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President-elect Obama and the American people have a choice: embrace financial sanity and safety and soundness by deflating the last, biggest speculative bubble using the time-tested mechanism of insolvency. Or we can muddle along for the next decade or more, using the Paulson/Geithner model of financial rescue for the AIG CDS Ponzi scheme and embrace the Japanese model of economic stagnation.
And, yes, we can put AIG and the other providers of protection through a bankruptcy and force the CDS market into a quick and final extinction. Remember, when AIG goes bankrupt the insurance units are taken over by NY, WI and put into statutory receiverships. Only the rancid CDS positions and financial engineering unit of AIG end up in bankruptcy. And fortunately we have a fine example of just how to do it in the bankruptcy of Lehman Brothers.
Our friends at Katten Muchin Rosenman in Chicago wrote last week in their excellent Client Advisory: "On November 13, 2008, Lehman Brothers Holdings Inc. and its U.S. affiliates in bankruptcy, including Lehman Brothers Special Financing and Lehman Brothers Commercial Paper (collectively, "Lehman") filed a motion asking that certain expedited procedures be put in place to allow Lehman to assume, assign or terminate the thousands of executory derivative contracts to which they are a party. If Lehman's motion is granted, counterparties to transactions that have not been terminated will have very little time to react and will likely find themselves with new counterparties and no further recourse to Lehman because, by assigning contracts to third parties, Lehman will effectively receive, by normal operation of the Bankruptcy Code, a novation."
At some point, Washington is going to be forced to accept that bankruptcy and liquidation, the harsh medicine used with other financial insolvencies, are the best ways to deal with the last, greatest bubble, namely the CDS market. When the end comes, it will effect some of the largest financial institutions in the world, chief among them Citigroup (NYSE:C), JPMorganChase (NYSE:JPM), GS and MS, as well as some large Euroland banks.
The impending blowback from a CDS unwind at less than face amount is one of the reasons that the financial markets have been pummeling the equity values of the larger banks last week. Any bank with a large derivatives trading book is likely to be mortally wounded as the CDS markets finally collapse. We don't see problems with interest rate or currency contracts, by the way, only the great CDS Ponzi scheme is at issue - hopefully, if authorities around the world act with purpose on rendering extinct CDS contracts as they exist today. Call it a Christmas present to the entire world.
I often tell clients that the first thing you should do when you find yourself in a hole is quit digging. If your business is in a hole, bleeding cash and building debt, I would add one more bit of advice. Set yourself a limit, whether it is a dollar amount that you will invest in the business, or a length of time that you will operate at a loss, or some other measure. Decide on your tolerance for risk, and don’t go beyond it. I can’t tell you what that ought to be because it is a very personal limit. But set it, and live with it. Don’t just keep digging the hole deeper out of simple inertia.
- Do you have the time, energy, and desire to continue the business?
- Could the business prosper if it wasn’t servicing old debt?
- Could the business prosper if it shed equipment or premises leases?
- Could you start a like business if you walked away from this one?
- Could you sell this business as a going concern?
Corporate Bankruptcy
What happens when a public company files for protection under the federal bankruptcy laws? Who protects the interests of investors? Do the old securities have any value when, and if, the company is reorganized? We hope this information answers these and other frequently asked questions about the lengthy and sometimes uncertain bankruptcy process.
What Happens to the Company?
How Are Assets Divided in Bankruptcy?
Secured Creditors - often a bank, is paid first.
Unsecured Creditors - such as banks, suppliers, and bondholders, have the next claim.
Stockholders - owners of the company, have the last claim on assets and may not receive anything if the Secured and Unsecured Creditors' claims are not fully repaid.
Federal bankruptcy laws govern how companies go out of business or recover from crippling debt. A bankrupt company, the "debtor," might use Chapter 11 of the Bankruptcy Code to "reorganize" its business and try to become profitable again. Management continues to run the day-to-day business operations but all significant business decisions must be approved by a bankruptcy court.
Under Chapter 7, the company stops all operations and goes completely out of business. A trustee is appointed to "liquidate" (sell) the company's assets and the money is used to pay off the debt, which may include debts to creditors and investors.
The investors who take the least risk are paid first. For example, secured creditors take less risk because the credit that they extend is usually backed by collateral, such as a mortgage or other assets of the company. They know they will get paid first if the company declares bankruptcy.
Bondholders have a greater potential for recovering their losses than stockholders, because bonds represent the debt of the company and the company has agreed to pay bondholders interest and to return their principal. Stockholders own the company, and take greater risk. They could make more money if the company does well, but they could lose money if the company does poorly. The owners are last in line to be repaid if the company fails. Bankruptcy laws determine the order of payment.
