Business Bankruptcy
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I. Introduction to Chapter 11 Business Reorganizations
A. Prisoner’s dilemma – Coordination problem
2 people (A & B) were arrested. Cops have enough evidence to convict for shoplift & will go to jail for a year. Cops suspect that they committed a large bank job but don’t have evidence so they need a confession. A & B have been separated & are interviewed & told “If you turn state’s evidence against partner then we’ll turn you free & we will recommend max penalty for your partner but if partner confesses too then we won’t let you off but you will both get 7 yrs., if you don’t confess & partner says anything about you then you get 10 yrs., if no one confesses then only shoplift charge for 1 year.”
A
B
Keep Quiet
Confess
Keep Quiet
1 – 1
2nd Choice
10 – 0
4th Choice
Confess
0 – 10
1st Choice
7 – 7
3rd Choice
· Dominant strategy – confess dominates b/c we are trying to do what is best for ourselves. They both cheated the cooperative strategy which is for both to keep quiet & they will each do a year.
· This is a coordination problem b/c there’s lack of coordination coupled w/individuals acting w/in their own self-interest. A did the smart thing which does not guarantee the best result.
Market economies operate on idea that individuals acting on their self-interest will be better for everyone. Self-interest doesn’t always turn the best results. Problems arise when individual interest is counter to group as a whole & like prisoners dilemma is bad for one self. BR law is like this.
Common Pool problem – pond, everybody owns it so every one has an incentive to catch as much fish as possible. If we don’t have a mechanism to check fishing incentives of other people then I will catch a lot of fish (against the interest of the group). If one person owned the lake then that person will put a limit on what everyone can catch.
BR law responds to prisoner’s dilemma or common pool problem. W/out it, ind. creditors will seek payment on their own. If there’s .5 m of assets & 2 m worth of claims then I’ll want to get everything as fast as I can so they will decide “I gotta confess” or fish like crazy. A lot of times it’s a bad idea for collective & for ind. creditor. E.g. debtor is printer, has printer press, secured creditor, default & s creditor takes printer press & gets paid out of asset & rest of creditors get little. Business is shut down so no more income. Bad for other creditors & bad for secured creditor b/c owed 1 m. & s creditor gets .5 m. b/c press is worth that much so he gets .5 m. & rest is treated as other creditor.
BR law encourages creditors to act like a single owner will act (act cooperative). Individual actions of creditors can be wasteful & even self-destructive. D-C is like the coordination problem & BR law replaces incentives that ind. fishermen have & prisoners have so that we can get 1st choice outcome vs. 3rd choice outcome. BR is a collective action (collective forum for satisfying everyone’s claim).
· Automatic stay stops creditors from grabbing assets. Creditors who grab assets before BR will give them back so that debtor can continue to run its affairs until it’s sorted out.
To what extent does it make sense for BR law to change non-BR entitlements?
– Justification only goes to the procedural aspect, not substance of what people are entitled to get.
G. BR takes people’s non-BR rights given outside of BR.
· When does it make sense for a party’s BR rts be different in BR than it would have been outside BR? E.g. A has priority over B, C, & D. Should BR make A be treated equally like the rest? This is a bad idea b/c most businesses who fail, fail w/out BR (most
we know that $7K went out when we purchased & money didn’t come in Feb. when we got paid. We are matching it up to that product.
d. Statement of operations is prepared on the accrual basis to match up in the same time period the co’s revenues to expenses when revenues produced. Revenue is recognized when “earned” not when cash is actually transferred. When they bought chemicals $7K went out but $7K in chemicals came in so value of chemicals & labor went out when foam shipped – Dec. 2000.
– S of O helps managers see if what they did during a time period was profitable.
e. Foam’s K w/BuyCo turned into an asset that Foam could easily sell or use as a collateral when goods were shipped in Dec. 2000.
f. Suppose XYZ Corp. built huge debts from several years of losses, and that it paid a huge amount of interest during 2000 on those debts. XYZ’s statement of operations for 2000 showed a loss of $10m. Consider operating profit (or loss). Would the interest expense on the debt that XYZ built up over years of unprofitable operations be included as an expense in determining operating profit or loss?
– Interest payment are not costs of making or selling products or administering business to sell products. Not operating expense so not part of operating profit or loss. However, it does appear in the income statement.
g. If you were trying to determine whether XYZ could be reorganized successfully, why would you be more interested in XYZ’s operating profit or operating loss than in the bottom line $10m. loss from the statement of operations?
– If we look at operating profit/loss & see that ordinary operations aren’t generating income then it looks bleak b/c that is what it costs to make stuff. If we can’t make profit there then the hope is to cut the costs. Suppose we have a net loss but once we look at
