Bankruptcy and Reorganization – Case 39
MARK X COMPANY
Mark X Company is in a precarious financial position – it is overextended, and unless the company can persuade its bank to continue present loans and also grant substantial additional credit, Mark X may well go under. The company’s 1992 yearend balance sheet is contained in Table 1.
Before the bank will reach a decision on whether to continue supporting Mark X, Carolyn Mayo, the banker handling the Mark X account, must prepare a report for the bank’s Senior Loan Committee. The report must contain a complete bankruptcy analysis which sets forth the bank’s exposure in the event of liquidation. To begin her analysis, Mayo estimated what values the assets would have is Mark X were liquidated. Working with the bank’s appraisers and liquidation experts, she concluded that the land and buildings could be sold for $5 million, while the equipment would bring in another $3 million. The receivables could be sold for $0.75 on the dollar, but the inventory would bring only $0.50 on the dollar.
Next, Mayo had to make sure that she understood the nature of the claims against Mark X. The accruals currently (that is, at the end of 1992) consist of $5 million of accrued taxes and $2,331,000 of accrued wages. The wages were all earned within the past two weeks, and no single employee is due more than $2,000. A long-term bank loan actually consists of two different loans: $5 million in straight unsecured debt, plus another $4,563,000 in loans that are subordinate to the $5 million loan. WeelsFargo, extended both the short-term loan and the senior long-term loan, while a competitor bank holds the subordinated note for $4,563,000. Mayo estimates that the administrative expenses for the trustee in bankruptcy would total $600,000 – this amount would be “taken off the top” in any liquidation or reorganization procedure. Finally, Mark X has $6 million in unfunded pension liabilities which would have to be dealt with in any bankruptcy proceedings.
Now assume that you are Carolyn Mayo’s assistant, and she has asked you to determine what would happen if the bank called its loans and forced Mark X into bankruptcy. Obviously, Mark X would file for protection under Chapter 11 of the Bankruptcy Act, and it would then either be reorganized or liquidated. You job is to ascertain how the bank would fare in this event. You will have to make a report to Mayo and, perhaps, also to the Senior Loan Committee, so you should be able to answer any question likely to be thrown at you. To get started, you and Mayo drew up a list of issues and set them forth in the following questions.
1) What are the differences between informal and a formal bankruptcy proceeding, and between a reorganization and a liquidation? Also, explain the meaning of the terms “composition” and “extension” as they are used in bankruptcy proceedings. Could an agreement include both a composition and an extension?
3) What total dollar amount of funds could be expected, before any payments were made, if Mark X were liquidated?
4) Develop a table which shows the distribution of the expected proceeds to the “priority claimants”; that is, those claimants who have precedence over the general creditors. What dollar amount of proceeds would remain after the priority claimants had been paid? (Hint: Complete the top part of Table 2.)
5) Now create a table which shows the distribution to general creditors both before and after the adjustment for subordination. (Hint: Complete the remainder of Table 2.) What is the percentage of each claim (for both senior creditors and general creditors) that would be paid in the final distribution? What would stockholders get?
6) How would Wells Fargo Bank and its competitor bank fare if Mark X were liquidated, and what, in general terms, is the value to Wells Fargo of the subordination clause in the $4,563,000 long-term loan? What would be the impact on Well Fargo if there were no subordination clause?
7) Now consider how the different creditors (and the stockholders) would fare under different assumptions about the amount of the liquidation proceeds. For example, what would the distribution to creditors be if the land and buildings brought only $2 million or if they brought $8 million? Similarly, how would the value received from the equipment, or the inventory, affect the distributions? If you are using the Lotus model, quantify your answer; otherwise just discuss what would happen.