protection.

Question 38

Legal insolvency occurs when a firm's liabilities exceed the book value of its assets.

Question 39

Through a process called an assignment, a committee representing creditors grants the power to liquidate the firm's assets to a third party called an assignee or trustee.

Question 40

firm is said to be technically solvent when it is unable to pay its liabilities as they come due.

Question 41

If a firm enters into a workout in which a voluntary negotiated agreement with debtors is achieved, the firm may lose its right to claim NOLs in its tax filing.

Question 42

In the absence of a voluntary settlement out of court, the debtor firm may seek protection from its creditors by initiating bankruptcy. However, creditors cannot force the debtor firm into bankruptcy.

Question 43

Chapter 11 of the U.S. bankruptcy code deals with liquidation while Chapter 7 addresses reorganization.

Question 44

Under a prepackaged bankruptcy, the debtor negotiates with creditors well in advance of filing for a Chapter 7 bankruptcy.

Question 45

As part of a Chapter 15 proceeding, the U.S. bankruptcy court may authorize a trustee to act in a foreign country on behalf of the U.S. Bankruptcy Court.

Question 46

The filing of a petition triggers an automatic stay once the court accepts the request, which provides a period suspending all judgments, collection activities, foreclosures, and repossessions of property by the creditors on any debt or claim that arose before the filing of the bankruptcy petition.

Question 47

The court must approve any plan accepted by the debtor's shareholders and creditors. True of False

Question 48

Empirical studies show that company size (measured by assets), case duration (measured in days), and the number of parties involved in the proceedings (measured in terms of the numbers of professional firms working) explain most of the case-to-case variation in professional fees.

Question 49

The court can ignore the objections of creditors and stockholders if it feels the reorganization is both fair and feasible.

Question 50

Federal law prohibits trading in a bankrupt firm's securities.

Question 51

Prior to the Bankruptcy Abuse Protection and Consumer Protection Act of 2005, the debtor had the exclusive right to file a plan of reorganization for the first 120 days after it filed the case.

Question 52

In the absence of a voluntary settlement out of court, the debtor firm may seek protection from its creditors by initiating bankruptcy or may be forced into bankruptcy by its creditors.

Question 53

U.S. bankruptcy laws and practices focus on maintaining shareholder value during the bankruptcy process.

Question 54

Automatic stays are granted by the court only when the debtor files for bankruptcy.

Question 55

In liquidation, bankruptcy professionals, including attorneys, accountants, and trustees, often end up with the majority of the proceeds generated by selling the assets of the failing firm.

Question 56

Chapter 11 reorganization often enables creditors to recover relatively more of their claims than under liquidation.

Question 57

The purpose of Chapter 15 of the U.S. Bankruptcy Code is to prioritize the payment of creditors.

Question 58

Companies may not seek the protection of bankruptcy court to avoid liquidation. True of False

Question 59

Prepackaged bankruptcies are less common today than in years past.

Question 60

Prior to the Bankruptcy Abuse Protection and Consumer Protection Act of 2005 (BAPCPA), commercial enterprises used Chapter 11 Reorganization to continue operating a business and to repay creditors through a court-approved plan of reorganization.

Question 61

restructuring of a bankrupt firm is usually accomplished in which of the following ways:

A) An extension
B) A composition
C) A debt for equity swap
D) Some combination of a, b, or c
E) All of the above

Question 62

If the selling price of the failing firm is less than the going concern and liquidation value, the firm should sell the firm to another party.

Question 63

All of the following are true about voluntary liquidations except for

A) They can be conducted outside of court in a private auction.
B) They can be done within the protection of the bankruptcy court.
C) Creditors normally prefer liquidations to be conducted by the bankruptcy court.
D) A trustee is assigned to sell the debtor firm's assets as quickly as possible while obtaining the best possible price.
E) If the insolvent firm is willing to accept liquidation and all creditors agree, legal proceedings are not necessary.

Question 64

Chapter 11 reorganization may involve a corporation, sole proprietorship, or partnership.

