Services
Discover
Homeschooling
Ask a Question
Log in
Sign up
Filters
Done
Question type:
Essay
Multiple Choice
Short Answer
True False
Matching
Topic
Business
Study Set
Mergers Acquisitions
Quiz 17: Alternative Exit and Restructuring Strategies: Bankruptcy Reorganization and Liquidation
Path 4
Access For Free
Share
All types
Filters
Study Flashcards
Practice Exam
Learn
Question 61
Essay
PG&E SEEKS BANKRUPTCY PROTECTION Pacific, Gas, and Electric (PG&E), the San Francisco-based utility, filed for bankruptcy on April 7, 2001, citing nearly $9 billion in debt and un-reimbursed energy costs. The utility, one of three privately owned utilities in California, serves northern and central California. The intention of the Chapter 11 reorganization was to make the utility solvent again by protecting the firm from lawsuits or any other action by those who are owed money by the utility. The bankruptcy will also allow the utility to deal with all of the firm's debts in a single forum rather than with individual debtors in what had become a highly politicized venue. The following time line outlines the firm's road to bankruptcy.
. Utility industry analysts saw PG&E's move as largely an effort to escape the political paralysis that had befallen the state's regulatory apparatus. The bankruptcy filing came one day after Governor Davis dropped his opposition to raising retail rates. However, the Governor's reversal came after five month's of negotiations with the state's privately owned utilities on a rescue plan. PG&E's common shares fell 37 percent on the day the firm filed for reorganization. Fearing a similar fate for San Diego Gas and Electric, the shares of Sempra Energy, SDG&E's parent corporation, also dropped by 35 percent In an attempt to insulate California ratepayers from escalating wholesale electricity prices, the state entered into a series of 5-to-10 year contracts with electricity power generators that account for more than two-thirds of the state's projected power needs. The last contracts were signed by the state in June 2001. By September, a slowing economy pushed the wholesale price of electricity well below the level the state was required to pay in the "take or pay" contracts the state had just signed. Estimates suggest that California taxpayers will have to pay between $40 and $45 billion in power costs over the next decade depending on what happens to future energy costs. PG&E has continued to supply its customers without disruption or blackout while being under the protection of the bankruptcy court. Southern California Edison, nearing bankruptcy for reasons similar to those that drove PG&E to seek protection from its creditors, reached agreement with the Public Utility Commission to pay off $3.3 billion in debt owed to power generators from customer revenues. Previously, the PUC had forbid the utility to use monies generated from two previous rate increases for this purpose. The U.S. District Court judge approved the plan on October 5, 2001. While some creditors complained that the settlement was not reassuring because it did not include a timetable for repayment of outstanding debt, others viewed the agreement as a voluntary reorganization plan without going through the expensive process of filing for bankruptcy with the federal court. : -In your judgment,did regulators attenuate or exacerbate the situation? Explain your answer.
Question 62
Essay
PG&E SEEKS BANKRUPTCY PROTECTION Pacific, Gas, and Electric (PG&E), the San Francisco-based utility, filed for bankruptcy on April 7, 2001, citing nearly $9 billion in debt and un-reimbursed energy costs. The utility, one of three privately owned utilities in California, serves northern and central California. The intention of the Chapter 11 reorganization was to make the utility solvent again by protecting the firm from lawsuits or any other action by those who are owed money by the utility. The bankruptcy will also allow the utility to deal with all of the firm's debts in a single forum rather than with individual debtors in what had become a highly politicized venue. The following time line outlines the firm's road to bankruptcy.
. Utility industry analysts saw PG&E's move as largely an effort to escape the political paralysis that had befallen the state's regulatory apparatus. The bankruptcy filing came one day after Governor Davis dropped his opposition to raising retail rates. However, the Governor's reversal came after five month's of negotiations with the state's privately owned utilities on a rescue plan. PG&E's common shares fell 37 percent on the day the firm filed for reorganization. Fearing a similar fate for San Diego Gas and Electric, the shares of Sempra Energy, SDG&E's parent corporation, also dropped by 35 percent In an attempt to insulate California ratepayers from escalating wholesale electricity prices, the state entered into a series of 5-to-10 year contracts with electricity power generators that account for more than two-thirds of the state's projected power needs. The last contracts were signed by the state in June 2001. By September, a slowing economy pushed the wholesale price of electricity well below the level the state was required to pay in the "take or pay" contracts the state had just signed. Estimates suggest that California taxpayers will have to pay between $40 and $45 billion in power costs over the next decade depending on what happens to future energy costs. PG&E has continued to supply its customers without disruption or blackout while being under the protection of the bankruptcy court. Southern California Edison, nearing bankruptcy for reasons similar to those that drove PG&E to seek protection from its creditors, reached agreement with the Public Utility Commission to pay off $3.3 billion in debt owed to power generators from customer revenues. Previously, the PUC had forbid the utility to use monies generated from two previous rate increases for this purpose. The U.S. District Court judge approved the plan on October 5, 2001. While some creditors complained that the settlement was not reassuring because it did not include a timetable for repayment of outstanding debt, others viewed the agreement as a voluntary reorganization plan without going through the expensive process of filing for bankruptcy with the federal court. : -PG&E pursued bankruptcy protection,while Southern California Edison did not.What could PG&E have been done differently to avoid bankruptcy?
Question 63
Multiple Choice
All of the following are true of the bankruptcy process except for
Question 64
Essay
What alternative restructuring strategies do you believe may have been considered for GM? Of these,do you believe that the 363 sale in bankruptcy represented the best course of action? Explain your answers.
Question 65
Multiple Choice
All of the following are true about voluntary liquidations except for
Question 66
Essay
Lehman Brothers Files for Chapter 11 in the Biggest Bankruptcy in U.S. History A casualty of the 2008 credit crisis that shook Wall Street to its core, Lehman Brothers Holdings, Inc., a holding company, announced on September 15, 2008, that it had filed a petition under Chapter 11 of the U.S. Bankruptcy Code. Lehman's board of directors decided to opt for court protection after attempts to find a buyer for the entire firm collapsed. With assets of $639 billion and liabilities of $613 billion, Lehman is the largest bankruptcy in history in terms of assets. The next biggest bankruptcies were WorldCom and Enron with $126 billion and $81 billion in assets, respectively. None of the holding company's subsidiaries was included in the filing, enabling customers of Lehman's brokerage, Neuberger Berman Holdings, to continue to use their accounts to trade. Furthermore, by excluding its units from the bankruptcy filing, customers of its broker-dealer operations would not be subject to claims by LBHI's more than 100,000 creditors in the bankruptcy case. Prior to the Dodd-Frank Act of 2010 (see Chapter 2) limiting such rights, counterparties could cancel contracts when a financial services firm went bankrupt. Lehman would normally hedge or protect its investments by taking opposite positions to minimize potential losses in its derivatives portfolios. Derivatives are financial instruments whose value changes in response to the value of the underlying assets over a specific period. For example, if the firm purchased a contract to buy oil at a specific price at some point in the future, it would also sell a contract at a somewhat lower price to another party (called a counterparty) to minimize losses if the price of oil dropped. Thus, the bankruptcy filing left Lehman's investment positions unprotected. On September 20, 2008, Barclays PLC., a major U.K. bank, acquired Lehman's broker-dealer operations for $250 million and paid an additional $1.5 billion for the firm's New York headquarters building and two New Jersey-based data centers. Coming just five days after Lehman filed for bankruptcy, the deal reflected the urgency to find buyers for those businesses whose value consisted primarily of their employees. Barclays did not buy any of Lehman's commercial real estate assets or private equity and hedge fund investments. However, Barclays did agree to take $47.4 billion in securities and assume $45.5 billion in trading liabilities. On September 24, 2008, Japanese brokerage Nomura Securities acquired Lehman's Japanese