On December 10, 2013, the Federal Deposit Insurance Corporation (the “FDIC”) proposed for public comment a notice (the “Notice”) describing its “Single Point of Entry” (“SPOE”) strategy for resolving systemically important financial institutions (“SIFIs”) in default or in danger of default under the orderly liquidation authority granted by Title II of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”).  The Notice follows the FDIC’s endorsement of the SPOE model in its joint paper issued with the Bank of England last year.
Posts Tagged ‘Liquidation’
Chapter 11 bankruptcy is a dizzyingly complex and inefficient process. Voting on potential reorganization plans take place by class, rules are based on achieving majorities and super-majorities by different standards, and a judge must evaluate the plan to ensure it respects pre-bankruptcy entitlements appropriately. Plan proponents can gerrymander plans in order to isolate creditors; hedge funds can buy positions that pay off if plans fail while allowing them to exert influence over the negotiation process; and judges are often unable to stop such gaming. To cut through this morass, lawyers and economists have proposed reforms, such as holding an auction for the firm or offering options to junior creditors that enable them to buy out senior creditors.
While these reforms could make important steps towards improving Chapter 11, they neglect a crucial problem the current system is designed to address: that of collective action. The current owners of various claims on the firm are usually well-suited to play the particular roles they are playing within the capital structure. Because of sunk investments in learning about the firm or their risk-preferences they are the most valuable investors to hold the assets they hold. A reorganized firm that does not have their appropriate participation may not be nearly as valuable as one that does. In fact, it may be better to liquidate the firm, even if reorganization could be efficient, than to reorganize it with the wrong owners.
The English scheme of arrangement has existed for over a century as a flexible tool for reorganising a company’s capital structure. Schemes of arrangement can be used in a wide variety of ways. In theory a scheme of arrangement can be a compromise or arrangement between a company and its creditors or members about anything which they can properly agree amongst themselves. It is common to see both member-focused schemes and creditor-focused schemes. In practice the most common schemes are those which seek to transfer control of a company, as an alternative to a takeover offer, and those which restructure the debts of a financially distressed company with a view to rescuing the company or its business.
In recent years schemes of arrangement have proved popular as a restructuring tool not only for English companies but also for non-English companies. A number of recent high profile cases have allowed non-English companies to make use of the English scheme jurisdiction to restructure their debts, including Re Rodenstock GmbH  EWHC 1104 (Ch), Primacom Holdings GmbH  EWHC 164 (Ch), Re NEF Telecom Co BV  EWHC 2944 (Comm), Re Cortefiel SA  EWHC 2998 (Ch) and Re Seat Pagine Gialle SpA  EWHC 3686 (Ch). Typically, these cases involve financially distressed companies registered in another EU Member State making use of an English scheme of arrangement without moving either their seat or Centre of Main Interest (COMI). In general, the main connection to England is the senior lenders’ choice of English law and English jurisdiction as governing their lending relationship with the company.
Venture capitalists (VCs) play a significant role in the financing of high-risk, technology-based business ventures. VC exits usually take one of three forms: an initial public offering (IPO) of a portfolio company’s shares, followed by the sale of the VC’s shares into the public market; a “trade sale” of the company to another firm; or dissolution and liquidation of the company.
Of these three types of exits, IPOs have received the most scrutiny. This attention is not surprising. IPO exits tend to involve the largest and most visible VC-backed firms. And, perhaps just as importantly, the IPO process triggers public-disclosure requirements under the securities laws, making data on IPO exits easily accessible to researchers.
But trade sales are actually much more common than IPOs and, in aggregate, are more financially important to VCs. Unlike IPOs, however, trade sales do not trigger the intense public-disclosure requirements of the securities laws; they take place in the shadows. Thus, although trade sales play a critical role in the venture capital cycle, relatively little is known about them.