Question 65

While bankrupt firms generally are unable to meet the listing requirements of the major stock exchanges, their shares may trade in the over-the-counter market.

Question 66

Which of the following statements is not true?

A) Technical insolvency arises when a firm is unable to meet its obligations when they come due.
B) Legal insolvency occurs when a firm's liabilities exceed the fair market value of its assets.
C) A firm must be legally insolvent to enter bankruptcy.
D) Bankruptcy is a legal proceeding which protects a debtor firm from its creditors.
E) A firm is not considered bankrupt until its petition for bankruptcy is accepted by the court.

Question 67

Economic distress arises when a firm's growth and investment prospects deteriorate, causing a reduction in the value of the business due to the deteriorating outlook for the firm's cash flow.

Question 68

would creditors be willing to give a portion of what they are owed by the debtor firm for equity in the reorganized firm?

A) They are legally obligated to do so under U.S. bankruptcy law.
B) Ownership in a firm is inherently more valuable than being a creditor.
C) The value of the stock may in the long run far exceed the amount of debt the creditors were willing to forgive.
D) Creditors understand that they can sue the firm at a later date for what they are owed.
E) None of the above.

Question 69

If the going concern value is less than the selling or liquidation price, the firm should seek the protection of the bankruptcy court.

Question 70

Smaller creditors have little incentive to attempt to hold up the agreement unless they receive special treatment.

Question 71

determine which strategy to pursue, the failing firm's management needs to estimate which of the following:

A) Going concern value
B) Liquidation value
C) Selling price of the firm
D) A and B only
E) A, B, and C

Question 72

of the following are true of the bankruptcy process except for

A) The debtor firm may seek protection from its creditors by initiating bankruptcy or may be forced into bankruptcy by its creditors.
B) When creditors file for bankruptcy on behalf of the debtor firm, the action is said to be involuntary bankruptcy.
C) Once either a voluntary or involuntary petition is filed, the debtor firm is protected from any further legal action related to its debts until the bankruptcy proceedings are completed.
D) The filing of a petition triggers an automatic stay even before the court accepts the request.
E) An automatic stay suspends all judgments, collection activities, foreclosures, and repossessions of property by the creditors on any debt or claim that arose before the filing of the bankruptcy petition

Question 73

of the following are true except for

A) Chapter 15 deals with international or cross-border bankruptcies.
B) Chapter 11 deals with reorganizing the firm.
C) Chapter 7 defines the process and priorities of the liquidation process for commercial businesses.
D) Chapter 11 also addresses issues pertaining to personal bankruptcy.
E) A and B

Question 74

Which of the following are commonly used strategic alternatives for failing firms?

A) Merge with another firm
B) Reach out of court voluntary settlement with creditors
C) File for protection from creditors from the U.S. bankruptcy court
D) A, B, and C
E) A and B only

Question 75

All of the following are conditions most favorable for reaching settlement outside of bankruptcy court except for

A) The debtor firm is willing to share all necessary information with its creditors
B) Creditors have confidence in the debtor firm's management.
C) The debtor firm has relatively few creditors.
D) The debtor firm has many creditors.
E) The period of economic distress afflicting the firm is expected to be short-lived.

Question 76

leading causes of business failure include which of the following:

A) Recession
B) Excessive operating expenses
C) Excessive leverage
D) Management inexperience
E) All of the above

Question 77

All of the following represent different forms of debt restructuring except for

A) Debt extensions
B) Debt compositions
C) Share exchange ratios
D) Debt for equity swaps
E) A and D

Question 78

Financially distressed firms often are characterized by all of the following except for:

A) Underinvestment in operations
B) Employee layoffs
C) High levels of research and development spending
D) Declining product quality
E) Slower payments to suppliers

Question 79

Sales within the protection of Chapter 11 reorganization may be accomplished either by a negotiated private sale to a particular purchaser or through a public auction.

Question 80

Moody's credit rating agency defines instances of default as which of the following:

A) Missed or delayed payment of interest or principal
B) Bankruptcy
C) Receivership
D) Any exchange (equity for debt) diminishing the value of what is owed to bondholders
E) All of the above