and Australian operation for $250 million. Lehman's investment management group, Neuberger Berman, was sold in late December 2008 to a Neuberger management group for $922 million. Under the deal, Neuberger's management would own 51 percent of the firm, and Lehman's creditors would control the remainder. Other Lehman assets, consisting primarily of complex derivatives ranging from oil price futures to credit default swaps (i.e., debt insurance) to options on stock indices, with more than 8,000 counterparties, were expected to take years to identify, value, and liquidate. The firm also could expect to face numerous lawsuits. The October 18, 2008, auction of $400 billion of Lehman's debt issues was valued at 8.5 cents on the dollar. Because such debt was backed by only the firm's creditworthiness, the buyers of the Lehman debt had purchased insurance from other financial institutions to mitigate the risk of a Lehman default. The existence of these credit default swap arrangements meant that the insurers were required to pay Lehman bondholders $366 billion (i.e., 0.915 × $400 billion). Purchasers of this debt were betting that, following Lehman's liquidation, holders of this debt would receive more than 8.5 cents on the dollar and the insurers would be able to satisfy their obligations. Hedge funds also were affected by the Lehman bankruptcy. Hedge funds borrowed heavily from Lehman, putting up certain assets as collateral for the loans. While legal, Lehman was using this collateral to borrow from other firms. By using its customers' collateral as its own collateral, Lehman and other firms could borrow more money, using the proceeds to make additional investments. When Lehman filed for bankruptcy, the court took control of such assets until who was entitled to the assets could be determined. Moreover, while derivative agreements were designed to terminate whenever a party declares bankruptcy and be settled outside of court, Lehman's general creditors may lay claim to any collateral whose value exceeds the value of the derivative agreements. Disentangling these claims will take years. In early 2010, a report compiled by bank examiners described how Lehman manipulated its financial statements, leaving the investing public, credit rating agencies, government regulators, and Lehman's board of directors totally unaware of the accounting tricks. By departing from common accounting practices, Lehman appeared to be less levered than it actually was. It was pressure from speculators, sensing that the firm was in disarray, which uncovered the scam by selling Lehman's stock short and accomplishing what the regulators and credit rating agencies could not. See the Inside M&A case study at the beginning of Chapter 2 for more details on Lehman's accounting practices. Discussion Questions 1. Why did Lehman choose not to seek Chapter 11 protection for its subsidiaries? 2. How does Chapter 11 bankruptcy protect Lehman's creditors? How does it potentially hurt them? Explain your answers. 3. Do you believe the U.S. bankruptcy process was appropriate in this instance? Explain your answer. 4. Do you believe the U.S. government's failure to bail out Lehman, thereby forcing the firm to file for bankruptcy, exacerbated the global credit meltdown in October 2008? Explain your answer. Case Study Short Essay Examination Questions: A Reorganized Dana Corporation Emerges from Bankruptcy Court Dana Corporation, an automotive parts manufacturer, announced on February 1, 2008, that it had emerged from bankruptcy court with an exit financing facility of $2 billion. The firm had entered Chapter 11 reorganization on March 3, 2006. During the ensuing 21 months, the firm and its constituents identified, agreed on, and won court approval for approximately $440 million to $475 million in annual cost savings and the elimination of unprofitable products. These annual savings resulted from achieving better plant utilization due to changes in union work rules, wage and benefit reductions, the reduction of ongoing obligations for retiree health and welfare costs, and streamlining administrative expenses. The plan of reorganization accepted by the court, creditors, and investors included a $750 million equity investment provided by Centerbridge Capital Partners to fund a portion of the firm's health-care and pension obligations. Under the plan, shareholders received no payout. Bondholders of some $1.62 billion in various maturities and holders of $1.63 billion in unsecured claims recovered about 60-90 percent of their claims. Centerbridge would acquire $250 million of convertible preferred stock in the reorganized Dana operation, and creditors, who had agreed to support the reorganization plan, could acquire up to $500 million of the convertible preferred shares. The preferred shares were issued as an inducement to get creditors to support the plan of reorganization. Under the reorganization plan, Dana sold some businesses, cut plants in the United States and Canada, reduced its hourly and salaried workforce, and sought price -Does the process outlined in this business case seem equitable for all parties to the bankruptcy proceedings? Why? Why not? Be specific.
Question 67
Essay
Calpine Emerges from the Protection of Bankruptcy Court Following approval of its sixth Plan of Reorganization by the U.S. Bankruptcy Court for the Southern District of New York, Calpine Corporation was able to emerge from Chapter 11 bankruptcy on January 31, 2008. Burdened by excessive debt and court battles with creditors on how to use its cash, the electric utility had sought Chapter 11 protection by petitioning the bankruptcy court in December 2005. After settlements with certain stakeholders, all classes of creditors voted to approve the Plan of Reorganization, which provided for the discharge of claims through the issuance of reorganized Calpine Corporation common stock, cash, or a combination of cash and stock to its creditors. Shortly after exiting bankruptcy, Calpine cancelled all of its then outstanding common stock and authorized the issuance of 485 million shares of reorganized Calpine Corporation common stock for distribution to holders of unsecured claims. In addition, the firm issued warrants (i.e., securities) to purchase 48.5 million shares of reorganized Calpine Corporation common stock to the holders of the cancelled (i.e., previously outstanding) common stock. The warrants were issued on a pro rata basis reflecting the number of shares of "old common stock" held at the time of cancellation. These warrants carried an exercise price of $23.88 per share and expired on August 25, 2008. Relisted on the New York Stock Exchange, the reorganized Calpine Corporation common stock began trading under the symbol CPN on February 7, 2008, at about $18 per share. The firm had improved its capital structure while in bankruptcy. On entering bankruptcy, Calpine carried $17.4 billion of debt with an average interest rate of 10.3 percent. By retiring unsecured debt with reorganized Calpine Corporation common stock and selling certain assets, Calpine was able to repay or refinance certain project debt, thereby reducing the prebankruptcy petition debt by approximately $7 billion. On exiting bankruptcy, Calpine negotiated approximately $7.3 billion of secured "exit facilities" (i.e., credit lines) from Goldman Sachs, Credit Suisse, Deutsche Bank, and Morgan Stanley. About $6.4 billion of these funds were used to satisfy cash payment obligations under the Plan of Reorganization. These obligations included the repayment of a portion of unsecured creditor claims and administrative claims, such as legal and consulting fees, as well as expenses incurred in connection with the "exit facilities" and immediate working capital requirements. On emerging from Chapter 11, the firm carried $10.4 billion of debt with an average interest rate of 8.1 percent. The Enron Shuffle-A Scandal to Remember What started in the mid-1980s as essentially a staid "old-economy" business became the poster child in the late 1990s for companies wanting to remake themselves into "new-economy" powerhouses. Unfortunately, what may have started with the best of intentions emerged as one of the biggest business scandals in U.S. history. Enron was created in 1985 as a result of a merger between Houston Natural Gas and Internorth Natural Gas. In 1989, Enron started trading natural gas commodities and eventually became the world's largest buyer and seller of natural gas. In the early 1990s, Enron became the nation's premier electricity marketer and pioneered the development of trading in such commodities as weather derivatives, bandwidth, pulp, paper, and plastics. Enron invested billions in its broadband unit and water and wastewater system management unit and in hard assets overseas. In 2000, Enron reported $101 billion in revenue and a market capitalization of $63 billion. The Virtual Company Enron was essentially a company whose trading and risk management business strategy was built on assets largely owned by others. The complex financial maneuvering and off-balance-sheet partnerships that former CEO Jeffrey K. Skilling and chief financial officer Andrew S. Fastow implemented were intended to remove everything from telecommunications fiber to water companies from the firm's balance sheet and into partnerships. What distinguished Enron's partnerships from those commonly used to share risks