By DAVID MOON, Moon Capital Management,
May 18, 2008
OK, class. For some
strange reason, I feel inspired to review some of basics of Chapter 11
bankruptcy. Maybe I've read or heard something about it recently in the
business news; I don't remember. Perhaps some people would like to be reminded
how it works.
Chapter 11 bankruptcy is typically used to reorganize a business by reducing or
eliminating some of the company's outstanding debt.
The company will file a report listing its assets and liabilities. Often the
total amount of assets will include items that have limited value to an outside,
If a company has a lot of inventory, perhaps that can be sold and the proceeds
used to pay debts. Alternatively, if a company's assets include millions of
dollars of'oh, let's say'truck electrification systems or big ole yellow hoses,
those can't easily be turned into cash.
Rather than being repaid in cash, the creditors of the company end up with the
assets of the company, including the desks, computers, telephones and the big
ole yellow hoses.
If the debts exceed the value of the assets, the stockholders' rights in the
company are terminated; they get nothing. Creditors end up owning the newly
Secured creditors are the first to get paid. These are people with 'perfected'
collateral interest in certain assets of the company. It's like the mortgage
holder on your house. That bank has a perfected lien on your
Unsecured creditors are people who simply loaned money to the company with the
expectation of receiving interest and, presumably, their principal when the debt
The employees are best described as insecure creditors.
The stockholders are the last people to get their money, in the unlikely event
there is any left. Often the only things remaining are the marketing brochures
and souvenir stock certificates, not so subtle reminders that 'these securities
involve a high degree of risk.' That phrase was probably on the original
offering documents when the shares of stock were originally sold, but somehow
that boring, black-and-white, legal-looking item wasn't nearly as exciting or
interesting as the glossy brochure with the pictures.
Stockholders do get to keep those pictures, however.
There are all sorts of lessons to learn from a bankruptcy ' whether you're
watching it as a curious outsider or from inside the sausage factory. Many of
the lessons are obvious: Investments have risk. Speculation is fine, as long as
you know you're speculating and can afford the risk. Earnings are good. Cash
earnings are better. Earned cash is usually better than borrowed cash. Cash from
grants can dry up on a moment's notice. Financial statements matter.
But the best lesson may be that there is not always an EmeraldCity at the end of the Yellow Hose
David Moon is president of Moon Capital Management, a
Knoxville-based investment management firm. This article
originally appeared in the News Sentinel (Knoxville, TN).