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Financial Distress

Financial Distress. What is Financial Distress?. A situation where a firm’s operating cash flows are not sufficient to satisfy current obligations and the firm is forced to take corrective action.

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Financial Distress

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  1. Financial Distress

  2. What is Financial Distress? • A situation where a firm’s operating cash flows are not sufficient to satisfy current obligations and the firm is forced to take corrective action. • Financial distress may lead a firm to default on a contract, and it may involve financial restructuring between the firm, its creditors, and its equity investors.

  3. Default Failure to meet an interest payment, or Violation of debt agreement Bankruptcy Formal procedure for working out default Does not automatically follow from default. Financial Distress Includes default and bankruptcy, but also Threat of default or bankruptcy and its effect on the company Defined to capture the costs and benefits of using large amounts of debt finance Definition of Terms

  4. Solvent firm Insolvent firm Debt Assets Assets Debt Equity Equity Note the negative equity Insolvency • Stock-base insolvency; the value of the firm’s assets is less than the value of the debt. Debt

  5. $ Cash flow shortfall Contractual obligations time Insolvency Insolvency • Flow-base insolvency occurs when the firms cash flows are insufficient to cover contractually required payments. Firm cash flow

  6. What Happens in Financial Distress? • Financial distress does not usually result in the firm’s death. • Firms deal with distress by • Selling major assets. • Merging with another firm. • Reducing capital spending and research and development. • Issuing new securities. • Negotiating with banks and other creditors. • Exchanging debt for equity. • Filing for bankruptcy.

  7. No financialrestructuring 49% Privateworkout 47% 51% Financialrestructuring Reorganize and emerge 83% 53% Merge withanother firm Legal bankruptcyChapter 11 7% 10% Liquidation What Happens in Financial Distress Financialdistress

  8. Responses to Financial Distress • Think of the two sides of the balance sheet. • Asset Restructuring: • Selling major assets. • Merging with another firm. • Reducing capital spending and R&D spending. • Financial Restructuring: • Issuing new securities. • Negotiating with banks and other creditors. • Exchanging debt for equity. • Filing for bankruptcy.

  9. Bankruptcy Liquidation and Reorganization • Malaysia’s Bankruptcy Act 1967 is based on the English Bankruptcy Act of 1914. • A debtor is defined in Section 3(3) BA ’67 to include those personally present in Malaysia, ordinarily resident or had a place of residence in Malaysia, was carrying on business in Malaysia either personally or by means of an agent, or was a member of a firm or partnership which carried on business in Malaysia.

  10. Corporate Insolvency in Malaysia • General Liquidation • Receivership • Schemes of Arrangement • Special Administration under Pengurusan Danaharta Nasional Berhad Act 1998

  11. General Liquidation • Under S217 and 218 Companies Act 1965, a company may be wound-up upon presentation of a Winding-Up Petition if it is unable to pay its debt • Once the winding-up order is made, a court-appointed liquidator will be entrusted with the job of overseeing the liquidation process, including the handling of the wound-up Company’s assets and the repayment of debts

  12. Receivership • If a foreign creditor has a debenture over the assets of a Malaysian Company, he may appoint a receiver to run the business for a limited period with a view to realising it as a going concern

  13. Schemes of Arrangement • S 176 CA 1965 allows companies that are in financial difficulty to apply to the Courts for court-approved schemes of arrangements. • During the 1997 crisis, this device was used by numerous debtor companies in order to buy time to restructure their finances. • The typical modus operandi was to file an application to Court for Court approval of a proposed scheme of arrangement, pending that hearing, applying ex-parte to the High Court to stay all proceedings against the Company until the Court makes a decision on the proposed scheme. • The Company may continue to operate pending the outcome of the scheme.

  14. .. continue • Section 176’s provision was checked by a new Section 176 (10)(A) CA 1965 which was enacted to restrict any period of stay to merely 90 days or such longer period as the Court may for good reason allow if and only if certain conditions are met. • Even then, the schemes would only be approved if a majority (3/4) of creditors agrees to any compromise.

  15. Pengurusan Danaharta Nasional Berhad Act 1998 • The Act empowers Danaharta Corporation to acquire non-performing loans from banks and other financial institutions and manage these assets pending their sale by public tenders or auction. • The main objective was to restructure the loans where possible, and only resort to foreclosure and sale of collateral as a last resort.

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