Learn about Chapter 11: Bankruptcy Restructuring Video

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Learn about Chapter 11: Bankruptcy Restructuring

In the last video, we talked about the scenario where company for whatever reason. It just couldn’t pay its debt holder. So this is their debt holders right here. This is the debt of the liabilities. It couldn’t pay its debt holders. It went into bankruptcy and it was determined that these assets that they had right here. It made no sense operating them as a company and then the bankruptcy court essentially just decided to liquidate it and we learned that the debt holders we’re actually more senior than the equity holders. And they get paid first and if there wasn’t enough money to pay all of the debt holders then the equity holders got nothing and that was called equity. So that was a chapter seven and we’re just focusing on the corporate world right now maybe well do personal soon. So that chapter seven liquidation that was the last video. And in that case and I think that was the most people associate when you say that our company has gone bankrupt. That will just disappear that people to say okay these assets don’t make any sense. They can't pay these guys, we’re just going to take this into possession by the courts and then just liquidate the assets. But that raises kind of obvious question of what if these assets are worth something? You know what if I sell a socks web site and socks have gotten even more popular. And the only problem is I just can't pay all of the interests that I owned on the debt, right? Maybe for whatever reason I took out of to really crazy loan that was variable rate or for some reason I have to pay back some loans because I mess you know. And I'll talk more about covenants and things like that. Covenants are pretty much a bunch of rules that the debt holder say look your good but if any of these X, Y, or Z things happen. We can take you into bankruptcy and we could force you into bankruptcy. So maybe because of that I'm in bankruptcy but it’s determined that these assets right here are actually worth more as an operating entity than they are if you were to liquidate them. You know good example might be I don’t know a car company right. So let’s say, let's actually take these examples of car company that’s very, its very sealant to our--to at least was. I've heard a lot less about the auto bail outs but it was very sealant in the end of last year. So let's say that you know these are car factories, car factories. You know land and whatever else and if we’re the debt holders. And let’s say its goes in a bankruptcy and let say it only went to the bankrupt. Let's say, this is generating cash and I'll tell you, I'll teach you in our future video. How do you see? What is the cash being generated by the assets? And then you have to subtract out you know the cash that has to be use to pay the debt holders because you’re paying interest. And then what’s left for equity and I'll show you how to do that in the income statement but let's say that this is generating a lot of cash, all right. It should be good with the cash but let's say you know these guys eat up interest. So some of the cash will go to the debt holders as an interest. And let's say for whatever reason either interest rates went up or they had a bad quarter or bad year and they just didn’t generate enough cash. Let's say they couldn’t pay off one of the debt holders and that debt holders says, ‘hey you couldn’t pay my interest payment or you can't pay the principle payment. I'm taking you into bankruptcy,” I'm taking you to bankruptcy. So it goes into bankruptcy and this is situation where immediately we realize that you know it makes no sense to shutter this assets. If we were just, shut down the factory and lay off the employers, we’re going to get nothing for this assets because you know the land is in a part of country where you know there's no obvious buyer for the land. An empty factory is pretty much useless especially when the other people in the industry are no in mood to buy the factories from you. So everyone decides in their best interests to keep this thing running. So what happens is that the deter stays in possession of the assets. So you kind of view the deters, the equity holders and the management of the company. So they stay in possession of the assets. And what actually what happens is because you know these guys didn’t have enough cash to pay off their debt holders. What happens is that they take on a new loan called the deter in possession mode and this new loan is the most senior loan. It’s called deep financing. It’s actually a great business although it’s become scares recently, deep financing. It’s a great business because you’re at the top of the stock. You’re more senior than even the senior guys. It’s called deep financing, deter in possession financing. And this what provides is a company with some kind of cushion cash, so that it keeps operating. So it keeps the lights on. So it’s essentially deter is very senior type of debt and it happens once a company has entered bankruptcy right. And this bankruptcy that we’re going to talk about is chapter 11. Chapter 11 restructuring and in chapter 11 restructuring, you keep operating the company. And what you want to do is you want to essentially, I mean you might do somethings on the left hand side of the equation. You might want to sell off some of the assets and all that but we will go to that. Most of what you do is you’ll rearrange this side of the balance sheet and this why you probably, you know every airlines have, some of them have gotten to bankruptcy multiple times but they still exists. It’s not like when you go into bankruptcy, the company just disappears. The assets will persist and all of this gets reorganize on this side. A lot of times when someone goes into chapter 11 and then they go. They you know come put of it and they go back into. They called that chapter 22 and then chapter 33 and I think you get the idea. So anyway, what happens in chapter 11? So the assets essentially it becomes kind of the bankruptcy court takes over and they hire some investments. They get the deter in possession financing. So that the company has some cash to operate, pay the bills and pay the employees and whatever else. The company keeps operating as it always would. So it can pay its suppliers and operate is in regular business. And then all of these guys hire a bunch of lawyers. So all of these guys hire a bunch of lawyers and they start and—well, I've accrued just these guys. And they start negotiating with each other and essentially they’ll be a bank associated with the bankruptcy court whose whole job and its all part of the negotiation is to value this. And its often you know maybe this deter right here, you’ll hire one bank. This deter will hire one bank maybe the management will hire another bank and everyone is going to come up with bankruptcy plans. But bankruptcy plans are usually of you know what are or more varieties. It’s essentially just saying well you know we need to value these assets right. We’re not selling it, so we’re not just going to get cash. We’re going to hire some bankers, well do a lot of videos on that in the future and they’re just going to say you know base on the prospects of this company. How fast this growing or how fast it’s not growing or how much cash is there in a year. Their going to assign a value to it. So let's say that this guy appears. He hires a banker and this banker say let me, let me; this was originally same situation for this. This was 10 billion and let's say that the lie booties were six million and that the