What Will Happen to My Stock or Bond?
A company's securities may continue to trade even after the company has filed for bankruptcy under Chapter 11. In most instances, companies that file under Chapter 11 of the Bankruptcy Code are generally unable to meet the listing standards to continue to trade on Nasdaq or the New York Stock Exchange. However, even when a company is delisted from one of these major stock exchanges, their shares may continue to trade on either the OTCBB or the Pink Sheets. There is no federal law that prohibits trading of securities of companies in bankruptcy.
Note: Investors should be cautious when buying common stock of companies in Chapter 11 bankruptcy. It is extremely risky and is likely to lead to financial loss. Although a company may emerge from bankruptcy as a viable entity, generally, the creditors and the bondholders become the new owners of the shares. In most instances, the company's plan of reorganization will cancel the existing equity shares. This happens in bankruptcy cases because secured and unsecured creditors are paid from the company's assets before common stockholders. And in situations where shareholders do participate in the plan, their shares are usually subject to substantial dilution.
If the company does come out of bankruptcy, there may be two different types of common stock, with different ticker symbols, trading for the same company. One is the old common stock (the stock that was on the market when the company went into bankruptcy), and the second is the new common stock that the company issued as part of its reorganization plan. If the old common stock is traded on the OTCBB or on the Pink Sheets, it will have a five-letter ticker symbol that ends in "Q," indicating that the stock was involved with bankruptcy proceedings. The ticker symbol for the new common stock will not end in "Q". Sometimes the new stock may not have been issued by the company, although it has been authorized. In that situation, the stock is said to be trading "when issued," which is shorthand for "when, as, and if issued." The ticker symbol of stock that is trading "when issued" will end with a "V". Once the company actually issues the newly authorized stock, the "V" will no longer appear at the end of the ticker symbol. Be sure you know which shares you are purchasing, because the old shares that were issued before the company filed for bankruptcy may be worthless if the company has emerged from bankruptcy and has issued new common stock.
During bankruptcy, bondholders will stop receiving interest and principal payments, and stockholders will stop receiving dividends. If you are a bondholder, you may receive new stock in exchange for your bonds, new bonds, or a combination of stock and bonds. If you are a stockholder, the trustee may ask you to send back your old stock in exchange for new shares in the reorganized company. The new shares may be fewer in number and may be worth less than your old shares. The reorganization plan will spell out your rights as an investor, and what you can expect to receive, if anything, from the company.
The bankruptcy court may determine that stockholders don't get anything because the debtor is insolvent. (A debtor's solvency is determined by the difference between the value of its assets and its liabilities.) If the company's liabilities are greater than its assets, your stock may be worthless. Contact your local Internal Revenue Service (IRS) office or call 1-800-829-1040 for information about how to report worthless securities as a loss on your income tax return. If you don't know whether your stock has value, and you can't find a stock or bond price in the newspaper, ask your broker or the company for information.
Why Would a Company Choose Chapter 11?
"Prepackaged Bankruptcy Plans"
Sometimes companies prepare a reorganization plan that is negotiated and voted on by creditors and stockholders before they actually file for bankruptcy. This shortens and simplifies the process, saving the company money. For example, Resorts International and TWA used this method.
If prepackaged plans involve an offer to sell a security, they may have to be registered with the SEC. You will get a prospectus and a ballot, and it's important to vote if you want to have any impact on the process. Under the Bankruptcy Code, two-thirds of the stockholders who vote must accept the plan before it can be implemented, and dissenters will have to go along with the majority.
Most publicly-held companies will file under Chapter 11 rather than Chapter 7 because they can still run their business and control the bankruptcy process. Chapter 11 provides a process for rehabilitating the company's faltering business. Sometimes the company successfully works out a plan to return to profitability; sometimes, in the end, it liquidates. Under a Chapter 11 reorganization, a company usually keeps doing business and its stock and bonds may continue to trade in our securities markets. Since they still trade, the company must continue to file SEC reports with information about significant developments. For example, when a company declares bankruptcy, or has other significant corporate changes, they must report it within 15 days on the SEC's Form 8-K.
How Does Chapter 11 Work?
