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					                    Does debtor-in-possession financing add value?




                                      Maria Carapeto

                                 London Business School




                                       March 2, 2010





 PhD Programme, London Business School, Sussex Place, Regent’s Park, London NW1 4SA,
United Kingdom. Telephone: +44 (0) 171 262 5050. Facsimile: +44 (0) 171 724 7875. Email:
mcarapeto@lbs.ac.uk.
I would like to thank my supervisor Julian Franks, Kjell Nyborg, Lakshmanan Shivakumar,
Michael Brennan, Henri Servaes, Jan Mahrt-Smith, David Goldreich, Clara Raposo, Oren
Sussman, Mark Britten-Jones, Will Holt, Aneel Keswani and Rainer Kiefer for very helpful
comments on earlier drafts of this paper. This work was presented at the TMR Workshop on
Financial and Economic Efficiency (Florence, 1998), Institute of Finance and Accounting Seminar
(London Business School, 1999), Financial Management Association (Barcelona, 1999) and
European Financial Management Association (Paris, 1999). I would also like to thank Jonathan
Eaton and Russell Lloyd for providing access to the databases used in this study.
Financial support from Fundacao para a Ciencia e a Tecnologia is gratefully acknowledged.
                   Does debtor-in-possession financing add value?



Abstract


In this paper I analyse the role of debtor-in-possession (DIP) financing in the bankruptcy

process. I examine the plans of reorganisation of a large sample of Chapter 11s and find

that successful reorganisations benefited from DIP financing. The size of DIP financing is

shown to have a positive impact on recovery rates. DIP financing is also associated with

a larger probability of a successful reorganisation, thus favouring larger recovery rates. I

also find evidence of larger management turnover in firms with DIP financing,

particularly when the DIP lender has no pre-petition relation with the debtor.


Key words: Bankruptcy reorganisation and liquidation; Debtor-in-possession financing;

Recovery rates; Deviations from absolute priority; Management turnover.

JEL classification: G32, G33.
                   Does debtor-in-possession financing add value?



In this paper I examine the importance of debtor-in-possession (DIP) financing and its

contribution to the wealth of the stakeholders involved in the reorganisation of bankrupt

firms. DIP financing provides lending to troubled companies in Chapter 11 and is

usually a short-term lifeline in the form of working capital. The Code essentially aims to

induce lenders to provide credit to the debtor and at the same time encourage the

trustee or debtor-in-possession to incur expenses to maintain the collateral securing a

claim.


Dhillon et al. (1996) and Chatterjee et al. (1998) analysed stock and bond price

responses to the announcement of DIP financing and also the likelihood of a successful

reorganisation, when a firm emerges from bankruptcy with its independence preserved.

They observed that new financing in bankruptcy is a positive signal to the market and

DIP firms are involved in fewer liquidations. I employ a different approach, based on the

plans of reorganisation of Chapter 11 firms. I use a sample of 389 large publicly-traded

US firms that filed for Chapter 11 during 1986-1997, including both those with DIP

financing and those without DIP financing. I compare recovery rates for all claimants of

each firm to determine if DIP financing adds value to the company. I also examine the

sub-sample of DIP financing firms to assess whether relatively larger amounts of DIP

financing produce higher recovery rates, following a suggestion by Adams (1995). I find

that there is no significant relation between the presence of DIP financing and recovery

rates. However, DIP financing has a positive impact on creditors’ recovery rates as the

size of the new loan increases. This is consistent with firms with larger new loans being

subject to more monitoring from lenders and so less likely to over-invest. Gilson (1990)

                                                                                     1
presents evidence that bank lenders exercise significant influence over financially

distressed firms’ investment and financing policies. This indicates that DIP financing

should be considered as a positive signal for creditors only when the size of the loan is

considerably large. This evidence contrasts with that presented by Dhillon et al. (1996)

and Chatterjee et al. (1998), where the size of the new financing does not seem to be an

issue.1 Gilson (1989) observed that bank lenders are frequently responsible for

dismissing management in financially distressed firms. I find evidence of larger

management turnover for DIP firms, contrasting with Chatterjee et al. (1998). This role

is less evident when the DIP lender is also a pre-petition creditor.


