bankruptcy discussed earlier in the case study constitutes a blend of the second and third options.
The firm may voluntarily liquidate as part of an out–of-court settlement or be forced to liquidate
5. Financial buyers (both hedge funds and private equity investors) clearly are motivated by the
potential profit they can make by buying distressed debt. Their actions may have both a positive
and negative impact on parties to the bankruptcy process. Identify how parties to Hostess
bankruptcy may have been helped or hurt by the actions of the hedge funds and private equity
investors.
Answer: Hedge funds and other investor groups provide liquidity in the distressed debt and equity
markets by enabling those creditors and shareholders desirous of selling their claims on the failing
firm to cash out. Moreover, these financial investors may provide a more vigorous competitive
6. Hostess’s assets were sold in a 363 auction. Such auctions attract both strategic and financial
bidders. Which party tends to have the greater advantage: the strategic or financial bidder? Explain
your answer.
Answer: Strategic buyers are by definition interested in buying a business and integrating it into
their existing operations because they perceive significant synergy. Acquisitions out of bankruptcy
often provide a means of acquiring valuable assets free and clear of all liens at a significant
discount from their book value. In contrast, financial buyers such as hedge funds rely on their
7. Comment on the fairness of the 363 auction process to Hostess shareholders, lenders, employees,
communities, government, etc. Be specific.
Answer: The 363 auction process is intended to maximize the value of the Hostess assets through
an auction process in the shortest time possible. Assuming a sufficient number of viable bidders,
American Airlines Emerges from the Protection of Bankruptcy Court
Key Points
• Chapter 11 provides an opportunity for debtor firms to reorganize and for creditors to recover a
portion of what they are owed.
• Firms emerging from Chapter 11 often do so by being acquired or by being an acquirer.
• Gaining consensus among creditors requires aggressive negotiation by the debtor firm.
• By buying the bankrupt firm’s debt, hedge funds provide liquidity for creditors unwilling to wait
for the completion of the Chapter 11 process.
American Airlines emerged from Chapter 11 bankruptcy protection on December 9, 2013, merging with
U.S. Airways as the cornerstone of its reorganization plan approved by the bankruptcy court judge. Chapter
11 of the U.S. Bankruptcy Code gives debtors protection from creditors until the court can decide if the
debtor can be reorganized into a viable business or if it must be liquidated. The judge approved the plan
immediately following American’s resolution of a lawsuit filed by the U.S. Justice Department which
argued the combination would result in higher consumer airline fares.
The strategy of entering Chapter 11 only to exit by merging with another airline has been used several
major airline to seek court protection to reorganize its business, filing for bankruptcy in November 2011.
The wave of big mergers in the industry has created healthier and more profitable airlines that are now
better able to invest in new planes and products, including Wi-Fi, individual entertainment screens, and
more comfortable seats for business passengers. American’s board and senior management increasingly
saw it as a way to become competitive.
Chapter 11.
U.S. Airways’ CEO Doug Parker expected the deal would get done by the end of 2013, once
American’s creditors agreed to the Chapter 11 bankruptcy reorganization plan. U.S. Airways shareholders
voted overwhelmingly in favor of the merger; European Union regulators had also approved the deal.
However, the Justice Department lawsuit threatened to derail the entire transaction when it was filed just 2
a controlling 50.1% interest in the combined carriers with by implication putting Parker in control. Parker
has also secretly negotiated with American’s three unions, an event never before seen in an airline merger,
and had reached contracts with each union to support the merger. Each contract would take effect once the
merger was completed. If the carriers merged, the new contracts would provide for higher pay and work
rules than what Horton had proposed in his reorganization plan for American upon emerging from Chapter
11. Union leadership lauded Parker as a savior and was publicly cheering for the merger.
By February 2013, the 10-month-long duel between Parker and Horton ended in an agreement to
combine the two airlines. The combined airlines would have total revenues of $39 billion annually and a
market value of $11 billion. Parker was to become the CEO with Horton serving as Chairman for no more
2011, the board agreed to put the firm into Chapter 11 and named Horton the CEO, moving aside the then
CEO Gerard Arpey, who resisted efforts to enter bankruptcy as too disruptive to the firm.