were their lack of independence from Enron and the use of Enron's stock as collateral to leverage the partnerships. If Enron's stock fell in value, the firm was obligated to issue more shares to the partnership to restore the value of the collateral underlying the debt or immediately repay the debt. Lenders in effect had direct recourse to Enron stock if at any time the partnerships could not repay their loans in full. Rather than limiting risk, Enron was assuming total risk by guaranteeing the loans with its stock. Enron also engaged in transactions that inflated its earnings, such as selling time on its broadband system to a partnership at inflated prices at a time when the demand for broadband was plummeting. Enron then recorded a substantial profit on such transactions. The partnerships agreed to such transactions because Enron management seems to have exerted disproportionate influence in some instances over partnership decisions, although its ownership interests were very small, often less than 3 percent. Curiously, Enron's outside auditor, Arthur Andersen, had a dual role in these partnerships, collecting fees for helping to set them up and auditing them. Time to Pay the Piper At the time the firm filed for bankruptcy on December 2, 2001, it had $13.1 billion in debt on the books of the parent company and another $18.1 billion on the balance sheets of affiliated companies and partnerships. In addition to the partnerships created by Enron, a number of bad investments both in the United States and abroad contributed to the firm's malaise. Meanwhile, Enron's core energy distribution business was deteriorating. Enron was attempting to gain share in a maturing market by paring selling prices. Margins also suffered from poor cost containment. Dynegy Corp. agreed to buy Enron for $10 billion on November 2, 2001. On November 8, Enron announced that its net income would have to be restated back to 1997, resulting in a $586 million reduction in reported profits. On November 15, chairman Kenneth Lay admitted that the firm had made billions of dollars in bad investments. Four days later, Enron said it would have to repay a $690 million note by mid-December and it might have to take an additional $700 million pretax charge. At the end of the month, Dynegy withdrew its offer and Enron's credit rating was reduced to junk bond status. Enron was responsible for another $3.9 billion owed by its partnerships. Enron had less than $2 billion in cash on hand. The end came quickly as investors and customers completely lost faith in the energy behemoth as a result of its secrecy and complex financial maneuvers, forcing the firm into bankruptcy in early December. Enron's stock, which had reached a high of $90 per share on August 17, 2001, was trading at less than $1 by December 5, 2001. In addition to its angry creditors, Enron faced class-action lawsuits by shareholders and employees, whose pensions were invested heavily in Enron stock. Enron also faced intense scrutiny from congressional committees and the U.S. Department of Justice. By the end of 2001, shareholders had lost more than $63 billion from its previous 52-week high, bondholders lost $2.6 billion in the face value of their debt, and banks appeared to be at risk on at least $15 billion of credit they had extended to Enron. In addition, potential losses on uncollateralized derivative contracts totaled $4 billion. Such contracts involved Enron commitments to buy various types of commodities at some point in the future. Questions remain as to why Wall Street analysts, Arthur Andersen, federal or state regulatory authorities, the credit rating agencies, and the firm's board of directors did not sound the alarm sooner. It is surprising that the audit committee of the Enron board seems to have somehow been unaware of the firm's highly questionable financial maneuvers. Inquiries following the bankruptcy declaration seem to suggest that the audit committee followed all the rules stipulated by federal regulators and stock exchanges regarding director pay, independence, disclosure, and financial expertise. Enron seems to have collapsed in part because such rules did not do what they were supposed to do. For example, paying directors with stock may have aligned their interests with shareholders, but it also is possible to have been a disincentive to question aggressively senior management about their financial dealings. The Lessons of Enron Enron may be the best recent example of a complete breakdown in corporate governance, a system intended to protect shareholders. Inside Enron, the board of directors, management, and the audit function failed to do the job. Similarly, the firm's outside auditors, regulators, credit rating agencies, and Wall Street analysts also failed to alert investors. What seems to be apparent is that if the auditors fail to identify incompetence or fraud, the system of safeguards is likely to break down. The cost of failure to those charged with protecting the shareholders, including outside auditors, analysts, credit-rating agencies, and regulators, was simply not high enough to ensure adequate scrutiny. What may have transpired is that company managers simply undertook aggressive interpretations of accounting principles then challenged auditors to demonstrate that such practices were not in accordance with GAAP accounting rules (Weil, 2002). This type of practice has been going on since the early 1980s and may account for the proliferation of specific accounting rules applicable only to certain transactions to insulate both the firm engaging in the transaction and the auditor reviewing the transaction from subsequent litigation. In one sense, the Enron debacle represents a failure of the free market system and its current shareholder protection mechanisms, in that it took so long for the dramatic Enron shell game to be revealed to the public. However, this incident highlights the remarkable resilience of the free market system. The free market system worked quite effectively in its rapid imposition of discipline in bringing down the Enron house of cards, without any noticeable disruption in energy distribution nationwide. Epilogue Due to the complexity of dealing with so many types of creditors, Enron filed its plan with the federal bankruptcy court to reorganize one and a half years after seeking bankruptcy protection on December 2, 2001. The resulting reorganization has been one of the most costly and complex on record, with total legal and consulting fees exceeding $500 million by the end of 2003. More than 350 classes of creditors, including banks, bondholders, and other energy companies that traded with Enron said they were owed about $67 billion. Under the reorganization plan, unsecured creditors received an estimated 14 cents for each dollar of claims against Enron Corp., while those with claims against Enron North America received an estimated 18.3 cents on the dollar. The money came in cash payments and stock in two holding companies, CrossCountry containing the firm's North American pipeline assets and Prisma Energy International containing the firm's South American operations. After losing its auditing license in 2004, Arthur Andersen, formerly among the largest auditing firms in the world, ceased operation. In 2006, Andrew Fastow, former Enron chief financial officer, and Lea Fastow plead guilty to several charges of conspiracy to commit fraud. Andrew Fastow received a sentence of 10 years in prison without the possibility of parole. His wife received a much shorter sentence. Also in 2006, Enron chairman Kenneth Lay died while awaiting sentencing, and Enron president Jeffery Skilling received a sentence of 24 years in prison. Citigroup agreed in early 2008 to pay $1.66 billion to Enron creditors who lost money following the collapse of the firm. Citigroup was the last remaining defendant in what was known as the Mega Claims lawsuit, a bankruptcy lawsuit filed in 2003 against 11 banks and brokerages. The suit alleged that, with the help of banks, Enron kept creditors in the dark about the firm's financial problems through misleading accounting practices. Because of the Mega Claims suit, creditors recovered a total of $5 billion or about 37.4 cents on each dollar owed to them. This lawsuit followed the settlement of a $40 billion class action lawsuit by shareholders, which Citicorp settled in June 2005 for $2 billion. -In your judgment,what were the major factors contributing to the demise of Enron? Of these factors,which were the most important?
Question 68
Essay
Discuss the relative fairness to the various stakeholders in a bankruptcy of a more traditional Chapter 11 bankruptcy in which a firm emerges from the protection of the bankruptcy court following the development of a plan of reorganization versus an expedited sale under Section 363 of the federal bankruptcy law.Be specific.
Question 69
Essay
Comment on the fairness of the bankruptcy process to shareholders,lenders,employees,communities,government,etc.Be specific.
Question 70
Essay
The first round of government loans to GM occurred in December 2008.The firm did not file for bankruptcy until June 1,2009.Discuss the advantages and disadvantages of the firm having filed for bankruptcy much earlier in 2009.Be specific.
Question 71
Essay
How does Chapter 11 potentially affect adversely competitors of those firms emerging from bankruptcy? Explain your answer.