original equity was four million right. And let's say these bankers evaluate the business. They make detail models. They you know, they take it into contacts with the current macro environment. And they say you know what I think this company is actually only worth five million dollars. I think this company is worth five millions and even though it’s worth five million dollars and we think that it can sustain, that it can sustain I don’t know only I can't—you know, it's only worth five million dollars and there's no way that it can pay interests on six million dollars of debt right. It doesn’t have enough cash to generate six million dollars of debt. We think it can afford two million dollars of debt right. So what will happen is the new company and this is just a plan. And then once you have a plan that everyone has to vote on it and there are things cram down, and will do that in more detail but the plan will say you know the assets are worth five million dollars. This plan might say you know those assets are worth five million dollars. So assets are worth five million dollars and the company can only handle two million dollars of debt not six million dollars of debt not six million dollars of debt. So now, this can only handle two million dollars of debt. And then there will be three million dollars left of equity right and I'll call this, the new equity because sometimes this can get confusing. So let's just say for a second and I want to think about it. What’s everyone incentive? This guy up here. He’s incentive is to value the company as slowly as possible right because if he gets more of the company and I'll think that will be clear to you in a second. And this guy incentive is say no; this company is worth a lot. So all of you guys are going to get paid back and then I'll get what’s leftover and you’ll probably asking. What do you get paid back if there's not actual for not liquidating? And the answer is the new shares of the company. So what happens is that this stock? Let's say this plan get pass. This plan right here. In this situation, these guys up here we’re the most senior right. Let's say there's two million dollars of senior debt up here. Let me write that in different color and its gets vary. There's two million dollars of senior debt up here. So what they’ll do is they’ll actually get two million dollars of the new debt. Their most senior and then all of these other, these other four million dollars for more junior. Let's see if I can color in and I know this hard to read. These other four million guys instead of getting, instead of getting any kind of cash or any kind of debt securities for having been owed this money. They’ll get the new stocks. So they’ll get three million dollars of new stock. Let's see if I can draw that in. They’ll get the three million dollars of new stocks. So these three million of new equity will go to these guys and this unsecured guy down here. He’s not going to get as much equity. He’ll be impaired a little bit and the old equity guys. Their stocks are going to go zero. There not going to get anything. So the old share holder companies are wiped out. They go to zero and essentially the debt holders, the debt holders become the new shareholders of the company. These guys become the new share holders company and you’ll often see when a company goes into bankruptcy but its getting reorganized. You’ll often see some people start to buy up this debt or these bonds right here. You’ll see people buy up these bonds because they want to be the new equity holders. They want to win their company emerges from bankruptcy. Let's say that is how it emerges from bankruptcy. They want to be these guys. The new equity holders because usually when you value it. You want to under value a little bit at least this. I know I've over drawn this picture a little bit too much but the debt guys especially the senior debt guys. They want to assign. They want to be safe. They want to say you know what, we’ve already been hurt by this company. Their already not paying our debt. We want us assign as lower possible value to the company’s possible or in this case five million dollars. So that we make sure, you know hopefully this their company will end up being worth 10 million dollars again. In which case, these guys right here, in which case these guys right here make out like bandits right. If their company was really worth 10 million but the bankruptcy court value at five million. These guys get all of the shares that company. These guys get wipe out even though the company really was worth something. So let's say the company emerges from bankruptcy like this. They actually turn out there worth 10 million dollars. Then let's say a year later and the company starts doing well again ad let's say that someone could value the company to get 10 million not only has two million dollars of debt. And now you have eight million dollars worth of equity, so these guys, you know maybe there are owed two or three million dollars before. They got three million dollars of the new equity. They might have made out like bandits because now all of a sudden that equity can be worth a lot that’s always the case but that’s how, that’s the view from the debt holders point of view. The equity holders you can imagine. They don’t want to be left with nothing. Then they’ll say, they’ll hire their own bankers and their banker goes probably submit a plan. It says no, no, no, no this company its worth at least eight million. It’s worth at least eight million, so you know it’s up here, eight million and we think you can handle I don’t know four million dollars of debt. So they didn’t want scenario like this. Well they think the company’s worth eight million, eight million. It can handle four million dollars worth of debt. It has four million dollars with that equity and of course. The first six million dollars of the value. So the four million dollars of debt and then two million of the equity will go to the debt holders right because there we owed six million dollars to begin with. And then what’s leftover which is essentially, so this two million of equity and then you have two million of equity here. This would go this two million of new equity right. This is the new shares of the company will be given to the old shareholders of the company. So that’s what the shareholders want. I know this gets a little confusing but its all about, it all ends up being valuing the assets as you emerge from bankruptcy. You say you know its generating cash. It’s worth something and then you pay people off according to seniority. And first you pay them off. You say, okay, I'll still you owe some money but this company can't support six million dollars. It cannot support two million and whatever there is else, whatever is left. People are paid with actually shares new shares of the company not the old shares. So the old shares will go to zero. So you can imagine a world where GM goes bankrupt. Right now, that shares of GM go to zero. GM old goes to zero but the assets keep operating and that’s why some people are a little bit misleading in this whole automotive bankruptcy debate. Their kind of using scare attack to say, oh if GM goes bankrupt that these assets are just going to disappear. No, they’ll just keep operating. If it makes sense to operate them, they’ll keep operating. The only people who lose big are the old equity holders and then some of the unsecured. The more junior levels of debt will probably loose some money but if the assets are worth operating, they’ll continue to operate. And if the people if it make sense to have them employed. They’ll keep working. See you in the next video.

