Summer 2009

Focus on Bankruptcy and Reorganization Analyses

Editor for This Issue: Robert F. Reilly

Bankruptcy Structure Insights

Thought Leadership Article:
Ponzi Schemes and Clawbacks: Investors Pay Twice for the Crimes of Others
John J. Monaghan, Richard E. Lear, and Diane Rallis
In the last few years, many investors have been victims of what amounts to Ponzi-like investment schemes. These investors surely feel that they have suffered enough when they realize that their investments have been fraudulently mismanaged. Many of these Ponzi-like investment organizations have filed for bankruptcy protection. In these cases, the defrauded investors are also subject to the clawback provisions of the Bankruptcy Code. These clawback provisions include: (1) preferential transfers and (2) fraudulent transfers. This discussion summarizes the clawback provisions of the Bankruptcy Code. And, this discussion focuses on the application of those clawback provisions to Ponzi-like investment schemes

Best Practices Article:
Debt Is the New Equity: How Private Equity Funds Will Sponsor Buyouts Through Chapter 11
Jonathan S. Henes, Kirk A. Radke, and Christopher T. Greco In the current distressed economy, private equity funds are having difficulty purchasing companies through traditional leveraged buyouts. One solution to this problem is for a private equity fund to sponsor the chapter 11 plan of reorganization of a highly leveraged (but operationally sound) target company. This discussion describes the process by which a private equity fund can effectively acquire a highly leveraged target company through a sponsored chapter 11 plan transaction structure.

Section 409A Considerations Related to the Grant of Closely Held Corporation Employee Stock Options
Robert F. Reilly
Closely held debtor corporations often have to grant employee stock options in order to attract or retain highly qualified employees. This is particularly true with regard to (1) companies that are currently operating in bankruptcy protection and (2) companies that have recently emerged from bankruptcy protection. Such companies may have to grant stock options to attract or retain employees due to the perceived stigma associated with working for a company in bankruptcy. Debtor corporation managements should be aware of the income tax implications associated with the grant of "discounted" stock options (i.e., options where the exercise price is less than the grant date stock fair market value). Such a grant may trigger Internal Revenue Code Section 409A negative consequences for both the employer corporation and the employee.

Valuation of Debtor Corporation Intellectual Property During a Distressed Economy
Robert F. Reilly
Debtor corporations operating in bankruptcy protection own and operate intellectual property. Financially troubled companies not operating in bankruptcy may also own and operate intellectual property. In the current recessionary economy, debtor corporation intellectual property may be worth less (than in an expansionary economy). However, even in a recession, the debtor corporation intellectual property is not worthless. This discussion focuses on the procedures that the valuation analyst may use to identify and value debtor corporation intellectual property in a distressed economic environment. And, this discussion illustrates how the valuation analyst can adapt the generally accepted valuation approaches in order to produce a credible debtor corporation intellectual property value conclusion-even in a recessionary economy.

Financial Adviser Procedures Related to Bankruptcy-Related Solvency Opinions
Katherine Gilbert
Bankruptcy-related solvency opinion issues can be rather complicated. Debtor corporation transactions that may require solvency opinions include leveraged buyouts, leveraged recapitalizations, and leveraged dividend distribution transactions. For purposes of a leveraged corporate transaction, the debtor corporation should demonstrate that it is solvent at the time of the transaction. In order for the debtor corporation to be solvent, it should "pass" all three solvency tests: (1) the balance sheet test, (2) the cash flow test, and (3) the capital adequacy test. A solvency opinion is an important tool to mitigate the legal and financial risks for all of the debtor corporation transaction participants. This discussion presents a checklist of the due diligence and analytical procedures that the valuation analyst should consider when performing a bankruptcy-related solvency opinion.

Bankruptcy-Related Valuation and Financial Advisory Services
Nguyen "Wen" Ho
When a debtor corporation files for bankruptcy protection, there are a variety of reasons why the debtor in possession, the creditors, and their respective legal advisors may seek bankruptcy-related valuations. These reasons range from solvency and insolvency issues to planning a corporate transaction during the bankruptcy to valuing the reorganized debtor corporation equity interest given to a creditor class as part of the proposed plan of reorganization. There are a unique set of regulatory, accounting, and market-related issues to consider when a debtor corporation is involved in a bankruptcy proceeding. This discussion summarizes ten common reasons to conduct a valuation analysis within a bankruptcy context.

Financially Troubled Company Purchase/Sale Transaction Structure Issues
Scott Cobb and Nguyen "Wen" Ho
Purchase/sale transactions involving financially troubled companies can be structured either as (1) a sale of stock or (2) as a sale of assets. It is also common for these transactions to include (1) noncompetition agreements, (2) consulting services agreements, and/or (3) goodwill. The structure of the troubled company sale transaction has income tax ramifications that may have an impact on the transaction price. This discussion focuses on the income tax implications for both the troubled company buyer and seller with regard to these common transaction structures.

Income Tax Issues Related to the Financially Distressed S Corporation
Jin Wang
Like any other type of business entity, a financially distressed S corporation may have to restructure its debt obligations in the current economic environment. Unlike many types of business entities, there are specific S corporation income tax ramifications associated with some of the common troubled company debt restructuring procedures. This discussion summarizes the income tax consequences-and the tax planning opportunities-related to some of the typical S corporation debt restructuring procedures.

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