Horton knew that since the firm’s creditors effectively owned American he had to get their support. Two
creditor groups were crucial: the court-appointed Unsecured Creditors Committee (UCR), a combination of
representatives from American’s unions, trade creditors, and trustees, and a second group made up chiefly
of hedge funds (dubbed the “ad hocs”) that had acquired American’s unsecured bonds for pennies on the
dollar around the time of bankruptcy. Nothing could pass the UCC without two-thirds approval of the
bondholders.
continued to negotiate aggressively eventually improving American’s ownership stake in the new firm to
72%.
The $16 billion all-stock deal gives creditors of AMR control of the combined firm due to an agreement
to exchange creditors’ debt for equity in the new firm. U.S. Airways stockholders received one share of
common stock in the combined airline for each U.S. Airways share they owned, giving them a 28% share
of the equity of the new firm. The remaining 72% of the shares were issued to American shareholders,
this distribution, holders of American common stock also have the potential to receive additional shares if
the value of the common stock received by holders of prebankruptcy unsecured claims satisfies the value of
their claims.
Blockbuster Acquired by Dish Network in a Section 363 Sale
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Key Points
Section 363 auctions are an increasingly common means of preserving asset value when failing firms are
hemorrhaging cash flow.
Such sales allow buyers to purchase assets at potentially bargain prices.
While not without risk, 363 sales are often viewed as a more efficient way to exit bankruptcy than via a
more conventional reorganization plan.
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Despite facing challenges reminiscent of a Hollywood movie thriller, Blockbuster, the movie rental giant,
went from a mundane prepackaged bankruptcy agreement to acknowledging its own insolvency to facing
the real possibility of liquidation in the span of six months. What follows is a discussion of the sometimes–
American operations on September 23, 2010, with 5,600 stores, including 3,300 in the United States. The
fate of 29,000 employees and hundreds of creditors hung in the balance.
Prior to the firm’s petition for protection under Chapter 11 of the U.S. Bankruptcy Code, Blockbuster
had reached an agreement with its major creditors on a so-called prepackaged reorganization plan that
would have left the firm with $400 million in new senior debt as it emerged from bankruptcy as an ongoing
won three seats on the firm’s board of directors. Eventually, Icahn was able to oust then–board Chairman
John Antioco. In 2010, due to increasing demands on his time, Icahn stepped down from the board and sold
his shares in Blockbuster.
By buying such a large percentage of the outstanding debt, Icahn, as a major creditor, was able to submit
his own plan for revamping Blockbuster. His proposal was to eliminate Blockbuster’s debt when it
million debtor-in-possession (DIP) loan from a group of the senior note holders. Such lenders’ credit claims
are given a much higher payment priority than those of other creditors in the event of the firm’s liquidation
and, as such, are often viewed as relatively low risk.
Movie studio creditors, critical suppliers to Blockbuster, supported the plan because they were promised
payments for what they were owed on a priority basis out of the operating cash flows once the firm
technically insolvent, the firm was fast running out of cash.
Having missed several performance milestones in the prepackaged (but never filed) reorganization plan,
Blockbuster was in default on its DIP loan, even though it had never utilized any of the funds. By
defaulting, the firm violated a covenant that allowed senior note holders to include $125 million of their
securities as part of the DIP loan. This action gave them the same high-priority position as that afforded a
Court’s supervision and in accordance with Section 363 of the U.S. Bankruptcy Code. Following approval
by the Court, Blockbuster initiated the bidding process. The auction allowed for a 30-day period during
which potential bidders could perform due diligence. At the end of this period, interested parties would
have one week to submit bids, with the winning bid to be announced shortly following the close of the
auction.
liquidate the assets at a price in excess of what they paid for the debt. The other bidders included South
Korea’s SK Telecom Co. and satellite television provider Dish Network. Both were interested in
Blockbuster because of potential synergy with their current operations.