Like Dhillon et al. (1996), Chatterjee et al. (1998) and Elayan & Meyer (1999), I also

show that DIP financing does contribute to successful emergence from bankruptcy. 2 In

particular, I find that when firms did not obtain DIP financing they are more likely to be

liquidated, and unsecured claimants would get lower recovery rates. In this way, since

getting DIP financing improves the probability of a successful reorganisation (or

decreases the probability of a liquidation), it is possible that, upon the announcement of

DIP financing, the market may actually be reacting to a smaller probability of liquidation

and not necessarily to higher recovery rates when compared with other bankrupt

companies without DIP financing. I also run logit models to assess the likelihood of a

successful emergence from Chapter 11, based on some firm characteristics and features

of the bankruptcy processes.


The paper is organised as follows: The next section provides a brief description of DIP

financing. Section II presents the literature review. The hypotheses are introduced in

Section III. The data and methodology are presented in Section IV. Section V provides


                                                                                     2
the results, including recovery rates, the impact of DIP financing in successful

reorganisations and the assessment of probabilities of a successful reorganisation,

management turnover, the bankruptcy venue and the determinants of DIP financing.

Section VI concludes.




                         I.   Debtor-in-possession financing


The market for debtor-in-possession (DIP) financing in Chapter 11 filings has

experienced great development since 1984, when Chemical Bank created a separate DIP

financing unit. Other banks have entered this market, namely Bankers Trust New York,

Citibank and General Electric Capital Corp. They have experienced minimal losses on

these loans because of their priority status.


The company filing for a Chapter 11 that needs new financing has to file a motion for

authorisation, which involves a two-step process. First, there is an interim financing

order authorising the borrowing of a limited amount to enable the company to operate

for a few weeks. Then, the entry of a permanent (final) order will potentially grant

borrowing up to the full amount of the lender’s commitment. 3


The conditions of new financing are considered in Section 364 of the Bankruptcy Code.

There is a hierarchy for obtaining post-petition financing, implying that the debtor first

has to seek unsecured credit before the Court will grant any kind of greater protection

to a new lender (see Rochelle, 1990). Following the legal fiction that a Chapter 11 is a

new legal entity, the Court can permit new financing with priority over pre-petition

unsecured creditors, with super-priorities over other post-petition creditors (even post-

petition priority administrative expenses and taxing authorities), and secured by liens

                                                                                     3
that have priority over pre-petition liens (priming liens) where the holders of such claims

are adequately protected. However, there must be assets sufficient enough to cover both

the new loan and all pre-petition secured debt not expressly subordinated by the Court’s

order to the debtor-in-possession lender’s lien (Fitch Research, 1991).4 See Appendix A

for a detailed examination of the different types of DIP financing.




                                 II.   Literature review


Ostrow (1994) states that the decision whether to approve new financing is directly

related to the likelihood that creditors would get more from the distribution under the

plan of reorganisation. However, sometimes there is little time to consider that an

immediate liquidation could be more profitable for the creditors, and the focus is instead

on whether the debtor should be permitted an opportunity to reorganise. This implies

that the total value of the firm available for distribution to the claimants may be smaller

than without this new financing. Rohman & Policano (1990) say that even when the

debtors are not confronted with imminent default, they may choose to file for Chapter

11 as a means to secure new financing and so preserve their flexibility to accommodate

future growth. In this way, rather than the last resort, DIP financing can be viewed as a

“pro-active” strategy. Perhaps surprisingly, the bankrupt companies see their terms of

credit improve, both in accessibility and in cost, because there is only one post-petition

creditor - the debtor-in-possession bank (Millman, 1990).


Empirical studies in this area have essentially focused on the market reaction to the

announcement of DIP financing and on the bankruptcy outcome. None of these studies

considered the plans of reorganisation themselves, which provide the ultimate means of


                                                                                      4
comparison between firms with DIP financing and firms without DIP financing, in terms

of recovery rates and deviations from absolute priority rules. Also, these studies did not

try to assess probabilities of a successful reorganisation once in Chapter 11, based on

characteristics of the firm and the bankruptcy process.


Datta & Iskandar-Datta (1995) examined the restructuring activities of 135 financially

distressed companies that filed for Chapter 11 during 1989-1990. They found significant

evidence for the fact that, during the two-year period prior to filing for bankruptcy, these

firms were unable to obtain financing; however, after the filing, the infusion of new

capital via fresh loans is large, which may be explained by the super-priority status

conferred to post-petition debt. In this way, the authors argued that firm value might

not decrease, as there is an opportunity to invest in positive NPV projects.