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In the last video, we talked about the scenario where company for whatever reason. It just couldn’t pay its debt holder. So this is their debt holders right here. This is the debt of the liabilities. It couldn’t pay its debt holders. It went into bankruptcy and it was determined that these assets that they had right here. It made no sense operating them as a company and then the bankruptcy court essentially just decided to liquidate it and we learned that the debt holders we’re actually more senior than the equity holders. And they get paid first and if there wasn’t enough money to pay all of the debt holders then the equity holders got nothing and that was called equity. So that was a chapter seven and we’re just focusing on the corporate world right now maybe well do personal soon. So that chapter seven liquidation that was the last video. And in that case and I think that was the most people associate when you say that our company has gone bankrupt. That will just disappear that people to say okay these assets don’t make any sense.

They can't pay these guys, we’re just going to take this into possession by the courts and then just liquidate the assets. But that raises kind of obvious question of what if these assets are worth something? You know what if I sell a socks web site and socks have gotten even more popular. And the only problem is I just can't pay all of the interests that I owned on the debt, right? Maybe for whatever reason I took out of to really crazy loan that was variable rate or for some reason I have to pay back some loans because I mess you know. And I'll talk more about covenants and things like that. Covenants are pretty much a bunch of rules that the debt holder say look your good but if any of these X, Y, or Z things happen. We can take you into bankruptcy and we could force you into bankruptcy.

So maybe because of that I'm in bankruptcy but it’s determined that these assets right here are actually worth more as an operating entity than they are if you were to liquidate them. You know good example might be I don’t know a car company right. So let’s say, let's actually take these examples of car company that’s very, its very sealant to our--to at least was.

I've heard a lot less about the auto bail outs but it was very sealant in the end of last year. So let's say that you know these are car factories, car factories. You know land and whatever else and if we’re the debt holders. And let’s say its goes in a bankruptcy and let say it only went to the bankrupt. Let's say, this is generating cash and I'll tell you, I'll teach you in our future video. How do you see? What is the cash being generated by the assets? And then you have to subtract out you know the cash that has to be use to pay the debt holders because you’re paying interest. And then what’s left for equity and I'll show you how to do that in the income statement but let's say that this is generating a lot of cash, all right. It should be good with the cash but let's say you know these guys eat up interest. So some of the cash will go to the debt holders as an interest. And let's say for whatever reason either interest rates went up or they had a bad quarter or bad year and they just didn’t generate enough cash.

