Cram Down in Bankruptcy Proceedings
February 12, 2025
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When a company files for bankruptcy, the interests of many different parties are impacted. This is the reason that bankruptcy cases can be very difficult to conclude. There are a lot of stakeholders involved, and each wants to pursue their own interest at the expense of everyone else. The result is that a tug of war ensues between the various stakeholders, and reaching a decision becomes extremely difficult for everyone involved.
Hence, if a company wants to negotiate effectively, it is important for them to know the objectives of everyone involved. Once they know the objectives, they can try and accommodate the interests of as many stakeholders as possible. The interests of different stakeholder groups tend to be consistent even if they are in different companies or industries.
In this article, we will have a closer look at what the interests of different stakeholder groups are.
Secured creditors have the strongest position when it comes to bankruptcy cases. Hence, as long as they have a lien on assets which are equal in amount or greater than the loan that they have given out, they do not seem to be very eager to negotiate.
In a lot of cases, secured debt is held by big investment firms. These include mutual funds, pension funds, etc. These funds want to look good in front of their investors when they declare results. Hence, they are ready to adjust with the creditors as long as the creditor is ready to provide enough cash flow that the loan does not have to be written down as a non-performing asset. Non-performing assets look bad on the record of the firm as well as the manager. Hence, the managers may have a personal incentive to avoid the same.
Secured creditors can be very difficult to deal with since they have the minimum to lose in the event of a bankruptcy. Also, secured creditors tend to be hard negotiators, particularly if they are not the original holders of debt.
Secured creditors often sell their debt to third parties at a discount. These third parties are organizations that specialize in the field of collecting debt from bankrupt companies. This means that they often have debt collection specialists on their payroll. As such, they do not have to pay big retainer amounts to avail the services of these professionals. Such companies are highly experienced in bankruptcy negotiations. Often, they are engaged in negotiations with more than one company at the same time. This gives them an upper hand during the negotiation process.
In many cases, secured creditors also end up becoming a major shareholder group in the company. This is because many times, large amounts of debt get converted into equity, and they happen to be the largest holders of debt. Depending upon a case to case basis, this may or may not be good for the company.
Unsecured creditors are the exact opposite of secured creditors. This is because, under the bankruptcy law, their rights are minimal. As a result, if the company actually goes into liquidation, unsecured creditors may or may not receive anything at all. Since they have no lien on any asset, they may not receive any money at all. This is what makes them more flexible.
There have been instances where secured creditors have agreed to accept as less as 40% of the amount they are owed. This is because of two reasons. Firstly, unlike secured creditors, unsecured creditors happen to be trade creditors. This means that they are not finance-related or investment companies. Rather, these are companies that sell goods to other businesses. As such, they neither have the knowledge nor the financial wherewithal to take a big stake in another company. Also, the bankruptcy law makes it impossible to immediately sell or liquidate securities which are received as part of a restructuring plan, and trade creditors have no intention of using their working capital to buy securities where their money will get locked for the long term.
Instead, they would happy taking a haircut and then getting back to their original business. Also, firms that file for bankruptcy often happen to be bug customers of the unsecured creditors. Hence, they want their customers to survive so that they can continue selling goods (on a cash basis). If the firm survives, then the unsecured creditor stands to make more money in the long run.
A company filing bankruptcy should understand that offering equity stake to an unsecured creditor is unlikely to change their mind.
Once a company files for bankruptcy, its shareholders may suddenly become a very hostile group. This is because, after a bankruptcy has been filed, they have the last claim on the assets. Hence, their chances of making a financial recovery are very slim.
Therefore, they start using other means to try to recover their money. One of the most common ways is to file lawsuits on the management of the firm, accusing them of willful, negligent, or fraudulent behavior. Another way is to hope to obtain equity is the restructured company. The reality is that the shareholders have a very slim chance of receiving any equity in the restructured company. As a result, they try to file lawsuits and recover as much as possible. Hence, if shareholders have to be pacified, they need to be offered more equity.
The bottom line is that the same incentive i.e., more equity may be palatable to some investors, whereas it may not be palatable to many others.
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