Dhillon et al. (1996) used a sample of 25 firms with debtor-in-possession financing and

80 firms without debtor-in-possession financing that filed for Chapter 11 during the

period of January 1990 to December 1993 and showed the signalling role of this new

financing. The announcement of debtor-in-possession financing is associated with

positive abnormal returns on equity securities and positive (weak evidence) abnormal

returns on debt securities. Also, firms that employ debtor-in-possession financing have

more successfully reorganisations - higher percentage of firms emerging successfully

from Chapter 11 and higher ex-post EBIDT (Earnings Before Interest, Depreciation and

Taxes) as a proportion of total assets and sales.


Chatterjee et al. (1998) examined a sample of 55 publicly traded firms that filed for

Chapter 11 from January 1990 to December 1995 and received approval for DIP

financing. Their results support the benefits of the certification and monitoring role

                                                                                       5
provided by DIP lenders, that outweigh the high priority of DIP financing. They also

show some evidence of management entrenchment. DIP financing is associated with a

positive stock and bond price response, which may suggest the absence of wealth

transfers from pre-petition creditors to high priority DIP lenders. They found that most

firms that obtained DIP financing are not in economic distress. When compared to

bankrupt firms without new financing, DIP firms show a significant larger probability of

successfully emerging from Chapter 11 and not being involved in posterior filings.


Elayan & Meyer (1999)5 used a sample of 123 firms with debtor-in-possession financing

and 337 firms without debtor-in-possession financing that filed for Chapter 11 over the

period 1980-1995. They support the signalling role provided by DIP lenders that DIP

firms face a lower probability of liquidation. DIP financing is associated with a positive

stock price response, in particular if the DIP firm was subsequently liquidated or the

lender was a pre-existing creditor or a bank. Larger loans (relative to total assets) and

the first DIP transaction (as opposed to subsequent transactions) are also associated

with a more positive market reaction. In addition, they found a shorter duration under

bankruptcy proceedings for DIP firms, which may indicate lower bankruptcy costs. 6




                                   III. Hypotheses


Datta & Iskandar-Datta (1995) claim that with DIP financing the firm value suffers less

erosion, due to an opportunity to invest in positive NPV projects. Dhillon et al. (1996)

and Chatterjee et al. (1998) analysed the effect of DIP financing in the stock and bond

markets and found a positive impact. This suggests that the concession of DIP financing

does add value to the firm. Adams (1995) points out that it is not the concession of DIP


                                                                                     6
financing per se that matters, but its size, implying that small loans should not make

much of a difference. These effects should then be reflected in the payments received by

the claimants upon reorganisation, which are stated in the plans of reorganisation.


Hypothesis 1: Claimants of firms with DIP financing show higher recovery rates than

those of firms without DIP financing. In particular, the larger the size of DIP financing, the

higher the recovery rates.


Dhillon et al. (1996), Chatterjee et al. (1998) and Elayan & Meyer (1999) show that firms

with DIP financing are more likely to successfully reorganise. Schwarcz (1985) argues

that obtaining new financing can act as a good signal to trade creditors and have them

re-establish the terms of the trade credit with the company, thus increasing the

likelihood of a successful reorganisation. These studies emphasise the positive role of

DIP financing in a successful reorganisation. This is a very important issue, as far as

bankruptcy is often associated with asset sales at depressed prices, in particular with

piecemeal liquidations, which constitute a significant dead-weight loss (see Andrade &

Kaplan, 1998). Also, the productivity of the plants of Chapter 11 firms that were

converted to Chapter 7 is much lower than those that remained in Chapter 11, as

documented by Maksimovic & Phillips (1998), which suggests a lower value for the

former firms. The positive impact of DIP financing should however be reduced in two

circumstances: a) when the new loan is secured by a lien on already encumbered assets

with equal or senior priority to the existing liens (priming liens); b) when the DIP lender

is a pre-existing creditor and obtains an increase in the seniority of his pre-petition debt.

These situations suggest a lack of confidence of the DIP lender in a successful

reorganisation of the firm. Also, when DIP financing is granted by the Court shortly after

filing for bankruptcy, this should not indicate necessarily good news, as far as there was

                                                                                         7
not enough time to examine the financial situation of the firm, and so its true needs.