The U.S. Trustee, the bankruptcy arm of the Justice Department, will appoint one or more committees to represent the interests of creditors and stockholders in working with the company to develop a plan of reorganization to get out of debt. The plan must be accepted by the creditors, bondholders, and stockholders, and confirmed by the court. However, even if creditors or stockholders vote to reject the plan, the court can disregard the vote and still confirm the plan if it finds that the plan treats creditors and stockholders fairly. Once the plan is confirmed, another more detailed report must be filed with the SEC on Form 8-K. This report must contain a summary of the plan, but sometimes a copy of the complete plan is attached.
Who Develops the Reorganization Plan for the Company?
Committees of creditors and stockholders negotiate a plan with the company to relieve the company from repaying part of its debt so that the company can try to get back on its feet.
One committee that must be formed is called the "official committee of unsecured creditors." They represent all unsecured creditors, including bondholders. The "indenture trustee," often a bank hired by the company when it originally issued a bond, may sit on the committee.
An additional official committee may sometimes be appointed to represent stockholders.
The U.S. Trustee may appoint another committee to represent a distinct class of creditors, such as secured creditors, employees or subordinated bondholders.
After the committees work with the company to develop a plan, the bankruptcy court must find that it legally complies with the Bankruptcy Code before the plan can be implemented. This process is known as plan confirmation and is usually completed in a few months.
Steps in Development of the Plan:
The debtor company develops a plan with committees.
Company prepares a disclosure statement and reorganization plan and files it with the court.
SEC reviews the disclosure statement to be sure it's complete.
Creditors (and sometimes the stockholders) vote on the plan.
Court confirms the plan, and
Company carries out the plan by distributing the securities or payments called for by the plan.
What is the Role of the U.S. Securities & Exchange Commission in Chapter 11 Bankruptcies?
Generally, the SEC's role is limited. The SEC will:
review the disclosure document to determine if the company is telling investors and creditors the important information they need to know; and
ensure that stockholders are represented by an official committee, if appropriate.
Although the SEC does not negotiate the economic terms of reorganization plans, we may take a position on important legal issues that will affect the rights of public investors in other bankruptcy cases as well. For example, the SEC may step in if we believe that the company's officers and directors are using the bankruptcy laws to shield themselves from lawsuits for securities fraud.
How Will I Know What's Going On?
Sometimes, you may first learn about a bankruptcy in the news. If you hold stock or bonds in street name with a broker, your broker should forward information from the company to you. If you hold a stock or bond in your own name, you should receive information directly from the company.
You may be asked to vote on the plan of reorganization, although you may not get the full value of your investment back. In fact, sometimes stockholders don't get anything back, and they don't get to vote on the plan.
Before you vote, you should receive from the company:
a copy of the reorganization plan or a summary;
a court approved disclosure statement which includes information to help you make an informed judgment about the plan;
a ballot to vote on the plan; and
notice of the date, if any, for a hearing on the court's confirmation of the plan, including the deadline for filing objections.
Even when stockholders do not vote, they should get a summary of the disclosure statement, and a notice on how to file an objection to the plan.
Stockholders may also receive other notices unrelated to the plan of reorganization, such as a notice of a hearing on the proposed sale of the debtor's assets, or notice of a hearing if the company converts to a Chapter 7 bankruptcy.
What is Chapter 7 Bankruptcy?
Some companies are so far in debt or have other problems so serious that they can't continue their business operations. They are likely to "liquidate" and file under Chapter 7. Their assets are sold for cash by a court appointed trustee. Administrative and legal expenses are paid first, and the remainder goes to creditors. Secured creditors will have their collateral returned to them. If the value of the collateral is not sufficient to repay them in full, they will be grouped with other unsecured creditors for the rest of their claim. Bondholders, and other unsecured creditors, will be notified of the Chapter 7, and should file a claim in case there's money left for them to receive a payment.
Stockholders do not have to be notified of the Chapter 7 case because they generally don't receive anything in return for their investment. But, in the unlikely event that creditors are paid in full, stockholders will be notified and given an opportunity to file claims.
Does My Stock or Bond Have Any Value?
Usually, the stock of a Chapter 7 company is worthless and you have lost the money you invested.
If you hold a bond, you might only receive a fraction of its face value. It will depend on the amount of assets available for distribution and where your debt ranks in the priority list on the first page. If your bond is secured by collateral, your payment will depend in large part on the value of the collateral.
Where Can I Find More Information?
The Company. - Contact the investor relations department in the company's home office. They can give you more information on the bankruptcy proceeding, including the name, address, and phone number of the court handling the bankruptcy.
Your Broker. - If you can't find information in the newspaper or the library, or you haven't received any correspondence from the company, call the person who sold you the investment.