Icahn’s, Monarch’s, and the Gordon Brothers’ strategies appeared to be similar: Close the Blockbuster
stores, liquidate the inventories, and sell the digital download business. In contrast, SK Telecom and Dish
notes that had been “rolled up” into the DIP loan, with 75% of the rest of the proceeds paid to note holders
and 25% to the holders of administrative claims. Senior note holders were expected to receive about 26%
of their claims and unsecured lenders about 19% of their claims, with preferred and common shareholders
Discussion Questions
1. What are the primary objectives of the bankruptcy process?
2. What types of businesses are most appropriate for Chapter 11 reorganization, Chapter 7 liquidation, or
a Section 363 sale?
3. The Blockbuster case study illustrates the options available to the creditors and owners of a failing
firm. How do you believe creditors and owners might choose among the range of available options?
Explain your answer.
4. Financial buyers such as hedge funds clearly are motivated by the potential profit they can make by
buying distressed debt. Their actions may have both a positive and a negative impact on parties to the
bankruptcy process. Identify how parties to a bankruptcy may be helped or hurt by the actions of the
hedge funds.
5. Do you believe that a strategic bidder like Dish Network has an inherent advantage over a financial
bidder in a 363 auction? Explain your answer.
6. Speculate as to why Blockbuster filed a motion with the Court to initiate a Section 363 auction rather
than to continue to negotiate a reorganization plan with its creditors to exit Chapter 11.
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The Deal from Hell: The Tribune Company Emerges from Chapter 11
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Key Points
Tribune Company’s LBO failed because it was structured without any margin for error.
Large secured creditors failing to recover what they are owed often exchange their debt for equity in the
restructured company.
The extreme length of time in Chapter 11 reflected the absence of prenegotiation with creditors due to the
firm’s rapid entry into bankruptcy, the deal structure’s complexity, and fraud allegations.
______________________________________________________________________________________
Four years after its ill-fated leveraged buyout left the media firm with an unsustainably large debt load,
Tribune Company (Tribune) emerged from Chapter 11 bankruptcy on December 31, 2012. Founded in
1847, Tribune publishes some of the best-known newspapers in the United States, such as the Los Angeles
Times, the Baltimore Sun, and the Chicago Tribune. The firm also owns WGN in Chicago and 22 other
own 91% of the firm’s shares in exchange for forgiving their credit claims. This group held most of
Tribune’s senior debt and worked with the company and the committee representing unsecured creditors to
create a reorganization plan acceptable to the bankruptcy court judge. Court documents indicated that the
restructured firm was valued at about 40% of its $8.2 billion valuation when it was taken private in 2007.
The firm’s broadcast business had an estimated value of $2.85 billion, and its publishing businesses were
opposition to the final reorganization plan alleged that the larger creditors that financed the LBO
transaction were well aware of the Tribune’s precarious financial position in 2007 and that they were
largely escaping any punitive action stemming from their alleged fraudulent activities. The junior creditors
believed that the large lenders expected that the firm would become insolvent once the transaction was
completed, prompting some to sell loans made to the Tribune.
Despite these considerations, Tribune seemed ripe for a takeover, with its share price having lagged well
behind that of other media companies. This also was one of the most active periods in decades for LBO
transactions. With interest rates at near–record lows, prices paid for LBO targets soared. While the firm’s
cash flows from newspapers were declining, operating cash flow from its other media operations had been
relatively stable in recent years. With profit margins on loans squeezed, lenders were trying to offset
which the remaining outstanding Tribune shares were acquired. In the first stage, Tribune initiated a cash
tender offer for 51% of total shares for $34 per share, totaling $4.2 billion. The tender was financed using
$250 million of the $315 million provided by Sam Zell in the form of subordinated debt plus additional
borrowing to cover the balance. Stage 2 was triggered when the deal received regulatory approval. During
this stage, an employee stock ownership plan (ESOP) bought the rest of the shares at $34 a share (totaling
amounting to less than 4% of the purchase price. The Tribune ended up with $13 billion in debt (including
the $5 billion it currently held). At this level, the firm’s debt was 10 times EBITDA, more than 2.5 times
that of the average media company. Annual interest and principal repayments reached $800 million (almost
three times their preacquisition level), about 62% of the firm’s previous EBITDA cash flow of $1.3 billion.
