Chapter 24, Problem 1Q

a.

Summary Introduction

To define: The term informal restructuring and reorganization in bankruptcy.

Explanation of Solution

When the firm negotiate with its creditors to change the debt structure at the time when it becomes financially weak then it is known as informal restructuring if the firm. There are two ways of debt restructuring i.e. by extension or by composition. In extension, creditors allow its debtor to pay off the date after certain period whereas in composition, the creditors decrease the amount of debtor’s fixed liabilities.

Under reorganization, capital structure is reorganized with court’s involvement. It is not done through informal means. The rules and regulation for restructuring as per courts required to be adhere by the company.

b.

Summary Introduction

To define: The term assignment, fairness, feasibility and liquidation in bankruptcy.

Explanation of Solution

Liquidation in any company may take place when the company becomes incapable of paying its debt. The assignment is a type of liquidation process which is informal in nature. This is more beneficial for a creditor as it pays more prices for its assets rather than the prices offered under formal liquidation procedure in bankruptcy.

The assignment is feasible for small companies rather than too complex organizations.

The fairness as per basic doctrines states that the legal and contractual aspects should be considered while recognizing the claims.

c.

Summary Introduction

To define: The term absolute and relative priority doctrine.

Explanation of Solution

The absolute priority doctrine under the early bankruptcy laws says that the claimants should be classified as senior and junior and priority should be given to senior claimants while making debt payments. In any delay in their payments will result in shut down of the company and liquidation.

On the other hand, the relative priority doctrine suggests paying all the claimants equally with the available amount for debt-payment.

d.

Summary Introduction

To define: The term bankruptcy reform act, 1978.

Explanation of Solution

The Bankruptcy reform act 1978 of chapter 7 contains liquidation procedures. It protects the creditors from any fraudulent act of debtor, ensure equal distribution among the creditors, and allow debtors to restart a new business after discharging its obligations.

The chapter 11 of bankruptcy reform act, 1978 deals with the formal reorganization procedures.

e.

Summary Introduction

To define: The priorities of claims in liquidation

Explanation of Solution

There are two types of priority doctrine in liquidation which are as follows:

The absolute priority doctrine under the early bankruptcy laws says that the claimants should be classified as senior and junior and priority should be given to senior claimants while making debt payments. In any delay in their payments will result in shut down of the company and liquidation.

On the other hand, the relative priority doctrine suggests paying all the claimants equally with the available amount for debt-payment.

f.

Summary Introduction

To define: The terms such as extension, composition, cram down, pre-packaged bankruptcy, workout and holdout.

Explanation of Solution

There are two ways of debt restructuring i.e. by extension or by composition. In extension, creditors allow its debtor to pay off the date after certain period whereas in composition, the creditors decrease the amount of debtor’s fixed liabilities.

Cramdown is the procedure whereby the court approves the reorganization plan even after the disagreement of both the parties i.e. creditors and stockholders.

The pre-packaged bankruptcy is a hybrid of informal workout and formal reorganization.

The workouts are the voluntary reorganization plan that is initiated by creditors to help an organization to recoup its financial soundness.

The holdout is a problem that a company faces while getting all the members to agree upon a similar condition during informal reorganization.