The SEC. - Companies file regular reports with the SEC in a computer database known as EDGAR. For example, a company declaring bankruptcy will file a form 8-K that tells where the case is pending and which chapter of bankruptcy was filed. You can access EDGAR through your computer at: http://www.sec.gov If you don't have access to a computer, your public library may have a computer you can use. You can also request a copy of Form 8-K, or any other reports that the company files with the SEC, see "How to Request Public Documents". Or, you can visit the SEC's Public Reference Room, 100 F Street NE, Washington, DC 20549. You might also be able to get copies of SEC filings from your full-service stockbroker, or the company itself.
Bankruptcy Court. - If the company is in Chapter 7, and has not filed reports with the SEC, or you need more information, the bankruptcy court itself is another source. This court is usually located where the company has its main place of business or where the company is incorporated. (There is at least one bankruptcy court in each state and the District of Columbia.) Once you know a company's main place of business or state of incorporation, you can obtain the address and phone number of the bankruptcy court for that region by visiting the website of the Administrative Office of the United States Courts or by calling (202) 502-1900. Court addresses and phone numbers are also listed in the publication, The American Bench, which you can find at your local library. In addition, you'll find links to U.S. Bankruptcy Court websites at http://www.uscourts.gov/bankruptcycourts.html.
U.S. Trustee at the Department of Justice. - The U.S. Trustee has broad administrative responsibilities in bankruptcy cases. Check the U.S. Trustee's website, your local telephone book, or the public library for the field office closest to you, and contact them for information on the status of the bankruptcy.
A Securities or Bankruptcy Attorney. - You may want to talk to an attorney, especially if you believe that the debtor defrauded you and you want to know your legal options. If you suspect fraud, you should also report it to the SEC or your state securities regulator.
For a more detailed discussion of different types of bankruptcy, please read Bankruptcy Basics, which the Bankruptcy Division of the Administrative Office of the United States Courts produced to assist the public in understanding bankruptcy.
http://www.sec.gov/investor/pubs/bankrupt.htm
Chapter 13 – where Chapter 7 is not for you or you need a repayment plan
Because of the Means Test, many people cannot file a Chapter 7 to liquidate their debts. They must file a Chapter 13, or in some cases, a Chapter 13. Others need Chapter 13 because they want to catch up payments in order to keep their home, cars or other property that is on an installment payment plan.
Chapter 13 bankruptcy is a repayment plan that protects the debtor from collection action during the plan and discharges any unpaid balance of dischargeable debts at the end of the plan.
The discharge in Chapter 13 covers some debts that cannot be discharged in Chapter 7. It is a powerful tool for debtors to regain control of their financial lives and to get a meaningful fresh start.
Debtors choose to file a repayment plan under Chapter 13 when
• they owe debts not dischargeable in Chapter 7 (such as taxes, child support, marital property settlements)
• they have liens that are larger than the value of the assets securing the debt
• they are behind on car or house payments
• their assets are worth more than the available exemptions
• they are repaying retirement fund loans not permitted in Chapter 7
Contrast: What's dischargeable in Chapter 7.
The Chapter 13 plan does not have to pay debts in full; it can provide for only fractional payment. How much the plan has to pay to creditors is a function of the confirmation tests.
The Bankruptcy Code does require that priority claims be paid in full. The most frequently found priority claims are recent taxes and family support. More on creative use of Chapter 13 for tax troubles.
The Chapter 13 discharge eliminates some debts that cannot be discharged in Chapter 7, like recent tax penalties and non support debts incurred in the course of a divorce.
It permits the debtor time to pay debts that can't be discharged in either chapter, like recent taxes or back child support; to cure defaults on home mortgages; and to eliminate liens to the extent the lien is greater than the value of the asset.
Who is eligible for Chapter 13?
To file Chapter 13, you must be
• an individual (no corporations or partnerships);
• have a regular income greater than your reasonable living expenses; and
• have liquidated, unsecured debts not exceeding $336,900 and secured debts not exceeding $1,010,650.
A liquidated debt is one where the amount the debtor owes is known, or capable of easy calculation. For example, a loan is a liquidated debt; the damages owing in an auto accident are usually unliquidated until judgment is entered.
Effect of prior bankruptcies
While you can only file Chapter 7 every 8 years, you can file a Chapter 13 bankruptcy even if you got a Chapter 7 discharge less than 8 years ago.