Thus, successful reorganisations should be associated with more time to obtain DIP

financing upon filing for bankruptcy.


Hypothesis 2: DIP financing increases the probability of a going concern and so reduces

the probability of liquidation, which involves lower recovery rates. The presence of

priming liens or increased seniority of pre-petition loans, and a short time to obtain DIP

financing increase the probability of liquidation.


Chatterjee et al. (1998) argue that the evidence of management turnover in firms with

DIP financing is not significant. The authors compared management turnover in their

sample of DIP financing firms to those of Hotchkiss’ (1995), but it is possible that in this

last sample some firms actually received DIP financing. This suggests that the two

samples may not be independent, thereby limiting the validity of their results. Gilson

(1989) observed that bank lenders frequently initiate top management changes in

financially distressed firms. Gilson (1990) adds that bank lenders wield considerable

influence over investment and financing policies in financially distressed firms. Since the

DIP lender is usually a bank with considerable expertise in the DIP financing market

and the bankruptcy process, one should expect a larger monitoring and disciplining role

in DIP firms, and eventually more management turnover. When the new financing was

provided by a pre-petition creditor, this disciplining role should then be less evident, due

to a previous relation with the debtor.


Hypothesis 3: Management turnover is larger in firms with DIP financing. In particular,

management turnover is larger when the new financing was granted by a new lender,

without a pre-petition relation with the debtor.



                                                                                       8
                             IV. Data and methodology



A.   Data sources


The main source for the data used in this paper was the Bankruptcy DataSource. This

database includes bankruptcy information for every publicly-traded company with

assets in excess of $50 million7 that are in bankruptcy proceedings, have defaulted on

public debt, or have issued a distressed exchange offer. The database begins in 1986.


I compiled a list of 389 firms that went bankrupt from the 1st January 1986 to the 31st

December 1997.8 Of these firms, 212 reorganised independently, 40 were acquired in

bankruptcy, 57 were liquidated in Chapter 11, 13 were converted to Chapter 7 and 4

were dismissed; the result is unknown or still pending in 63 cases. The Bankruptcy

DataSource (BKRDATA        - Plans of    Reorganization) supplied complete plans of

reorganisation, with data concerning the satisfaction of all the claims, for 172 firms that

reorganised successfully, including 72 debtors that raised DIP financing during the

bankruptcy process. Also, complete plans of liquidation were compiled for 21 firms,

including 5 cases of DIP financing. The SEC (Securities Exchange Commission) filings

(including the 8Ks, 10Ks and 10Qs) were also used to check and complement the

information contained in BKRDATA.


The stock prices and the number of outstanding shares were extracted from the Center

for Research in Security Prices (CRSP), Bloomberg and Datastream, upon emergence

from Chapter 11. Occasionally there was no market value for the stock because the firm

might have become private. In these cases (37 firms), I used the estimates provided in

the plans of reorganisation (when a range of values was provided, I used the mid point).

                                                                                      9
The same criteria was applied to the prices of debt securities, preferred stock, options,

rights and warrants, where the sources included Bloomberg and DataStream, and

ultimately the plans of reorganisation themselves. In the absence of market values or

estimates for debt and preferred stock, the face value and the liquidation preference

value were used instead, respectively (only 16 (2) firms in my sample had market values

for debt (preferred stock)); as for options, rights and warrants, I used the Black-Scholes

valuation model to price these securities (in 33 cases). 9


All the news concerning the evolution of the bankruptcy process for the Chapter 11

firms were picked from the Dow Jones News Retrieval and also from the Bankruptcy

DataSource (BKRDATA - DataPage and News Notes, and BKRNEWS). The DataPage

covers such aspects as filing data, business reports, five year summary financials,

descriptions of outstanding securities and schedules of assets and liabilities; it also

supplies the creditors and equity-holders committees, the twenty largest unsecured

creditors list and lists of attorneys and other appointed professionals. The News Notes is

a search base that compiles significant news and developments (i.e. scheduled hearings),

including some relevant dates (filing date, confirmation date and effective date), DIP

financing (amounts, dates, agents), reasons and type of filing, industry, trustees,

previous LBOs, acquisitions and mergers, top management, etc.