In our paper, Carrots & Sticks: How VCs Induce Entrepreneurial Teams to Sell Startups recently made public on SSRN, Brian Broughman and I seek to shine more light on intra-firm dynamics around trade sales. In particular, we investigate how VCs induce the “entrepreneurial team” – the founder, other executives, and common shareholders – to go along with a trade sale that they might have an incentive to resist.
Delaware courts frequently are called upon to determine the “fair value” of a company’s stock. For a company whose capital structure includes preferred stock with a liquidation preference, there is the question of how to treat that liquidation preference when determining the per-share “fair value” of the common, the preferred, or some other specific class of the company’s stock.
Two recent Delaware Court of Chancery decisions by Chancellor Leo E. Strine Jr. demonstrate that the answer depends on whether the liquidation preference actually has been triggered (or otherwise represents a non-speculative payment obligation), or whether the payout of the liquidation preference is a matter of speculation. Importantly, that determination depends on the specific rights defining the liquidation preference, as set forth in the charter or certificate of designations, and does not necessarily depend on “market realities” that might suggest a discount for common stock relative to the preferred.
I would like to take the opportunity to discuss one of those challenging issues – the orderly resolution of systemically important financial institutions ( SIFIs). The Dodd-Frank Act provided important new authorities to the FDIC to resolve SIFIs. Prior to the recent crisis, the FDIC’s receivership authorities were limited to federally insured banks and thrift institutions. There was no authority to place the holding company or affiliates of an insured institution or any other non-bank financial company into an FDIC receivership to avoid systemic consequences. The lack of this authority severely constrained the ability of the government to resolve a SIFI.
This authority has now been provided to the FDIC under the Dodd-Frank Act. The question is whether the FDIC can develop the operational capability to utilize this authority effectively and a credible strategy under which an orderly resolution of a SIFI can be carried out without putting the financial system itself at risk. These key challenges have been the focus of the FDIC’s efforts since the enactment of the Dodd-Frank Act in July 2010. I would like to focus my comments today on the progress we have made in meeting these important challenges.
Liquidation Values and the Credibility of Financial Contract Renegotiation: Evidence from U.S. Airlines
My paper “Liquidation Values and the Credibility of Financial Contract
Renegotiation: Evidence from U.S. Airlines” co-written with Nittai Bergman, which is forthcoming in the Quarterly Journal of Economics, documents empirically the conditions under which airlines renegotiate aircraft leases in the United States. The control rights that financial contracts provide over firms’ underlying assets play a fundamental role in the incomplete contracting literature since the threat of asset liquidation motivates debtors to avoid default. Thus, in the incomplete contracting literature, asset liquidation values play a key role in the ex-post determination of debt payments. To date, there is little empirical evidence analyzing the ability of firms to renegotiate their financial liabilities and the role asset values play in such renegotiations. This paper attempts to fill this gap.
We develop an incomplete-contracting model of financial contract renegotiation and estimate it using data on the airline industry in the United States. Our model has two testable implications. First, firms will be able to credibly renegotiate their financial commitments only when their financial situation is sufficiently poor. Second, when a firm’s financial position is sufficiently poor, and hence its renegotiation threat is credible, a reduction in the liquidation value of assets increases the concessions that the firm obtains in renegotiation.
Our empirical analysis examines renegotiation of leases amongst U.S. airlines. We collect data on all publicly traded, passenger-carriers and construct a dataset which includes information about contracted lease payments, actual lease payments, and fleet composition by aircraft type.
In addition, we construct four different measures of the ease of overall re-deployability of an airline’s leased aircraft. We find that publicly traded airlines often renegotiate their lease contracts. Furthermore, we show that aircraft lease renegotiations take place when liquidation values are low and airlines’ financial condition is poor. We supplement our analysis by studying lease renegotiation out of bankruptcy. We find that, even out of bankruptcy, airlines in poor financial condition can reduce their lease payments and that lower fleet re-deployability enables these airlines to extract greater concessions from their lessors.
The full paper is available for download here.