Let's say they couldn’t pay off one of the debt holders and that debt holders says, ‘hey you couldn’t pay my interest payment or you can't pay the principle payment. I'm taking you into bankruptcy,” I'm taking you to bankruptcy. So it goes into bankruptcy and this is situation where immediately we realize that you know it makes no sense to shutter this assets. If we were just, shut down the factory and lay off the employers, we’re going to get nothing for this assets because you know the land is in a part of country where you know there's no obvious buyer for the land. An empty factory is pretty much useless especially when the other people in the industry are no in mood to buy the factories from you. So everyone decides in their best interests to keep this thing running. So what happens is that the deter stays in possession of the assets. So you kind of view the deters, the equity holders and the management of the company. So they stay in possession of the assets.

And what actually what happens is because you know these guys didn’t have enough cash to pay off their debt holders. What happens is that they take on a new loan called the deter in possession mode and this new loan is the most senior loan. It’s called deep financing. It’s actually a great business although it’s become scares recently, deep financing. It’s a great business because you’re at the top of the stock. You’re more senior than even the senior guys. It’s called deep financing, deter in possession financing. And this what provides is a company with some kind of cushion cash, so that it keeps operating. So it keeps the lights on. So it’s essentially deter is very senior type of debt and it happens once a company has entered bankruptcy right. And this bankruptcy that we’re going to talk about is chapter 11. Chapter 11 restructuring and in chapter 11 restructuring, you keep operating the company. And what you want to do is you want to essentially, I mean you might do somethings on the left hand side of the equation. You might want to sell off some of the assets and all that but we will go to that.

Most of what you do is you’ll rearrange this side of the balance sheet and this why you probably, you know every airlines have, some of them have gotten to bankruptcy multiple times but they still exists. It’s not like when you go into bankruptcy, the company just disappears. The assets will persist and all of this gets reorganize on this side. A lot of times when someone goes into chapter 11 and then they go. They you know come put of it and they go back into. They called that chapter 22 and then chapter 33 and I think you get the idea. So anyway, what happens in chapter 11? So the assets essentially it becomes kind of the bankruptcy court takes over and they hire some investments. They get the deter in possession financing. So that the company has some cash to operate, pay the bills and pay the employees and whatever else. The company keeps operating as it always would. So it can pay its suppliers and operate is in regular business. And then all of these guys hire a bunch of lawyers. So all of these guys hire a bunch of lawyers and they start and—well, I've accrued just these guys.

And they start negotiating with each other and essentially they’ll be a bank associated with the bankruptcy court whose whole job and its all part of the negotiation is to value this. And its often you know maybe this deter right here, you’ll hire one bank. This deter will hire one bank maybe the management will hire another bank and everyone is going to come up with bankruptcy plans. But bankruptcy plans are usually of you know what are or more varieties. It’s essentially just saying well you know we need to value these assets right. We’re not selling it, so we’re not just going to get cash. We’re going to hire some bankers, well do a lot of videos on that in the future and they’re just going to say you know base on the prospects of this company. How fast this growing or how fast it’s not growing or how much cash is there in a year. Their going to assign a value to it. So let's say that this guy appears. He hires a banker and this banker say let me, let me; this was originally same situation for this. This was 10 billion and let's say that the lie booties were six million and that the original equity was four million right. And let's say these bankers evaluate the business. They make detail models. They you know, they take it into contacts with the current macro environment. And they say you know what I think this company is actually only worth five million dollars.

I think this company is worth five millions and even though it’s worth five million dollars and we think that it can sustain, that it can sustain I don’t know only I can't—you know, it's only worth five million dollars and there's no way that it can pay interests on six million dollars of debt right. It doesn’t have enough cash to generate six million dollars of debt. We think it can afford two million dollars of debt right. So what will happen is the new company and this is just a plan. And then once you have a plan that everyone has to vote on it and there are things cram down, and will do that in more detail but the plan will say you know the assets are worth five million dollars. This plan might say you know those assets are worth five million dollars. So assets are worth five million dollars and the company can only handle two million dollars of debt not six million dollars of debt not six million dollars of debt. So now, this can only handle two million dollars of debt. And then there will be three million dollars left of equity right and I'll call this, the new equity because sometimes this can get confusing.

