This document is intended as a general guide only. It does not contain a general legal analysis or constitute an opinion of Chicago/Midwest Chapter of the Turnaround Management Association, any of its members or any of the contributors to this document. It is not recommended that readers rely in this general guide in structuring individual transactions but that professional advice be sought in connection with individual transactions.
To use property that is pledged to a secured creditor, a debtor must provide that secured creditor “adequate protection” to protect the secured creditor from a decrease in the value of its interest in property during the bankruptcy case. Common forms of adequate protection include replacement liens, cash payments, agreeing to maintain insurance and provide reporting.
Assignment for the Benefit of Creditors or ABC
An assignment for the benefit of creditors is a proceeding governed by state law (common law or by statute) whereby a debtor assigns all of its interest in property to a third party (the assignee) for the benefit of its creditors. The assignee sells the property to a purchaser, who takes title to the property free and clear of certain claims and encumbrances. This process is sometimes viewed as less expensive and time consuming when compared to a bankruptcy proceeding but often does not have the benefit of a court order.
Cash Collateral is the cash generated from the proceeds of the sale of goods or services in which the company’s lender has a security interest to secure repayment of the loan . Upon the filing of a Chapter 11 bankruptcy, the debtor-company cannot use cash collateral without either the consent of the lender or, in the absence of consent, a ruling by the bankruptcy court that the lender’s interest in the cash collateral is “adequately protected.”
Debt for Equity
A “debt for equity” Chapter 11 plan of reorganization is based upon converting some or all of the debt into equity. The equity interests of the pre-bankruptcy equity holders are substantially reduced or eliminated and the creditors become the majority shareholders.
Debtor in Possession Financing or DIP Loan
A Debtor in Possession loan or DIP loan is a loan provided a debtor in a bankruptcy proceeding, generally to provide sufficient liquidity for the debtor to conduct its business operations during the bankruptcy proceeding and to give confidence to trade creditors that the debtor has the ability to pay its post filing trade credit when it becomes due
The term “Distressed M&A” refers to mergers & acquisitions of a financially distressed entity. Distressed M&A takes place both inside and outside of bankruptcy proceedings.
The term Enterprise Value is a measure of whole value of a business on a going concern basis. Typically, Enterprise Value is calculated as the value of a firm’s equity (which may different than its market capitalization) plus the value of its debt.
Section 510(c) of the Bankruptcy Code grants a bankruptcy court authority to subordinate the claims of certain creditors’ who have injured or received an unfair benefit to the claims of one or all of the creditors .
Going Concern Value
Going concern value recognizes that the combined market value may be different from the sum of the separate values: It is defined as the market value of all the tangible and intangible assets of an established operating business with an indefinite life, as if sold in aggregate.
The term Liquidation Value is a measure of value of a business if it were to cease operating and sell its remaining assets. Liquidation Value is typically lower than going concern valuations. Liquidation Value may be expressed as “forced” or “orderly” liquidations. Due to the time and expense associated with a liquidation process, it is often expressed as Net Orderly Liquidation Value to include the costs of the process.
Section 363 Transaction
A Section 363 Transaction is a sale of a business inside of a bankruptcy proceeding under section 363 of the Bankruptcy Code. The process usually follows certain defined auction procedures and section 363 of the Bankruptcy Code permits transfer of the debtor's property free and clear of most interests in, and claims against, the property if specified conditions are satisfied in the process. Therefore these types of sales can be a favorable method of purchasing a distressed business.
The Bankruptcy Code allows a trustee or a Chapter 11 debtor-in-possession to recover from creditors payments (or transfers) made in the 90-day (or, in certain cases, one year) period before bankruptcy petition . The payment must be on an “antecedent debt” or outstanding debt, while the debtor was insolvent, within 90 days (or, in certain cases, one year) before bankruptcy that allowed the creditor to receive more on its claim than it would have, had the payment not been made and the claim paid through the bankruptcy proceeding.
The doctrine of recharacterization allows the bankruptcy court “recharacterizes" debt as equity. The policy underlying recharacterization of debt to equity is to prevent a shareholder from making loans that an ordinary lender would not make, and therefore allowing the shareholder to recover, as a lender, instead of as an equity holder, thereby reducing recovery to the company's true creditors.
Ray Anderson (Huron Consulting Group LLP)
Harold Israel (Kaye Scholer)
Mark Leipold (Gould & Ratner, LLC)
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