Bankruptcy and Restructuring

Why this matters

With luck you'll never own a company on the day it files for bankruptcy. The reason to learn how it works is that it explains everything upstream of it. Capital Structure said too much debt can destroy more value than it adds. Debt, Covenants, and Credit Ratings said control moves toward lenders as a company weakens. This lesson shows where that road ends and what's left for shareholders when it does.

Before bankruptcy

A company in trouble with its debts can try to fix the problem outside court. The options, roughly in order of how much they cost shareholders:

• Renegotiate. Ask lenders to relax a covenant or push back a repayment date, for a fee and a higher interest rate.
• Sell assets. Raise cash by selling businesses, as in Spin-Offs and Divestitures, as a seller without much time.
• Issue new shares. Raise cash from shareholders or new investors at a price that reflects the trouble.
• Swap debt for shares. Persuade lenders to accept ownership in place of some of what they're owed.

	Before	After
Value of the business	450	450
Debt	600	300
Value left for shareholders	none	150
Shares outstanding	50 million	500 million
Owned by the original shareholders	100%	10%
Value of the original shareholders' stake	none	15

The company owes more than it's worth. Lenders agree to cancel $300 million of debt in exchange for 450 million new shares, 90% of the company. The original shareholders keep a tenth of a company that's now solvent. That's better than nothing, which is what the order of priority would have given them, and it's why a deal like this can be agreed. The lenders accept it to avoid the cost and delay of a court process.

An agreement outside court has one weakness. Nothing can be imposed on a lender who refuses, so a single holdout can block it. That's the main thing a court process changes.

Chapter 11 and Chapter 7

US bankruptcy law offers a company two main routes.

• Chapter 11 is reorganization. The company usually proposes a plan to keep its business alive and pay creditors over time. Unless a trustee is appointed, it keeps possession and control of its assets while it does so, as what's called a debtor in possession.¹
• Chapter 7 is liquidation. A trustee is appointed to gather and sell the company's assets and use the proceeds to pay creditors.² A Chapter 11 case can also end in a sale of the assets, or be converted to Chapter 7.¹

Filing triggers what's called the automatic stay. Judgments, collection activities, foreclosures, and repossessions are suspended for debts that arose before the filing.¹ Lenders can't seize assets one by one, which gives the company room to keep trading and negotiate.

How a plan is approved

1. The company proposes. For the first 120 days only the company may file a plan, and the court can extend that period to as long as 18 months.¹
2. Claims are sorted into classes. A plan generally classifies them as secured creditors, unsecured creditors entitled to priority, general unsecured creditors, and shareholders.¹
3. The court approves a disclosure statement with enough information for creditors to judge the plan, and only then can votes be sought.¹
4. Creditors vote. Those who'll be paid less than they're owed, or whose rights will change, vote by class. A class accepts if creditors holding at least two thirds of the amount and more than half the number of its claims vote in favour.¹
5. The court confirms. It holds a hearing, and confirmation generally releases the company from the debts that arose before it.¹

One rule shapes the whole negotiation. If a class of unsecured creditors rejects the plan, the court can still confirm it, but only if that class is paid in full or nobody ranking below it receives anything.³ Shareholders rank below every creditor. So they can keep something only if all the creditors are paid in full, or if the creditors agree to let them.

The rest of this lesson is for members

Still to come in this lesson: What a reorganization looks like, What a shareholder sees, The warnings that come first, the key takeaways, and 2 quiz questions with explanations.

Membership opens every lesson in the curriculum, the capstone projects, the interactive tools, and the members-only channels in the Hyperion Entities Discord. The first lesson of every module stays free.

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