The conversion of the Tribune into a subchapter S corporation eliminated the firm’s current annual tax
the price was about 15% less than expected.
At the closing in late December 2007, Sam Zell described the takeover of the Tribune Company as “the
transaction from hell.” His comments were prescient, in that what had appeared to be a cleverly crafted deal
from a tax standpoint was unable to withstand the credit malaise of 2008. The end came swiftly when the
161-year-old Tribune filed for bankruptcy on December 8, 2008, to conserve its rapidly dwindling cash
flow.
Those benefiting from the deal included the Tribune’s public shareholders, such as the Chandler family,
which owed 12% of the Tribune as a result of its prior sale of the Times Mirror to Tribune, and Dennis
crunch, and its own leverage. Ironically, those who constructed what appeared on paper to be a very shrewd
deal had failed to include in their planning the potential for a slowing economy, let alone one of the worst
recessions in U.S. history. For this highly leveraged deal to have worked, everything would have had to go
according to plan, a plan that did not seem to include any contingencies.
Discussion Questions
1. What are the primary objectives of the bankruptcy process?
Answer: Bankruptcy enables a failing firm to reorganize, while protected from its creditors, or to
cease operation by selling its assets to satisfy all or a portion of the firm’s outstanding debt. U.S.
2. What types of businesses are most appropriate for Chapter 11 reorganization, Chapter 7
liquidation, or a Section 363 sale?
Answer: Although intended to give firms time to restructure, whether a business is likely to be
successful in Chapter 11 in part depends on the type of business and the circumstances under
which it seeks the protection of the bankruptcy court. For example, a firm may be technically
insolvent but still have sufficient cash flow to meet its immediate liquidity requirements;
3. The Blockbuster case study illustrates options available to the creditors and owners of a failing
firm. How do you believe creditors and owners might choose from among the range of available
options?
Answer: A failing firm’s strategic options are to merge with another firm, reach an out–of-court
voluntary settlement with creditors, or file for Chapter 11 bankruptcy. Note the prepackaged
4. Financial buyers clearly are motivated by the potential profit they can make by buying distressed
debt. Their actions may have both a positive and negative impact on parties to the bankruptcy
process. Identify how parties to a bankruptcy may be helped or hurt by the actions of the hedge
funds.
Answer: Hedge funds and other investor groups provide liquidity in the distressed debt and equity
markets by enabling those creditors and shareholders desirous of selling their claims on the failing
5. Do you believe that a strategic bidder has an inherent advantage over a financial bidder in a 363
auction? Explain your answer.
Answer: Strategic buyers are by definition interested in buying a business and integrating it into
their existing operations because they perceive significant synergy. Acquisitions out of bankruptcy
often provide a means of acquiring valuable assets free and clear of all liens at a significant
discount from their book value. In contrast, financial buyers such as hedge funds rely on their
subsequently try to sell the assets they have acquired in the auction.
6. Speculate as to why Blockbuster filed a motion with the Court to initiate a Section 363 auction
rather than to continue to negotiate a reorganization plan with its creditors to exit Chapter 11.
Photography Icon Kodak Declares Bankruptcy, A Victim of Creative Destruction
Key Points
Having invented the digital camera, Kodak knew that the longevity of its traditional film business was
problematic.
Concerned about protecting its core film business, Kodak was unable to reposition itself fast enough to
stave off failure.