B.   Methodology


In order to obtain values for recovery rates and deviations from absolute priority for the

different classes of claimants I constructed a table for each company, containing a

summary of its plan of reorganisation:



                                                                                    10
1) A description of the claims in terms of “secured”, “unsecured” and “equity”10   11




Administrative claims were not considered in the analysis for two reasons: first, in most

of the cases their value is still unknown as of the confirmation date; second, these

claims always get paid, thus not incurring any write-downs or deviations from absolute

priority (see Tashjian et al. (1996)).


2) The estimated allowed claims


One should note the limitations that the use of the estimated allowed claims bring

about. As pointed out by Weiss (1992), these values usually rely on management

valuations that the Court accepts, unless a creditor manages to establish another

amount through costly hearings; sometimes, the quantities involved are understated, as

the Court might fail to provide the appropriate interest; also, the Court generally accepts

management’s view on whether the classes of creditors are impaired12, and so the

creditors may think it is not worth the effort and cost to show otherwise.


3) The amounts received upon reorganisation, distributed by the sub-classes “cash”,

  “debt”, “preferred stock”, “shares” and “options”13


4) The amounts that should have been distributed to all claimants, had the absolute

  priority rules been enforced14, the percentage recovery rates and the percentage

  deviation from absolute priority rules. It should be noted that recoveries for equity

  were obtained as a percentage of the ownership upon reorganisation, allowing for

  dilution. In this analysis I follow closely the same methodology as Franks & Torous

  (1989, 1994), LoPucki & Whitford (1990), Weiss (1990), Eberhart et al. (1990), Fabozzi

  et al. (1993) and Tashjian et al. (1996).


                                                                                        11
C.   Data analysis


Table I describes the time-series distribution by filing date for the sample of 389 Chapter

11s, consisting of 135 firms with DIP financing, 191 firms without DIP financing and 63

cases where the result is unknown or still pending. For the complete cases, the

companies were classified by type of bankruptcy outcome: independence preserved

(65% ), acquired or merged (13% ), liquidated in Chapter 11 (17% ), converted to Chapter

7 (4% ) and dismissed (1% ).


When a firm commences a Chapter 11 proceeding, it is usually the result of a voluntary

action of the management of the distressed company. However, creditors can also file an

involuntary bankruptcy petition or even ask for the immediate liquidation of the firm, if

the company is not paying its debts as they come due. An involuntary petition must be

filed by a minimum of three creditors and the unsecured portions of their claims in

aggregate should be at least $10,000 (see KPMG (1997, p. 323)). There is no

requirement, though, that the debtor be insolvent or unable to pay his debts as they

mature, as pointed out by Saft (1993). The firm will then either agree with the filing and

file a voluntary petition, or ask the Court to move for dismissal, if the management

thinks the creditors have no just cause. Another possible classification of different

bankruptcies is in terms of prepackaged bankruptcies (pre-packs) and the more

traditional (conventional) Chapter 11 cases. A pre-pack is a form of corporate

restructuring where the terms of the reorganisation are negotiated outside the Court,

between the debtor and the creditor (under Subsection 1126(b) of the Bankruptcy Code,

that permits negotiation between debtor and creditors prior to filing for bankruptcy). In

order to become effective, the company must file a bankruptcy petition and a plan of

reorganisation that has to be ratified by the Court, like a traditional Chapter 11. It is
                                                                                     12
important to consider pre-packs and non-prepacks separately as far as Tashjian et al.

(1996) found substantial differences between these two types of filing: prepackaged

bankruptcies are less lengthy and involve larger recovery rates than conventional

Chapter 11s. Table II presents the distribution of bankrupt companies by type of filing

and bankruptcy outcome. They include 90% of voluntary filings and 22% of pre-packs.

The most common case is a voluntary filing that is a non-prepack (69% ) and the most

unusual is an involuntary filing that is accepted by the company and followed by a pre-

pack (1% ).


Chatterjee et al. (1998) noted that DIP firms are in less economic distress than non-DIP

firms. Table III compares the two sub-samples, with DIP financing and without DIP

financing, in terms of some selected financial characteristics, measured at the

accounting year end prior to filing for Chapter 11. Firms that obtained new financing

are generally more profitable, with larger values for revenue and income in terms of total

assets. This table shows the incidence of equity committees in the sample of bankrupt

firms as well. Equity committees seem to be more abundant in Chapter 11s with DIP

financing, which indicates that equity has some value in these firms. Table III also

displays the time spent in bankruptcy 15 by the sample of Chapter 11 firms. Time in

bankruptcy does not appear to be (significantly) much higher for firms with DIP

financing (only in terms of medians), but these firms account for a smaller proportion of

the pre-packs in the sample, that are less lengthy than traditional Chapter 11s. If I

compute the time in bankruptcy for DIP firms and non-DIP firms, by type of filing, there

are no significant differences.16 These results contrast with Elayan & Meyer (1999), who

found the bankruptcy process to be less lengthy for DIP firms.



