1 financial distress and bankruptcy

7/23/2019 1 Financial Distress and Bankruptcy

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What is Financial Distress?

A situation where afrms operating cashfows are not sucientto satisy current

obligations and the frmis orced to takecorrective action.

Financial distress maylead a frm to deaultona contract, and it mayinvolve fnancialrestructuring betweenthe frm, its creditors,and its euity investors.


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Defnition o !erms

Deault

Failure tomeet aninterest"ayment, or

#iolation odebtagreement

$ankru"tcyFormal"rocedure or

working outdeault

Does notautomaticallyollow romdeault.

Financial Distress %ncludes deaultand bankru"tcy,but also

!hreat o deault orbankru"tcy and itse&ect on thecom"any

Defned to ca"turethe costs and


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%nsolvency

'tock(base insolvency) the value o the frmsassets is less than the value o the debt.

Assets

Debt

Equity

Solvent firm

Debt

AssetsEquity

Insolvent firm

Debt

Note the negative equity


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%nsolvency Flow(base insolvency occurs when the frms cash *ows

are insu+cient to cover contractually reuired "ayments.

Contractual

obligations

Insolvency

$

Firm cash flow

Cash flow

shortfall

time


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1$% 'urvey 2 'tudy o1easons

3. /ismanagement 456

5. Faulty initial "lanning 376

8. 0abor trouble 567. /arket recession 586

4. 9ther reasons :6

!otal3;;6


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PRODU

CTIO

0owca"

acity

utili


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-rediction o $ankru"tcy

)E"*ER %ODE#$eaver used 8; ratios,classifed under @categories. =e testedthese ratios to "redictailure o com"any.1atio o cash(*ow tototal debt was thebest single "redictor

o ailure. Financialratios are useul in"rediction 4 years"rior to the event.

+I#CO, %ODE#et liuidation value

o a frm, i.e.liuidation value oassets minusliuidation value oliabilities. %t is marketvalue o both at a"oint o time.


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"lt-an . !core %odel

%t is a model based on the study used sity(si ailed2non(ailed cor"orations selectedrom manuacturing industries 55 ratios

grou"ed under fve categories) liuidity,"roftability, leverage, solvency and activityratios. Five ratios fnally emerged as good"redictors o cor"orate /an0ruptc12


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.3425T47 428T57 929T97 2;T87 2


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osts o Financial Distress

Direct Costs

$ankru"tcy costsauditorsJ eeslegal eemanagement

ees

Indirect Costsreduced attention

on the o"erationso the com"any.increase in theinterest rates i a

state o fnancialdistressed occurs


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What =a""ens in FinancialDistress? Financial distress does not usually result in the

frms death.

Firms deal with distress by

'elling maKor assets.

/erging with another frm.

1educing ca"ital s"ending and research anddevelo"ment.

%ssuing new securities.

egotiating with banks and other creditors.

Lchanging debt or euity.

Filing or bankru"tcy.


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Reorganiean! emerge

"erge withanother firm

#iqui!ation

83%

10%

7%

What =a""ens in FinancialDistress

Financial!istress

Financialrestructuring

No financialrestructuring

49%

51%

#egal banru%tcy

&rivateworout

47%

53%


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1easons or or"orate1estructuring

1easons or restructuring include a

change o ownershi" ownershi"structure,

demerger,a res"onse to a crisis or maKor change inthe business suchas bankru"tcy, re"ositioning, or buyout.

1estructuring may also be described ascor"orate restructuring, debtrestructuring and fnancial restructuring.


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!y"es 9 1estructuring


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-ortolio M Asset 1estructuring


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a"ital 1estructuring

Fundamental, voluntary change in a frmJs ca"ital structure,e&ected by altering the voting

rights othe "roviders o euity

ca"ital and2or loan ca"ital)such as by converting commonstock Nordinary shares>

into redeemable "reerredstock N"reerence

shares>. a"ital reorgani


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9$TL!%#L' 9F '%A

!imely detection o sick and "otentiallysick com"anies.

'"eedy determination by a body o e"erts

o the "reventive, ameliorative, remedialand other measures which need to betaken with res"ect to such com"anies.

!he e"editious enorcement o the

measures so determined and or allmatters connected therewith or incidentalthereto.


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%/-91!A! -19#%'%9'ODL1 '%A

Constitution o two ?uasiGHudicial /odies )I(Rand ""I(R and their $enches2

Procedure o the )oard andthe A""ellate"uthorit12

riteriao sic0ness2 "ppoint-ent o !pecial Directorsand O"s -re"arationo sanctioned sche-e under section Proision or monitoringo sche-es Reha/ilitation /1 giing fnancialassistance

Windingup o sic0 industrial com"anies -rotectionto saeguardthe interests o the sic0

co-panies -rovisionsor dealing with potential sic0ness


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$F%1

!he )oard or Industrial and (inancialReconstructionN$%F1> is an agency o thegovernment o %ndia, "art o theDe"artment o Financial 'ervices othe /inistry o Finance. %ts obKective is todetermine sickness o industrial com"aniesand to assist in reviving those that may beviable and shutting down the others.

!he $%F1 was established under !he 'ick%ndustrial om"anies N'"ecial -rovisions>Act, 3:G4 N'%A>.


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/easures ado"ted by $%F1

1estructuring the ca"ital base o the com"any.

%nducting more ca"ital to im"rove its resource "osition.

/erger and amalgamation o the sick com"any with ahealthy unit.

-roviding sot loans to the com"any.

$ringing about technological changes and modernisation inthe com"any.

$ringing about a change in its management

Writing o& the interest burden o the com"any.

1escheduling its loans.

-roviding fscal concessions like ta rebate,ta eem"tionsor ta relies to it.


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!ic0 Industrial Co-panies B!pecial Proisions "ct>459. !henew Act diluted some o the "rovisions o '%A and "luggedcertain loo"holes. %t aimed not only to combat industrial

sickness but also to reduce the same by ensuring thatcom"anies do not view declaration o sickness as an esca"istroute rom legal "rovisions ater the ailure o the "roKect orsimilar other reasons and thereby gain access to variousbenefts or concessions rom fnancial institutions. Onder it,the )oard or Industrial and (inancial ReconstructionB)I(Rand A""ellate Authority or %ndustrial and Financial1econstruction NAA%F1> were dissolved and re"laced byational om"any 0aw !ribunal N0!> and ational 0awA""ellate !ribunal N0A!> res"ectively.

1 financial distress and bankruptcy

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