Chapter 11 reorganization offers an opportunity to emerge as a viable business, save jobs, minimize
creditor losses, and limit the impact on communities.
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Economic historian Joseph Schumpeter described the free market process by which new technologies and
deregulation create new industries, often at the expense of existing ones, as “creative destruction.” In the
short run, this process can have a highly disruptive impact on current employees whose skills are made
Founded in 1880 by George Eastman, Kodak became the latest giant to fall in the face of advancing
technology, announcing that it had filed for the protection of the bankruptcy court early in 2012. Kodak had
established the market for camera film and then dominated the marketplace before suffering a series of
setbacks over the last 40 years. First foreign competitors, most notably Fujifilm of Japan, undercut Kodak’s
film prices. Then the increased popularity of digital photography eroded demand for traditional film,
eventually causing the firm to cease investment in its traditional film product in 2003. Although it had
invented the digital camera, Kodak had failed to develop it further, announcing on February 12, 2012, that
it would discontinue its production of such cameras. Kodak’s failure to move aggressively into the digital
world may have reflected its concern about cannibalizing its core film business. This concern may have
ultimately destined the firm for failure.
Kodak closed 13 manufacturing plants and 130 processing labs and had reduced its workforce to 17,000
in 2011 from 63,000 in 2003. In recent years, the firm has undertaken a two-pronged strategy: expanding
into the inkjet printer market and initiating patent lawsuits to generate royalty payments from firms
in 2011.
11 filing was made in the U.S. bankruptcy court in lower New York City and excluded the firm’s non-U.S.
subsidiaries. The objectives of the bankruptcy filing were to buy time to find buyers for some of its 1,100
digital patents, to continue to shrink its current employment, to reduce significantly its healthcare and
pension obligations, and to renegotiate more favorable payment terms on its outstanding debt. Kodak had
put the patents up for sale in August 2011 but did not receive any bids, since potential buyers were
concerned that they would be required to return the assets by creditors if Kodak filed for bankruptcy
protection. While the firm’s pension obligations are well funded, the firm owes health benefits to 38,000
U.S. retirees, which in 2011 cost the firm $240 million.
Kodak also announced that it had obtained a $950 million loan from Citibank to keep operating during
the bankruptcy process. Moreover, the firm filed new patent infringement suits in March 2012 against a
number of competitors, including Fujifilm, Research in Motion (RIM), and Apple, in order to increase the
another firm. The firm has pinned its remaining hopes for survival on selling commercial printing
equipment and services, a business that generated about $2 billion in revenue in 2012 but that may lack the
scale to sustain profitability. If it cannot demonstrate viability, Kodak will face liquidation. In either case,
the outcome is a sad ending to a photography icon.
Discussion Questions
1. To what extent do you believe the factors contributing to Tribune’s bankruptcy were beyond the
control of management? To what extent do you believe past mismanagement may have
contributed to the bankruptcy?
Answer: Factors such as fluctuations in the economy are largely beyond the control of
management. However, responsible managers plan for the unexpected, particularly when
2. Comment on the fairness of the bankruptcy process to shareholders, lenders, employees,
communities, government, etc. Be specific.
Answer: The purpose of the bankruptcy option is to reduce the cost of borrowing by giving
creditors a mechanism for recovering their loans when the borrower defaults. Bankruptcy also
3. Describe the firm’s strategy to finance the transaction?
Answer: The transaction was to be financed primarily by debt. The expected $348
4. Comment on the fairness of this transaction to the various stakeholders involved. How
would you apportion the responsibility for the eventual bankruptcy of Tribune among
Sam Zell and his advisors, the Tribune board, and the largely unforeseen collapse of the
credit markets in late 2008? Be specific.
Answer: The transaction was clearly highly leveraged by most measures. It was financed almost
entirely with debt, with Zell’s equity contribution amounting to less than 4 percent of the purchase
price. The transaction resulted in Tribune being burdened with $13 billion in debt (including the
approximate $5 billion currently owed by Tribune). At this level, the firm’s debt was 10 times
EBITDA, more than 2.5 times that of the average media company. Annual interest and principal
5. Why do the bankruptcy courts allow investors such as hedge funds to buy deeply discounted debt
from creditors and later exchange such debt at face value for equity in the newly restructured firm?