Question 72
Essay
The General Motors' Bankruptcy-The Largest Government-Sponsored Bailout in U.S. History Rarely has a firm fallen as far and as fast as General Motors. Founded in 1908, GM dominated the car industry through the early 1950s with its share of the U.S. car market reaching 54 percent in 1954, which proved to be the firm's high water mark. Efforts in the 1980s to cut costs by building brands on common platforms blurred their distinctiveness. Following increasing healthcare and pension benefits paid to employees, concessions made to unions in the early 1990s to pay workers even when their plants were shut down reduced the ability of the firm to adjust to changes in the cyclical car market. GM was increasingly burdened by so-called legacy costs (i.e., healthcare and pension obligations to a growing retiree population). Over time, GM's labor costs soared compared to the firm's major competitors. To cover these costs, GM continued to make higher margin medium to full-size cars and trucks, which in the wake of higher gas prices could only be sold with the help of highly attractive incentive programs. Forced to support an escalating array of brands, the firm was unable to provide sufficient marketing funds for any one of its brands. With the onset of one of the worst global recessions in the post-World War II years, auto sales worldwide collapsed by the end of 2008. All automakers' sales and cash flows plummeted. Unlike Ford, GM and Chrysler were unable to satisfy their financial obligations. The U.S. government, in an unprecedented move, agreed to lend GM and Chrysler $13 billion and $4 billion, respectively. The intent was to buy time to develop an appropriate restructuring plan. Having essentially ruled out liquidation of GM and Chrysler, continued government financing was contingent on gaining major concessions from all major stakeholders such as lenders, suppliers, and labor unions. With car sales continuing to show harrowing double-digit year over year declines during the first half of 2009, the threat of bankruptcy was used to motivate the disparate parties to come to an agreement. With available cash running perilously low, Chrysler entered bankruptcy in early May and GM on June 1, with the government providing debtor in possession financing during their time in bankruptcy. In its bankruptcy filing for its U.S. and Canadian operations only, GM listed $82.3 billion in assets and $172.8 billion in liabilities. In less than 45 days each, both GM and Chrysler emerged from government-sponsored sales in bankruptcy court, a feat that many thought impossible. Judge Robert E. Gerber of the U.S. Bankruptcy Court of New York approved the sale in view of the absence of alternatives considered more favorable to the government's option. GM emerged from the protection of the court on July 10, 2009, in an economic environment characterized by escalating unemployment and eroding consumer income and confidence. Even with less debt and liabilities, fewer employees, the elimination of most "legacy costs," and a reduced number of dealerships and brands, GM found itself operating in an environment in 2009 in which U.S. vehicle sales totaled an anemic 10.4 million units. This compared to more than 16 million in 2008. GM's 2009 market share slipped to a post-World War II low of about 19 percent. While the bankruptcy option had been under consideration for several months, its attraction grew as it became increasingly apparent that time was running out for the cash-strapped firm. Having determined from the outset that liquidation of GM either inside or outside of the protection of bankruptcy would not be considered, the government initially considered a prepackaged bankruptcy in which agreement is obtained among major stakeholders prior to filing for bankruptcy. The presumption is that since agreement with many parties had already been obtained, developing a plan of reorganization to emerge from Chapter 11 would move more quickly. However, this option was not pursued because of the concern that the public would simply view the post-Chapter 11 GM as simply a smaller version of its former self. The government in particular was seeking to position GM as an entirely new firm capable of profitably designing and building cars that the public wanted. Time was of the essence. The concern was that consumers would not buy GM vehicles while the firm was in bankruptcy. Consequently, a strategy was devised in which GM would be divided into two firms: "old GM," which would contain the firm's unwanted assets, and "new GM," which would own the most attractive assets. "New GM" would then emerge from bankruptcy in a sale to a new company owned by various stakeholder groups, including the U.S. and Canadian governments, a union trust fund, and bondholders. Only GM's U.S. and Canadian operations were included in the bankruptcy filing. Figure 16.2 illustrates the GM bankruptcy process. Buying distressed assets can be accomplished through a Chapter 11 plan of reorganization or a post-confirmation trustee. Alternatively, a 363 sale transfers the acquired assets free and clear of any liens, claims, and encumbrances. The sale of GM's attractive assets to the "new GM" was ultimately completed under Section 363 of the U.S. Bankruptcy Code. Historically, firms used this tactic to sell failing plants and redundant equipment. In recent years, so-called 363 sales have been used to completely restructure businesses, including the 363 sales of entire companies. A 363 sale requires only the approval of the bankruptcy judge, while a plan of reorganization in Chapter 11 must be approved by a substantial number of creditors and meet certain other requirements to be approved. A plan of reorganization is much more comprehensive than a 363 sale in addressing the overall financial situation of the debtor and how its exit strategy from bankruptcy will affect creditors. Once a 363 sale has been consummated and the purchase price paid, the bankruptcy court decides how the proceeds of sale are allocated among secured creditors with liens on the assets sold. Total financing provided by the U.S. and Canadian (including the province of Ontario) governments amounted to $69.5 billion. U.S. taxpayer-provided financing totaled $60 billion, which consisted of $10 billion in loans and the remainder in equity. The government decided to contribute $50 billion in the form of equity to reduce the burden on GM of paying interest and principal on its outstanding debt. Nearly $20 billion was provided prior to the bankruptcy, $11 billion to finance the firm during the bankruptcy proceedings, and an additional $19 billion in late 2009. In exchange for these funds, the U.S. government owns 60.8 percent of the "new GM's common shares, while the Canadian and Ontario governments own 11.7 percent in exchange for their investment of $9.5 billion. The United Auto Workers' new voluntary employee beneficiary association (VEBA) received a 17.5 percent stake in exchange for assuming responsibility for retiree medical and pension obligations. Bondholders and other unsecured creditors received a 10 percent ownership position. The U.S. Treasury and the VEBA also received $2.1 billion and $6.5 billion in preferred shares, respectively. The new firm, which employs 244,000 workers in 34 countries, intends to further reduce its head count of salaried employees to 27,200 by 2012. The firm will also have shed 21,000 union workers from the 54,000 UAW workers it employed prior to declaring bankruptcy in the United States and close 12 to 20 plants. GM did not include its foreign operations in Europe, Latin America, Africa, the Middle East, or Asia Pacific in the Chapter 11 filing. Annual vehicle production capacity for the firm will decline to 10 million vehicles in 2012, compared with 15 to 17 million in 1995. The firm exited bankruptcy with consolidated debt at $17 billion and $9 billion in 9 percent preferred stock, which is payable on a quarterly basis. GM has a new board, with Canada and the UAW healthcare trust each having a seat on the board. Following bankruptcy, GM has four core brands-Chevrolet, Cadillac, Buick, and GMC-that are sold through 3,600 dealerships, down from its existing 5,969-dealer network. The business plan calls for an IPO whose timing will depend on the firm's return to sufficient profitability and stock market conditions. By offloading worker healthcare liabilities to the VEBA trust and seeding it mostly with stock instead of cash, GM has eliminated the need to pay more than $4 billion annually in medical costs. Concessions made by the UAW before GM entered bankruptcy have made GM more competitive in terms of labor costs with Toyota. Assets to be liquidated by Motors Liquidation Company (i.e., "old GM) were split into four trusts, including one financed by $536 million in existing loans from the federal government. These funds were set aside to clean up 50 million square feet of industrial manufacturing space at 127 locations spread across 14 states. Another $300 million was set aside for property taxes, plant security, and other shutdown expenses. A second trust will handle claims of the owners of GM's prebankruptcy debt, who are expected to get 10 percent of the equity in General Motors when the firm goes public and warrants to buy additional shares at a later date. The remaining two trusts are intended to process litigation such as asbestos-related claims. The eventual sale of the remaining assets could take four years, with most of the environmental cleanup activities completed within a decade.
Lat
tman and de la Merced, 2010
Reflecting the overall improvement in the U.S. economy and in its operating performance, GM repaid $10 billion in loans to the U.S. government in April 2010. Seventeen months after emerging from bankruptcy, the firm completed successfully the largest IPO in history on November 17, 2010, raising $23.1 billion. The IPO was intended to raise cash for the firm and to reduce the government's ownership in the firm, reflecting the firm's concern that ongoing government ownership hurt sales. Following completion of the IPO, government ownership of GM remained at 33 percent, with the government continuing to have three board representatives. GM is likely to continue to receive government support for years to come. In an unusual move, GM was allowed to retain $45 billion in tax loss carryforwards, which will eliminate the firm's tax payments for years to come. Normally, tax losses are preserved following bankruptcy only if the equity in the reorganized company goes to creditors who have been in place for at least 18 months. Despite not meeting this criterion, the Treasury simply overlooked these regulatory requirements in allowing these tax benefits to accrue to GM. Having repaid its outstanding debt to the government, GM continued to owe the U.S. government $36.4 billion ($50 billion less $13.6 billion received from the IPO) at the end of 2010. Assuming a corporate marginal tax rate of 35 percent, the government would lose another $15.75 in future tax payments as a result of the loss carryforward. The government also is providing $7,500 tax credits to buyers of GM's new all-electric car, the Chevrolet Volt.