A strategy frequently used is to file Chapter 7 to discharge those debts that are dischargeable, and file a subsequent Chapter 13 to repay those debts that were not discharged in Chapter 7. This sequence is sometimes called a "Chapter 20", a 7 plus 13. In fact there is no Chapter 20 of the Bankruptcy Code. This approach is limited by the provisions of the 2005 amendments which allow a discharge in a subsequent 13 only when specified time has passed (four years).
Chapter-13-bankruptcy
By Michael Doan on Sep 8, 2008 in Mortgage Law Network
A new law enacted on July 8, 2008, now requires Lenders of residential loans in the State of California to accept loan modifications in most foreclosure situations. California Civil Code 2923.6 went into effect on July, 2008, and applies to all residential loans made from January 1, 2003, to December 31, 2007, inclusive, that are secured by residential real property and are for owner-occupied residences.
Practically all residential mortgages have Pooling and Servicing Agreements ("PSA") since they were transferred to various Mortgage Backed Security Trusts after origination. These vehicles likewise almost always contain a duty to maximize net present value to its investors and related parties. Under the new laws, California Civil Code 2823.6 broadens and extends this PSA duty by requiring servicers to accept loan modifications with borrowers.
Essentially, California Civil Code 2823.6(a) states that "a servicer acts in the best interest of all parties if it agrees to or implements a loan modification where the (1)loan is in payment default, and (2) anticipated recovery under the loan modification or workout plan exceeds the anticipated recovery through foreclosure on a net present value basis."
Likewise, California Civil Code 2823.6(b) now provides "that the mortgagee, beneficiary, or authorized agent offer the borrower a loan modification or workout plan if such a modification or plan is consistent with its contractual or other authority."
So what does all this mean? Well, lets take an example:
John Martin's loan is presently in default, or reasonably foreseeable of near default. The house he previously bought 2 years ago for $800,000 with a $640,000 first and $140,000 second, has now plummeted to $375,000. While Mr. Martin can no longer afford the $9,000 per month mortgage payment, he is willing, able, and ready to execute a modification of his loan on the following terms:
a) New Loan Amount: $330,000.00
b) New Interest Rate: 6% fixed
c) New Loan Length: 30 years
d) New Payment: $1978.52
While this new loan amount of $330,000 is less than the current fair market value, the costs of foreclosure need to be taken into account. Foreclosures typically cost the lender $50,000 per foreclosure. For example, the Joint Economic Committee of Congress estimated in June, 2007, that the average foreclosure results in $77.935.00 in costs to the homeowner, lender, local government, and neighbors. Of the $77,935.00 in foreclosure costs, the Joint Economic Committee of Congress estimates that the lender will suffer $50,000.00 in costs in conducting a non-judicial foreclosure on the property, maintaining, rehabilitating, insuring, and reselling the property to a third party. Freddie Mac places this loss higher at $58,759.00.
Accordingly, the anticipated recovery through foreclosure on a net present value basis is $325,000.00 or less and the recovery under the proposed loan modification at $330,000.00 exceeds the net present recovery through foreclosure of $325,000.00 by over $5,000.00. Thus California Civil Code 2823.6 would mandate a loan modification to the new terms.
The homeowner just got a new arrow to add to his foreclosure defense quiver. Pursuant to California Civil Code 2823.6, the lender is now
contractually bound to accept the loan modification as provided above.
Failure to do so should allow the borrower to sue for specific performance or wrongful foreclosure in State Court.
This bill
9. Would codify a legislative finding that any duty servicers
may have to maximize the net present value under their
pooling and servicing agreements is owed to all parties in a
loan pool, not to any particular parties, and that a
servicer acts in the best interest of all parties if it
agrees to or implements a loan modification or workout plan,
as specified;
10. Would codify the intent of the Legislature that the
mortgagee, trustee, beneficiary, or authorized agent offer
the borrower a loan modification or workout plan, if such a
modification or plan is consistent with its contractual or
other authority;
Effective July 1, 2009, it will be unlawful for a foreclosure consultant, as defined in Civil Code Section 2945.1 to engage in the foreclosure consultant business unless it has registered with the Attorney General’s Office at: http://www.ag.ca.gov/register.php. All foreclosure consultants operating in California must post a $100,000 bond and register with Attorney General’s Office by July 1, 2009 and submit the following information:
Name, address, and telephone number;
All names, addresses, telephone numbers, websites, and e-mail addresses used or proposed to be used in connection with their business;
Copies of all advertising;
Copies of each different contract the consultant will use with consumers; and
A copy of its $100,000 bond
For more information please visit: http://ag.ca.gov/consumers/general/foreclosure_reg.php.
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