                                                                                    13
Table IV lists the DIP lenders for a sub-sample of 124 firms that obtained DIP financing.

Chemical, GECC and CIT are the banks that are more involved in this market, although

some financial institutions, like Foothill Capital, for example, are also well represented

(with smaller average loans). This distribution agrees with the study by Chatterjee et al.

(1998) of a sample of 55 firms with DIP financing, where those three banks were the

most important ones as well. Also, Dhillon et al. (1996) report that, for 25 Chapter 11s

with new financing in 1990-1993, 5.8% in value and 20.0% in number of new loans

came from one bank only, Chemical, and 64.7% in value and 48.0% in number from

three banks (General Electric Capital Corporation and CIT Group, besides Chemical),

whereas my sample is more diversified with respect to the sources of funding. We can

see that DIP financing is associated with a few number of liquidations: 24 (19% ) out of

124 firms.


Table V evidences the importance of DIP financing in terms of some selected financials,

by type of filing. The average (median) loan considered in the sub-sample of firms with

DIP financing is $91.0 ($35.0) million and its proportion of the total assets of the firm,

measured at the year end prior to filing for Chapter 11, has a mean of 15.6% and a

median of 11.3% .17 This compares with the study by Chatterjee et al. (1998) with a

higher average loan size of $121.6 million. Dhillon et al. (1996) obtained a mean loan

size of $75.0 million (median of $125.9 million) and the percentage of DIP financing on

total assets of 11.1% (17.5% ). Their sample has negative skewness, as oposed to the

positive skewness of my sample, which implies that they have many higher values than

those reported here, not only in size of DIP financing, but also in terms of its proportion

of the firm’s assets. This extends to the value of the assets as well, where the means

(medians) are $875.2 ($243.8) million in my sample and $461.0 ($1,318.0) million in

                                                                                     14
their sample. Pre-packs show lower levels of DIP financing, with an average (median)

loan of $54.9 ($35.0) million, which can be explained by the perspective of less time

spent in Chapter 1118 and so less need for new financing while in bankruptcy.


Table V also refers to the days in bankruptcy until the firm gets DIP financing, with a

mean of 78.6 and a median of 30.0 days. Though the variation is quite high (standard

deviation=174.6), there is a concentration on the left-hand side of the distribution,

implying that most of the firms are given the new loans shortly after filing for Chapter

11. This is corroborated by the first and third quartiles of the distribution.




                                       V.   Results



A.   Recovery rates


Recovery rates give the percentage of the face value of a creditor’s claim that is repaid

upon reorganisation. In the case of equity-holders, recovery rates give the percentage of

ownership upon reorganisation, allowing for dilution. In order to assess the role of DIP

financing in terms of its contribution to the value of the firm, recovery rates were

calculated for the several stakeholders involved - secured creditors, unsecured creditors

and equity-holders. Table VI reports the results for the two groups of firms, with and

without DIP financing. We can see for the total sample that recovery rates are usually

higher for firms without DIP financing than for firms with DIP financing, but these

values are not very significant, except for equity-holders. Average recovery rates for

firms with DIP financing and without are, respectively, 93.3% and 90.7% for secured

creditors, 48.0% and 55.5% for unsecured creditors, 10.9% and 20.8% for equity-

holders. The lower recoveries for equity-holders suggest that there is no coalition
                                                                                   15
between them and the DIP lender. In order to investigate these lower equity recovery

rates, another alternative indicator was used: total payments to equity as a percentage

of the total distribution to claimants. Despite retaining a smaller ownership in DIP

firms, equity-holders recoveries given by the new metric are not significantly different

between DIP and non-DIP firms, which reflects the larger stock value of DIP firms.