Discussion Questions -Do you agree or disagree that the taxpayer financed bankruptcy represented the best way to save jobs.Explain your answer.
Question 73
Essay
Calpine Emerges from the Protection of Bankruptcy Court Following approval of its sixth Plan of Reorganization by the U.S. Bankruptcy Court for the Southern District of New York, Calpine Corporation was able to emerge from Chapter 11 bankruptcy on January 31, 2008. Burdened by excessive debt and court battles with creditors on how to use its cash, the electric utility had sought Chapter 11 protection by petitioning the bankruptcy court in December 2005. After settlements with certain stakeholders, all classes of creditors voted to approve the Plan of Reorganization, which provided for the discharge of claims through the issuance of reorganized Calpine Corporation common stock, cash, or a combination of cash and stock to its creditors. Shortly after exiting bankruptcy, Calpine cancelled all of its then outstanding common stock and authorized the issuance of 485 million shares of reorganized Calpine Corporation common stock for distribution to holders of unsecured claims. In addition, the firm issued warrants (i.e., securities) to purchase 48.5 million shares of reorganized Calpine Corporation common stock to the holders of the cancelled (i.e., previously outstanding) common stock. The warrants were issued on a pro rata basis reflecting the number of shares of "old common stock" held at the time of cancellation. These warrants carried an exercise price of $23.88 per share and expired on August 25, 2008. Relisted on the New York Stock Exchange, the reorganized Calpine Corporation common stock began trading under the symbol CPN on February 7, 2008, at about $18 per share. The firm had improved its capital structure while in bankruptcy. On entering bankruptcy, Calpine carried $17.4 billion of debt with an average interest rate of 10.3 percent. By retiring unsecured debt with reorganized Calpine Corporation common stock and selling certain assets, Calpine was able to repay or refinance certain project debt, thereby reducing the prebankruptcy petition debt by approximately $7 billion. On exiting bankruptcy, Calpine negotiated approximately $7.3 billion of secured "exit facilities" (i.e., credit lines) from Goldman Sachs, Credit Suisse, Deutsche Bank, and Morgan Stanley. About $6.4 billion of these funds were used to satisfy cash payment obligations under the Plan of Reorganization. These obligations included the repayment of a portion of unsecured creditor claims and administrative claims, such as legal and consulting fees, as well as expenses incurred in connection with the "exit facilities" and immediate working capital requirements. On emerging from Chapter 11, the firm carried $10.4 billion of debt with an average interest rate of 8.1 percent. The Enron Shuffle-A Scandal to Remember What started in the mid-1980s as essentially a staid "old-economy" business became the poster child in the late 1990s for companies wanting to remake themselves into "new-economy" powerhouses. Unfortunately, what may have started with the best of intentions emerged as one of the biggest business scandals in U.S. history. Enron was created in 1985 as a result of a merger between Houston Natural Gas and Internorth Natural Gas. In 1989, Enron started trading natural gas commodities and eventually became the world's largest buyer and seller of natural gas. In the early 1990s, Enron became the nation's premier electricity marketer and pioneered the development of trading in such commodities as weather derivatives, bandwidth, pulp, paper, and plastics. Enron invested billions in its broadband unit and water and wastewater system management unit and in hard assets overseas. In 2000, Enron reported $101 billion in revenue and a market capitalization of $63 billion. The Virtual Company Enron was essentially a company whose trading and risk management business strategy was built on assets largely owned by others. The complex financial maneuvering and off-balance-sheet partnerships that former CEO Jeffrey K. Skilling and chief financial officer Andrew S. Fastow implemented were intended to remove everything from telecommunications fiber to water companies from the firm's balance sheet and into partnerships. What distinguished Enron's partnerships from those commonly used to share risks were their lack of independence from Enron and the use of Enron's stock as collateral to leverage the partnerships. If Enron's stock fell in value, the firm was obligated to issue more shares to the partnership to restore the value of the collateral underlying the debt or immediately repay the debt. Lenders in effect had direct recourse to Enron stock if at any time the partnerships could not repay their loans in full. Rather than limiting risk, Enron was assuming total risk by guaranteeing the loans with its stock. Enron also engaged in transactions that inflated its earnings, such as selling time on its broadband system to a partnership at inflated prices at a time when the demand for broadband was plummeting. Enron then recorded a substantial profit on such transactions. The partnerships agreed to such transactions because Enron management seems to have exerted disproportionate influence in some instances over partnership decisions, although its ownership interests were very small, often less than 3 percent. Curiously, Enron's outside auditor, Arthur Andersen, had a dual role in these partnerships, collecting fees for helping to set them up and auditing them. Time to Pay the Piper At the time the firm filed for bankruptcy on December 2, 2001, it had $13.1 billion in debt on the books of the parent company and another $18.1 billion on the balance sheets of affiliated companies and partnerships. In addition to the partnerships created by Enron, a number of bad investments both in the United States and abroad contributed to the firm's malaise. Meanwhile, Enron's core energy distribution business was deteriorating. Enron was attempting to gain share in a maturing market by paring selling prices. Margins also suffered from poor cost containment. Dynegy Corp. agreed to buy Enron for $10 billion on November 2, 2001. On November 8, Enron announced that its net income would have to be restated back to 1997, resulting in a $586 million reduction in reported profits. On November 15, chairman Kenneth Lay admitted that the firm had made billions of dollars in bad investments. Four days later, Enron said it would have to repay a $690 million note by mid-December and it might have to take an additional $700 million pretax charge. At the end of the month, Dynegy withdrew its offer and Enron's credit rating was reduced to junk bond status. Enron was responsible for another $3.9 billion owed by its partnerships. Enron had less than $2 billion in cash on hand. The end came quickly as investors and customers completely lost faith in the energy behemoth as a result of its secrecy and complex financial maneuvers, forcing the firm into bankruptcy in early December. Enron's stock, which had reached a high of $90 per share on August 17, 2001, was trading at less than $1 by December 5, 2001. In addition to its angry creditors, Enron faced class-action lawsuits by shareholders and employees, whose pensions were invested heavily in Enron stock. Enron also faced intense scrutiny from congressional committees and the U.S. Department of Justice. By the end of 2001, shareholders had lost more than $63 billion from its previous 52-week high, bondholders lost $2.6 billion in the face value of their debt, and banks appeared to be at risk on at least $15 billion of credit they had extended to Enron. In addition, potential losses on uncollateralized derivative contracts totaled $4 billion. Such contracts involved Enron commitments to buy various types of commodities at some point in the future. Questions remain as to why Wall Street analysts, Arthur Andersen, federal or state regulatory authorities, the credit rating agencies, and the firm's board of directors did not sound the alarm sooner. It is surprising that the audit committee of the Enron board seems to have somehow been unaware of the firm's highly questionable financial maneuvers. Inquiries following the bankruptcy declaration seem to suggest that the audit committee followed all the rules stipulated by federal regulators and stock exchanges regarding director pay, independence, disclosure, and financial expertise. Enron seems to have collapsed in part because such rules did not do what they were supposed to do. For example, paying directors with stock may have aligned their interests with shareholders, but it also is possible to have been a disincentive to question aggressively senior management about their financial dealings. The Lessons of Enron Enron may be the best recent example of a complete breakdown in corporate governance, a system intended to protect shareholders. Inside Enron, the board of directors, management, and the audit function failed to do the job. Similarly, the firm's outside auditors, regulators, credit rating agencies, and Wall Street analysts also failed to alert investors. What seems to be apparent is that if the auditors fail to identify incompetence or fraud, the system of safeguards is likely to break down. The cost of failure to those charged with protecting the shareholders, including outside auditors, analysts, credit-rating agencies, and regulators, was simply not high enough to ensure adequate scrutiny. What may have transpired is that company managers simply undertook aggressive interpretations of accounting principles then challenged auditors to demonstrate that such practices were not in accordance with GAAP accounting