Answer: Such hedge funds provide liquidity for those creditors uncertain about how much they
might recover if they wait until the final reorganization plan is approved. Often junior creditors are
concerned that they will not recover anything in the event the debtor firm is eventually liquidated.
Delta Airlines Rises from the Ashes
Key Points:
• Once in Chapter 11, a firm may be able to negotiate significant contract concessions with unions
as well as its creditors.
• A restructured firm emerging from Chapter 11 often is a much smaller but more efficient
operation than prior to its entry into bankruptcy.
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On April 30, 2007, Delta Airlines emerged from bankruptcy leaner but still an independent carrier after a
19-month reorganization during which it successfully fought off a $10 billion hostile takeover attempt by
US Airways. The challenge facing Delta’s management was to convince creditors that it would become
more valuable as an independent carrier than it would be as part of US Airways.
Ravaged by escalating jet fuel prices and intensified competition from low-fare, low-cost carriers, Delta
had lost $6.1 billion since the September 11, 2001, terrorist attack on the World Trade Center. The final
becoming increasingly concerned about the airline’s ability to meet its financial obligations. Running out of
cash and unable to borrow to satisfy current working capital requirements, the airline felt compelled to seek
the protection of the bankruptcy court in late August 2005.
Delta’s decision to declare bankruptcy occurred about the same time as a similar decision by Northwest
Airlines. United Airlines and US Airways were already in bankruptcy. United had been in bankruptcy
Corporation (PBGC), a federal pension insurance agency, while winning concessions on wages and work
rules from its pilots. The agreement with the pilot’s union would save the airline $280 million annually, and
the pilots would be paid 14 percent less than they were before the airline declared bankruptcy. To achieve
an agreement with its pilots to transfer control of their pension plan to the PBGC, Delta agreed to give the
union a $650 million interest-bearing note upon terminating and transferring the pension plans to the
the time of the bankruptcy filing, and it cut more than 20 percent of the 60,000 employees it had just prior
to entering Chapter 11. Delta’s domestic carrying capacity fell by about 10 percent since it petitioned for
Chapter 11 reorganization, allowing it to fill about 84 percent of its seats on U.S. routes. This compared to
only 72 percent when it filed for bankruptcy. The much higher utilization of its planes boosted revenue per
mile flown by 15 percent since it entered bankruptcy, enabling the airline to better cover its fixed expenses.
institutions providing the loans, the exit facility consisted of a $1.6 billion first-lien revolving credit line,
secured by virtually all of the airline’s unencumbered assets, and a $900 million second–lien term loan.
As required by the Plan of Reorganization approved by the Bankruptcy Court, Delta cancelled its
preplan common stock on April 30, 2007. Holders of preplan common stock did not receive a distribution
of any kind under the Plan of Reorganization. The company issued new shares of Delta common stock as
payment of bankruptcy claims and as part of a postbankruptcy compensation program for Delta employees.
Issued in May 2007, the new shares were listed on the New York Stock Exchange.
Discussion Questions:
1. To what extent do you believe the factors contributing to the airline’s bankruptcy were beyond the
control of management? To what extent do you believe past airline mismanagement may have
contributed to the bankruptcy?
Answer: Factors such as escalating fuel prices, the lasting effects of terrorist’s attacks on security,
and fluctuations in the economy are largely beyond the control of airline management. However,
2. Comment on the fairness of the bankruptcy process to shareholders, lenders, employees,
communities, government, etc. Be specific.
Answer: The purpose of the bankruptcy option is to reduce the cost of borrowing by giving
creditors a mechanism for recovering their loans when the borrower defaults. The bankruptcy
process also protects shareholders to the extent their liability is limited to the extent of their