Some firms displaying a small amount of new financing can however affect this

comparison. For a sub-sample of 25 conventional Chapter 11s with DIP financing in the

amount of at least 20% of the estimated total debt, and 68 firms without DIP financing,

we can see that creditors recover significantly more in the former firms.           19    This

important result shows that the size of DIP financing does seem to lead to higher

recovery rates for the claimants. This may be because firms with larger DIP loans (in

proportion to firm size) will be subject to more monitoring from the lenders. Due to the

possibility of erosion in the value of the collateral that usually secures the DIP loan, the

new lender is likely to exert more monitoring the larger the loan, despite its super-

priority status, in order to avoid incurring substantial losses (in case the value of the

collateral becomes smaller than the amount of the loan). Adams (1995) also points out

that more critical than the source or form of the new financing while in bankruptcy, it is

the size that matters. This also agrees with Elayan & Meyer (1999), who found a

stronger stock price response to the announcement of larger relative DIP loans.


One can argue that one reason for creditors in these firms to recover more is the fact

that they might be more solvent. For a sub-sample of 19 firms with DIP financing in the

amount of at least 20% of the estimated total debt, the regressions of the recovery rates

for secured and unsecured creditors on the percentage of income in terms of total assets


                                                                                         16
(one measure of profitability) and the percentage of DIP financing in terms of the

estimated total debt, produce the following results (variables in percentage, p-values in

brackets):




                                                       Income                    DIP value
     Unsecured Creditors Recoveries  31.9  2.289 *               1.035 *
                                                     Total assets           Estimated total debt
                                                                                                   (1)
     N  19     R 2  37.7%          (0.156) (0.081)               (0.032)




                                                      Income                    DIP value
       Secured Creditors Recoveries  85.6 - 0.045 *              0.220 *
                                                    Total assets           Estimated total debt
                                                                                                   (2)
       N  19   R 2  9.8%          (0.000) (0.924)               (0.207)




Regression (1) shows that when controlled for firm solvency, the size of DIP financing (as

a percentage of estimated total debt) does contribute positively to larger unsecured

creditors’ recoveries. However, this is not the case in Regression (2), where the p-values

are not significant.


The sample of pre-packs is quite modest (14 firms) and so the fact that unsecured

creditors in pre-packs with DIP financing recover significantly less than DIP non-

prepacks should not be given much relevance. In fact, if I discard three cases where the

unsecured creditors received at least 95.6% of their payments in shares, and recovered

on average only 6.4% of their claims (with a median of 7.1% ), the results are quite

different: the mean (median) recovery rate is now 53.3% (58.2% ), and these values are

not significantly different from the non-DIP pre-packs (p-value=0.145 (0.195)). This

analysis suggests a very optimistic valuation of the stock in those three firms at the time

of the reorganisation plan.




                                                                                                    17
The following sub-sections deal with four additional issues related to recovery rates. In

DIP firms, do creditors receive a larger proportion of their payments as equity because

they believe in the quality certification role provided by the DIP lender? Do creditor

recoveries violate absolute priority rules? Do creditors recover less in the event of a

liquidation and how crucial was to have obtained DIP financing? Do secured creditors as

a class have stronger bargaining power when the new financing was granted by a pre-

petition (secured) creditor?




                   A.1. The medium of exchange in the reorganisations


Table VII sets out for each class of claimants in both Chapter 11s with DIP financing

and without DIP financing, the percentage of the total payments received in the form of

cash, debt, preferred stock, options and common stock. The classes considered are

secured creditors, unsecured creditors and equity-holders. The majority of payments in

firms with DIP financing is in the form of common stock (36.3% ) and debt (32.5% ),

whereas in firms without DIP financing the bulk of the payments is in the form of debt

(44.8% ) and cash (27.1% ). Unsecured creditors receive significantly more common stock

and less debt in firms with DIP financing, showing their confidence in the performance

of these firms after bankruptcy. Equity-holders get more options but less cash and

common stock in the event of DIP financing.




                          A.2. Deviations from absolute priority


In the sub-sample of 72 Chapter 11s with DIP financing there are 23 cases where

priority was held, 27 cases where priority was violated for unsecured creditors only and

22 cases where priority was violated for secured creditors, using Weiss’ (1990)
                                                                                   18
classification. These results give an average incidence of deviations from absolute

priority rules of 68.1% , including 39 cases (79.6% ) where shareholders actually received

some consideration. The pattern for the 100 Chapter 11s that did not obtain DIP

financing is very similar: priority was held in 39 cases, priority was violated for

unsecured creditors in 37 cases and for secured creditors in 35 cases. The average

incidence of deviations from absolute priority is 61.0% , with equity receiving some

consideration in 53 cases (86.9% ). This compares with 77.8% and 85.7% cases,

respectively, in Frank & Torous (1989), 78.4% and 93.1% in Weiss (1990), 96.2% and

80.0% in Fabozzi et al. (1993). These results suggest that there are less violations of

absolute priority in large companies, which constitute the sample in the present study,

since the samples of the other authors are more diversified in terms of company size.