rules (Weil, 2002). This type of practice has been going on since the early 1980s and may account for the proliferation of specific accounting rules applicable only to certain transactions to insulate both the firm engaging in the transaction and the auditor reviewing the transaction from subsequent litigation. In one sense, the Enron debacle represents a failure of the free market system and its current shareholder protection mechanisms, in that it took so long for the dramatic Enron shell game to be revealed to the public. However, this incident highlights the remarkable resilience of the free market system. The free market system worked quite effectively in its rapid imposition of discipline in bringing down the Enron house of cards, without any noticeable disruption in energy distribution nationwide. Epilogue Due to the complexity of dealing with so many types of creditors, Enron filed its plan with the federal bankruptcy court to reorganize one and a half years after seeking bankruptcy protection on December 2, 2001. The resulting reorganization has been one of the most costly and complex on record, with total legal and consulting fees exceeding $500 million by the end of 2003. More than 350 classes of creditors, including banks, bondholders, and other energy companies that traded with Enron said they were owed about $67 billion. Under the reorganization plan, unsecured creditors received an estimated 14 cents for each dollar of claims against Enron Corp., while those with claims against Enron North America received an estimated 18.3 cents on the dollar. The money came in cash payments and stock in two holding companies, CrossCountry containing the firm's North American pipeline assets and Prisma Energy International containing the firm's South American operations. After losing its auditing license in 2004, Arthur Andersen, formerly among the largest auditing firms in the world, ceased operation. In 2006, Andrew Fastow, former Enron chief financial officer, and Lea Fastow plead guilty to several charges of conspiracy to commit fraud. Andrew Fastow received a sentence of 10 years in prison without the possibility of parole. His wife received a much shorter sentence. Also in 2006, Enron chairman Kenneth Lay died while awaiting sentencing, and Enron president Jeffery Skilling received a sentence of 24 years in prison. Citigroup agreed in early 2008 to pay $1.66 billion to Enron creditors who lost money following the collapse of the firm. Citigroup was the last remaining defendant in what was known as the Mega Claims lawsuit, a bankruptcy lawsuit filed in 2003 against 11 banks and brokerages. The suit alleged that, with the help of banks, Enron kept creditors in the dark about the firm's financial problems through misleading accounting practices. Because of the Mega Claims suit, creditors recovered a total of $5 billion or about 37.4 cents on each dollar owed to them. This lawsuit followed the settlement of a $40 billion class action lawsuit by shareholders, which Citicorp settled in June 2005 for $2 billion. -In what way was the Enron debacle a break down in corporate governance (oversight)? Explain your answer.
Question 74
Essay
Calpine Emerges from the Protection of Bankruptcy Court Following approval of its sixth Plan of Reorganization by the U.S. Bankruptcy Court for the Southern District of New York, Calpine Corporation was able to emerge from Chapter 11 bankruptcy on January 31, 2008. Burdened by excessive debt and court battles with creditors on how to use its cash, the electric utility had sought Chapter 11 protection by petitioning the bankruptcy court in December 2005. After settlements with certain stakeholders, all classes of creditors voted to approve the Plan of Reorganization, which provided for the discharge of claims through the issuance of reorganized Calpine Corporation common stock, cash, or a combination of cash and stock to its creditors. Shortly after exiting bankruptcy, Calpine cancelled all of its then outstanding common stock and authorized the issuance of 485 million shares of reorganized Calpine Corporation common stock for distribution to holders of unsecured claims. In addition, the firm issued warrants (i.e., securities) to purchase 48.5 million shares of reorganized Calpine Corporation common stock to the holders of the cancelled (i.e., previously outstanding) common stock. The warrants were issued on a pro rata basis reflecting the number of shares of "old common stock" held at the time of cancellation. These warrants carried an exercise price of $23.88 per share and expired on August 25, 2008. Relisted on the New York Stock Exchange, the reorganized Calpine Corporation common stock began trading under the symbol CPN on February 7, 2008, at about $18 per share. The firm had improved its capital structure while in bankruptcy. On entering bankruptcy, Calpine carried $17.4 billion of debt with an average interest rate of 10.3 percent. By retiring unsecured debt with reorganized Calpine Corporation common stock and selling certain assets, Calpine was able to repay or refinance certain project debt, thereby reducing the prebankruptcy petition debt by approximately $7 billion. On exiting bankruptcy, Calpine negotiated approximately $7.3 billion of secured "exit facilities" (i.e., credit lines) from Goldman Sachs, Credit Suisse, Deutsche Bank, and Morgan Stanley. About $6.4 billion of these funds were used to satisfy cash payment obligations under the Plan of Reorganization. These obligations included the repayment of a portion of unsecured creditor claims and administrative claims, such as legal and consulting fees, as well as expenses incurred in connection with the "exit facilities" and immediate working capital requirements. On emerging from Chapter 11, the firm carried $10.4 billion of debt with an average interest rate of 8.1 percent. The Enron Shuffle-A Scandal to Remember What started in the mid-1980s as essentially a staid "old-economy" business became the poster child in the late 1990s for companies wanting to remake themselves into "new-economy" powerhouses. Unfortunately, what may have started with the best of intentions emerged as one of the biggest business scandals in U.S. history. Enron was created in 1985 as a result of a merger between Houston Natural Gas and Internorth Natural Gas. In 1989, Enron started trading natural gas commodities and eventually became the world's largest buyer and seller of natural gas. In the early 1990s, Enron became the nation's premier electricity marketer and pioneered the development of trading in such commodities as weather derivatives, bandwidth, pulp, paper, and plastics. Enron invested billions in its broadband unit and water and wastewater system management unit and in hard assets overseas. In 2000, Enron reported $101 billion in revenue and a market capitalization of $63 billion. The Virtual Company Enron was essentially a company whose trading and risk management business strategy was built on assets largely owned by others. The complex financial maneuvering and off-balance-sheet partnerships that former CEO Jeffrey K. Skilling and chief financial officer Andrew S. Fastow implemented were intended to remove everything from telecommunications fiber to water companies from the firm's balance sheet and into partnerships. What distinguished Enron's partnerships from those commonly used to share risks were their lack of independence from Enron and the use of Enron's stock as collateral to leverage the partnerships. If Enron's stock fell in value, the firm was obligated to issue more shares to the partnership to restore the value of the collateral underlying the debt or immediately repay the debt. Lenders in effect had direct recourse to Enron stock if at any time the partnerships could not repay their loans in full. Rather than limiting risk, Enron was assuming total risk by guaranteeing the loans with its stock. Enron also engaged in transactions that inflated its earnings, such as selling time on its broadband system to a partnership at inflated prices at a time when the demand for broadband was plummeting. Enron then recorded a substantial profit on such transactions. The partnerships agreed to such transactions because Enron management seems to have exerted disproportionate influence in some instances over partnership decisions, although its ownership interests were very small, often less than 3 percent. Curiously, Enron's outside auditor, Arthur Andersen, had a dual role in these partnerships, collecting fees for helping to set them up and auditing them. Time to Pay the Piper At the time the firm filed for bankruptcy on December 2, 2001, it had $13.1 billion in debt on the books of the parent company and another $18.1 billion on the balance sheets of affiliated companies and partnerships. In addition to the partnerships created by Enron, a number of bad investments both in the United States and abroad contributed to the firm's malaise. Meanwhile, Enron's core energy distribution business was deteriorating. Enron was attempting to gain share in a maturing market by paring selling prices. Margins also suffered from poor cost containment. Dynegy Corp. agreed to buy Enron for $10 billion on November 2, 2001. On November 8, Enron announced that its net income would have to be restated back to 1997, resulting in a $586 million reduction in reported profits. On November 15, chairman Kenneth Lay admitted that the firm had made billions of dollars in bad investments. Four days later, Enron said it would have to repay a $690 million note by mid-December and it might have to take an additional $700 million pretax charge. At the end of the month, Dynegy withdrew its offer and Enron's credit rating was reduced to junk