So let's just say for a second and I want to think about it. What’s everyone incentive? This guy up here. He’s incentive is to value the company as slowly as possible right because if he gets more of the company and I'll think that will be clear to you in a second. And this guy incentive is say no; this company is worth a lot. So all of you guys are going to get paid back and then I'll get what’s leftover and you’ll probably asking. What do you get paid back if there's not actual for not liquidating? And the answer is the new shares of the company. So what happens is that this stock? Let's say this plan get pass. This plan right here. In this situation, these guys up here we’re the most senior right. Let's say there's two million dollars of senior debt up here. Let me write that in different color and its gets vary. There's two million dollars of senior debt up here. So what they’ll do is they’ll actually get two million dollars of the new debt. Their most senior and then all of these other, these other four million dollars for more junior. Let's see if I can color in and I know this hard to read. These other four million guys instead of getting, instead of getting any kind of cash or any kind of debt securities for having been owed this money. They’ll get the new stocks.

So they’ll get three million dollars of new stock. Let's see if I can draw that in. They’ll get the three million dollars of new stocks. So these three million of new equity will go to these guys and this unsecured guy down here. He’s not going to get as much equity. He’ll be impaired a little bit and the old equity guys. Their stocks are going to go zero. There not going to get anything. So the old share holder companies are wiped out. They go to zero and essentially the debt holders, the debt holders become the new shareholders of the company. These guys become the new share holders company and you’ll often see when a company goes into bankruptcy but its getting reorganized. You’ll often see some people start to buy up this debt or these bonds right here. You’ll see people buy up these bonds because they want to be the new equity holders. They want to win their company emerges from bankruptcy. Let's say that is how it emerges from bankruptcy. They want to be these guys. The new equity holders because usually when you value it. You want to under value a little bit at least this. I know I've over drawn this picture a little bit too much but the debt guys especially the senior debt guys. They want to assign. They want to be safe. They want to say you know what, we’ve already been hurt by this company. Their already not paying our debt. We want us assign as lower possible value to the company’s possible or in this case five million dollars.

So that we make sure, you know hopefully this their company will end up being worth 10 million dollars again. In which case, these guys right here, in which case these guys right here make out like bandits right. If their company was really worth 10 million but the bankruptcy court value at five million. These guys get all of the shares that company. These guys get wipe out even though the company really was worth something. So let's say the company emerges from bankruptcy like this. They actually turn out there worth 10 million dollars. Then let's say a year later and the company starts doing well again ad let's say that someone could value the company to get 10 million not only has two million dollars of debt. And now you have eight million dollars worth of equity, so these guys, you know maybe there are owed two or three million dollars before. They got three million dollars of the new equity. They might have made out like bandits because now all of a sudden that equity can be worth a lot that’s always the case but that’s how, that’s the view from the debt holders point of view.

The equity holders you can imagine. They don’t want to be left with nothing. Then they’ll say, they’ll hire their own bankers and their banker goes probably submit a plan. It says no, no, no, no this company its worth at least eight million. It’s worth at least eight million, so you know it’s up here, eight million and we think you can handle I don’t know four million dollars of debt. So they didn’t want scenario like this. Well they think the company’s worth eight million, eight million. It can handle four million dollars worth of debt. It has four million dollars with that equity and of course. The first six million dollars of the value. So the four million dollars of debt and then two million of the equity will go to the debt holders right because there we owed six million dollars to begin with. And then what’s leftover which is essentially, so this two million of equity and then you have two million of equity here. This would go this two million of new equity right. This is the new shares of the company will be given to the old shareholders of the company.

So that’s what the shareholders want. I know this gets a little confusing but its all about, it all ends up being valuing the assets as you emerge from bankruptcy. You say you know its generating cash. It’s worth something and then you pay people off according to seniority. And first you pay them off. You say, okay, I'll still you owe some money but this company can't support six million dollars. It cannot support two million and whatever there is else, whatever is left. People are paid with actually shares new shares of the company not the old shares. So the old shares will go to zero. So you can imagine a world where GM goes bankrupt. Right now, that shares of GM go to zero. GM old goes to zero but the assets keep operating and that’s why some people are a little bit misleading in this whole automotive bankruptcy debate. Their kind of using scare attack to say, oh if GM goes bankrupt that these assets are just going to disappear. No, they’ll just keep operating. If it makes sense to operate them, they’ll keep operating. The only people who lose big are the old equity holders and then some of the unsecured. The more junior levels of debt will probably loose some money but if the assets are worth operating, they’ll continue to operate. And if the people if it make sense to have them employed. They’ll keep working. See you in the next video.

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