bond status. Enron was responsible for another $3.9 billion owed by its partnerships. Enron had less than $2 billion in cash on hand. The end came quickly as investors and customers completely lost faith in the energy behemoth as a result of its secrecy and complex financial maneuvers, forcing the firm into bankruptcy in early December. Enron's stock, which had reached a high of $90 per share on August 17, 2001, was trading at less than $1 by December 5, 2001. In addition to its angry creditors, Enron faced class-action lawsuits by shareholders and employees, whose pensions were invested heavily in Enron stock. Enron also faced intense scrutiny from congressional committees and the U.S. Department of Justice. By the end of 2001, shareholders had lost more than $63 billion from its previous 52-week high, bondholders lost $2.6 billion in the face value of their debt, and banks appeared to be at risk on at least $15 billion of credit they had extended to Enron. In addition, potential losses on uncollateralized derivative contracts totaled $4 billion. Such contracts involved Enron commitments to buy various types of commodities at some point in the future. Questions remain as to why Wall Street analysts, Arthur Andersen, federal or state regulatory authorities, the credit rating agencies, and the firm's board of directors did not sound the alarm sooner. It is surprising that the audit committee of the Enron board seems to have somehow been unaware of the firm's highly questionable financial maneuvers. Inquiries following the bankruptcy declaration seem to suggest that the audit committee followed all the rules stipulated by federal regulators and stock exchanges regarding director pay, independence, disclosure, and financial expertise. Enron seems to have collapsed in part because such rules did not do what they were supposed to do. For example, paying directors with stock may have aligned their interests with shareholders, but it also is possible to have been a disincentive to question aggressively senior management about their financial dealings. The Lessons of Enron Enron may be the best recent example of a complete breakdown in corporate governance, a system intended to protect shareholders. Inside Enron, the board of directors, management, and the audit function failed to do the job. Similarly, the firm's outside auditors, regulators, credit rating agencies, and Wall Street analysts also failed to alert investors. What seems to be apparent is that if the auditors fail to identify incompetence or fraud, the system of safeguards is likely to break down. The cost of failure to those charged with protecting the shareholders, including outside auditors, analysts, credit-rating agencies, and regulators, was simply not high enough to ensure adequate scrutiny. What may have transpired is that company managers simply undertook aggressive interpretations of accounting principles then challenged auditors to demonstrate that such practices were not in accordance with GAAP accounting rules (Weil, 2002). This type of practice has been going on since the early 1980s and may account for the proliferation of specific accounting rules applicable only to certain transactions to insulate both the firm engaging in the transaction and the auditor reviewing the transaction from subsequent litigation. In one sense, the Enron debacle represents a failure of the free market system and its current shareholder protection mechanisms, in that it took so long for the dramatic Enron shell game to be revealed to the public. However, this incident highlights the remarkable resilience of the free market system. The free market system worked quite effectively in its rapid imposition of discipline in bringing down the Enron house of cards, without any noticeable disruption in energy distribution nationwide. Epilogue Due to the complexity of dealing with so many types of creditors, Enron filed its plan with the federal bankruptcy court to reorganize one and a half years after seeking bankruptcy protection on December 2, 2001. The resulting reorganization has been one of the most costly and complex on record, with total legal and consulting fees exceeding $500 million by the end of 2003. More than 350 classes of creditors, including banks, bondholders, and other energy companies that traded with Enron said they were owed about $67 billion. Under the reorganization plan, unsecured creditors received an estimated 14 cents for each dollar of claims against Enron Corp., while those with claims against Enron North America received an estimated 18.3 cents on the dollar. The money came in cash payments and stock in two holding companies, CrossCountry containing the firm's North American pipeline assets and Prisma Energy International containing the firm's South American operations. After losing its auditing license in 2004, Arthur Andersen, formerly among the largest auditing firms in the world, ceased operation. In 2006, Andrew Fastow, former Enron chief financial officer, and Lea Fastow plead guilty to several charges of conspiracy to commit fraud. Andrew Fastow received a sentence of 10 years in prison without the possibility of parole. His wife received a much shorter sentence. Also in 2006, Enron chairman Kenneth Lay died while awaiting sentencing, and Enron president Jeffery Skilling received a sentence of 24 years in prison. Citigroup agreed in early 2008 to pay $1.66 billion to Enron creditors who lost money following the collapse of the firm. Citigroup was the last remaining defendant in what was known as the Mega Claims lawsuit, a bankruptcy lawsuit filed in 2003 against 11 banks and brokerages. The suit alleged that, with the help of banks, Enron kept creditors in the dark about the firm's financial problems through misleading accounting practices. Because of the Mega Claims suit, creditors recovered a total of $5 billion or about 37.4 cents on each dollar owed to them. This lawsuit followed the settlement of a $40 billion class action lawsuit by shareholders, which Citicorp settled in June 2005 for $2 billion. -How were the Enron partnerships used to hide debt and inflate the firm's earnings? Should partnership structures be limited in the future? If so,how?
Question 75
Essay
Calpine Emerges from the Protection of Bankruptcy Court Following approval of its sixth Plan of Reorganization by the U.S. Bankruptcy Court for the Southern District of New York, Calpine Corporation was able to emerge from Chapter 11 bankruptcy on January 31, 2008. Burdened by excessive debt and court battles with creditors on how to use its cash, the electric utility had sought Chapter 11 protection by petitioning the bankruptcy court in December 2005. After settlements with certain stakeholders, all classes of creditors voted to approve the Plan of Reorganization, which provided for the discharge of claims through the issuance of reorganized Calpine Corporation common stock, cash, or a combination of cash and stock to its creditors. Shortly after exiting bankruptcy, Calpine cancelled all of its then outstanding common stock and authorized the issuance of 485 million shares of reorganized Calpine Corporation common stock for distribution to holders of unsecured claims. In addition, the firm issued warrants (i.e., securities) to purchase 48.5 million shares of reorganized Calpine Corporation common stock to the holders of the cancelled (i.e., previously outstanding) common stock. The warrants were issued on a pro rata basis reflecting the number of shares of "old common stock" held at the time of cancellation. These warrants carried an exercise price of $23.88 per share and expired on August 25, 2008. Relisted on the New York Stock Exchange, the reorganized Calpine Corporation common stock began trading under the symbol CPN on February 7, 2008, at about $18 per share. The firm had improved its capital structure while in bankruptcy. On entering bankruptcy, Calpine carried $17.4 billion of debt with an average interest rate of 10.3 percent. By retiring unsecured debt with reorganized Calpine Corporation common stock and selling certain assets, Calpine was able to repay or refinance certain project debt, thereby reducing the prebankruptcy petition debt by approximately $7 billion. On exiting bankruptcy, Calpine negotiated approximately $7.3 billion of secured "exit facilities" (i.e., credit lines) from Goldman Sachs, Credit Suisse, Deutsche Bank, and Morgan Stanley. About $6.4 billion of these funds were used to satisfy cash payment obligations under the Plan of Reorganization. These obligations included the repayment of a portion of unsecured creditor claims and administrative claims, such as legal and consulting fees, as well as expenses incurred in connection with the "exit facilities" and immediate working capital requirements. On emerging from Chapter 11, the firm carried $10.4 billion of debt with an average interest rate of 8.1 percent. The Enron Shuffle-A Scandal to Remember What started in the mid-1980s as essentially a staid "old-economy" business became the poster child in the late 1990s for companies wanting to remake themselves into "new-economy" powerhouses. Unfortunately, what may have started with the best of intentions emerged as one of the biggest business scandals in U.S. history. Enron was created in 1985 as a result of a merger between Houston Natural Gas and Internorth Natural Gas. In 1989, Enron started trading natural gas commodities and eventually became the world's largest buyer and seller of natural gas. In the early 1990s, Enron became the nation's premier electricity marketer and pioneered the development of trading in such commodities as weather derivatives, bandwidth, pulp, paper, and plastics. Enron invested billions in its broadband unit and water and wastewater system management unit and in hard assets overseas. In 2000, Enron reported $101 billion in revenue and a market capitalization of $63 billion. The Virtual Company Enron was essentially a company whose trading and risk management business strategy was built on assets largely owned by others. The complex financial maneuvering and off-balance-sheet partnerships that former CEO Jeffrey K. Skilling and chief financial officer Andrew S. Fastow implemented were intended to remove everything from telecommunications fiber to water companies from the firm's balance sheet and into partnerships. What distinguished Enron's partnerships from those commonly used to share risks were their lack of independence from Enron and the use of Enron's stock as collateral to leverage the partnerships. If Enron's stock fell in value, the firm was obligated to issue more shares to the partnership to restore the value of the collateral underlying the debt or immediately repay the debt. Lenders in effect had direct recourse to Enron stock if at any time the partnerships could not repay their loans in full. Rather than limiting risk, Enron was assuming total risk by guaranteeing the loans with its stock. Enron also engaged in transactions that inflated its earnings, such as selling time on its broadband system to a partnership at inflated prices at a time when the demand for broadband was plummeting. Enron then recorded a substantial profit on such transactions. The partnerships agreed to such transactions because Enron management seems to have exerted disproportionate influence in some instances over partnership decisions, although its ownership interests were very small, often less than 3 percent. Curiously, Enron's outside auditor, Arthur Andersen, had a dual role in these partnerships, collecting fees for helping to set them up and auditing them. Time to Pay the Piper At the time the firm filed for bankruptcy on December 2, 2001, it had $13.1 billion in debt on the books of the parent company and another $18.1 billion on the balance sheets of affiliated companies and partnerships. In addition to the partnerships created by Enron, a number of bad investments both in the United States and abroad contributed to the firm's malaise. Meanwhile, Enron's core energy distribution business was deteriorating. Enron was attempting to gain share in a maturing market by paring selling prices. Margins also suffered from poor cost containment. Dynegy Corp. agreed to buy Enron for $10 billion on November 2, 2001. On November 8, Enron announced that its net income would have to be restated back to 1997, resulting in a $586 million reduction in reported profits. On November 15, chairman Kenneth Lay admitted that the firm had made billions of dollars in bad investments. Four days later, Enron said it would have to repay a $690 million note by mid-December and it might have to take an additional $700 million pretax charge. At the end of the month, Dynegy withdrew its offer and Enron's credit rating was reduced to junk bond status. Enron was responsible for another $3.9 billion owed by its partnerships. Enron had less than $2 billion in cash on hand. The end came quickly as investors and customers completely lost faith in the energy behemoth as a result of its secrecy and complex financial maneuvers, forcing the firm into bankruptcy in early December. Enron's stock, which had reached a high of $90 per share on August 17, 2001, was trading at less than $1 by December 5, 2001. In addition to its angry creditors, Enron faced class-action lawsuits by shareholders and employees, whose pensions were invested heavily in Enron stock. Enron also faced intense scrutiny from congressional committees and the U.S. Department of Justice. By the end of 2001, shareholders had lost more than $63 billion from its previous 52-week high, bondholders lost $2.6 billion in the face value of their debt, and banks appeared to be at risk on at least $15 billion of credit they had extended to Enron. In addition, potential losses on uncollateralized derivative contracts totaled $4 billion. Such contracts involved Enron commitments to buy various types of commodities at some point in the future. Questions remain as to why Wall Street analysts, Arthur Andersen, federal or state regulatory authorities, the credit rating agencies, and the firm's board of directors did not sound the alarm sooner. It is surprising that the audit committee of the Enron board seems to have somehow been unaware of the firm's highly questionable financial maneuvers. Inquiries following the bankruptcy declaration seem to suggest that the audit committee followed all the rules stipulated by federal regulators and stock exchanges regarding director pay, independence, disclosure, and financial expertise. Enron seems to have collapsed in part because such rules did not do what they were supposed to do. For example, paying directors with stock may have aligned their interests with shareholders, but it also is possible to have been a disincentive to question aggressively senior management about their financial dealings. The Lessons of Enron Enron may be the best recent example of a complete breakdown in corporate governance, a system intended to protect shareholders. Inside Enron, the board of directors, management, and the audit function failed to do the job. Similarly, the firm's outside auditors, regulators, credit rating agencies, and Wall Street analysts also failed to alert investors. What seems to be apparent is that if the auditors fail to identify incompetence or fraud, the system of safeguards is likely to break down. The cost of failure to those charged with protecting the shareholders, including outside auditors, analysts, credit-rating agencies, and regulators, was simply not high enough to ensure adequate scrutiny. What may have transpired is that company managers simply undertook aggressive interpretations of accounting principles then challenged auditors to demonstrate that such practices were not in accordance with GAAP accounting rules (Weil, 2002). This type of practice has been going on since the early 1980s and may account for the proliferation of specific accounting rules applicable only to certain transactions to insulate both the firm engaging in the transaction and the auditor reviewing the transaction from subsequent litigation. In one sense, the Enron debacle represents a failure of the free market system and its current shareholder protection mechanisms, in that it took so long for the dramatic Enron shell game to be revealed to the public. However, this incident highlights the remarkable resilience of the free market system. The free market system worked quite effectively in its rapid imposition of discipline in bringing down the Enron house of cards, without any noticeable disruption in energy distribution nationwide. Epilogue Due to the complexity of dealing with so many types of creditors, Enron filed its plan with the federal bankruptcy court to reorganize one and a half years after seeking bankruptcy protection on December 2, 2001. The resulting reorganization has been one of the most costly and complex on record, with total legal and consulting fees exceeding $500 million by the end of 2003. More than 350 classes of creditors, including banks, bondholders, and other energy companies that traded with Enron said they were owed about $67 billion. Under the reorganization plan, unsecured creditors received an estimated 14 cents for each dollar of claims against Enron Corp., while those with claims against Enron North America received an estimated 18.3 cents on the dollar. The money came in cash payments and stock in two holding companies, CrossCountry containing the firm's North American pipeline assets and Prisma Energy International containing the firm's South American operations. After losing its auditing license in 2004, Arthur Andersen, formerly among the largest auditing firms in the world, ceased operation. In 2006, Andrew Fastow, former Enron chief financial officer, and Lea Fastow plead guilty to several charges of conspiracy to commit fraud. Andrew Fastow received a sentence of 10 years in prison without the possibility of parole. His wife received a much shorter sentence. Also in 2006, Enron chairman Kenneth Lay died while awaiting sentencing, and Enron president Jeffery Skilling received a sentence of 24 years in prison. Citigroup agreed in early 2008 to pay $1.66 billion to Enron creditors who lost money following the collapse of the firm. Citigroup was the last remaining defendant in what was known as the Mega Claims lawsuit, a bankruptcy lawsuit filed in 2003 against 11 banks and brokerages. The suit alleged that, with the help of banks, Enron kept creditors in the dark about the firm's financial problems through misleading accounting practices. Because of the Mega Claims suit, creditors recovered a total of $5 billion or about 37.4 cents on each dollar owed to them. This lawsuit followed the settlement of a $40 billion class action lawsuit by shareholders, which Citicorp settled in June 2005 for $2 billion. -What should (or can)be done to reduce the likelihood of this type of situation arising in the future? Be specific.
Question 76
Essay
Why would lenders be willing to lend to a firm emerging from Chapter 11? How did the lenders attempt to manage their risks? Be specific.
Question 77
Multiple Choice
The Bankruptcy Abuse Prevention and Creditor Protection Act of 2005 is intended to achieve all of the following except:
Question 78
Essay
In view of the substantial loss of jobs,as well as wage and benefit reductions,do you believe that firms should be allowed to reorganize in bankruptcy? Explain your answer.