DIP financing does then seem not to impact in the incidence of deviations from absolute

priority. This observation supports Chatterjee et al. (1998), who showed that DIP

financing is associated with a positive stock and bond price response, suggesting the

absence of wealth transfers amongst the claimants. The magnitude of deviations from

absolute priority rules is also not significantly different between the two groups of firms,

as reported in Table VIII. Unsecured creditors and equity-holders gain on average, to the

detriment of secured creditors. On average, deviations in DIP firms and non-DIP firms

are, respectively, -4.2% and -3.3% for secured creditors, 3.6% and 0.2% for unsecured

creditors, 0.6% and 3.1% for equity-holders. However, there is some weak evidence of a

less positive deviation for equity-holders in DIP firms, which suggests that shareholders

in firms without new financing are able to extract more value from the secured creditors

than those in firms with new financing. This implies that there is no coalition between

the old shareholders and the new lender in order to extract value from creditors. The

                                                                                      19
consideration of non-prepacks with DIP financing in the amount of at least 20% of the

estimated total debt produces negative average deviations for equity-holders, but this is

not significantly different from zero (p-value=0.560). Interestingly, a pseudo-median

company does not exhibit deviations from absolute priority.




                           A.3. Recovery rates and liquidation


In theory, one dissenting creditor can effectively prevent confirmation of a plan if he

shows that it does not grant him at least what he would get in a liquidation; in practice,

however, this is very difficult to prove. Moreover, because the valuations are based on a

going concern framework, and so higher than in a liquidation setting, it is unlikely that

the creditor could get more otherwise. In this way, Schwarcz (1996) argues that a cram-

down is very important as a threat to induce junior classes to accept a plan of

reorganisation proposed by more senior creditors or the debtor-in-possession because of

this risk of actually ending up getting less. Ravid & Sundgren (1998) in fact report very

modest recoveries for a sample of 61 small Finnish firms that filed for bankruptcy

between 1982 and 1992 and were liquidated in a piecemeal liquidation. Creditors

recovered on average 35.6% of their claims, with a median recovery rate of 33.7% . So,

do Chapter 11 creditors really get less in a liquidation?


I compared recovery rates between 126 firms that reorganised successfully from

Chapter 11 and 21 firms that were liquidated (in either Chapter 7 or Chapter 11). Only

conventional Chapter 11s were considered. In all 21 cases of liquidation, secured

creditors always received full payment or the collateral, and equity-holders always

recovered nothing. Figure 1 provides recovery rates for unsecured creditors. Panel A

shows unquestionably that unsecured creditors do recover substantially more (p-
                                                                                    20
value=0.029) when firms reorganise (mean=49.1% , median=39.3% ) than when they

liquidate (mean=28.7% , median=14.1% ), which legitimates the credibility of the cram-

down threat. In addition, Panel B indicates that unsecured creditors in firms without

DIP financing receive substantially less (p-value=0.043) in a liquidation (mean=28.6% ,

median=11.7% ) than in a successful reorganisation (mean=49.2% , median=42.5% ).

This also happens with DIP firms, but the values are not significant due to the small

sub-sample (5 firms) of DIP firms that were liquidated. These results show that

unsecured creditors do recover more in a successful reorganisation than in a

liquidation.




                 A.4. When the pre-petition lender provides DIP financing


Sometimes the debtor-in-possession lender already has a pre-petition relationship with

the debtor. By providing new financing, he is trying both to protect his collateral base

and give an appearance of normality towards the debtor’s customers and suppliers, to

ensure that the going concern of the collateral is maintained. At the same time, he is

avoiding the concession of a stronger negotiating position to the manager resulting from

the possibility of a new lender, while avoiding making concessions to the debtor that

might weaken his existing claims. DIP lenders are often pre-petition creditors, well

informed with respect to the value of the firm. In Table V an average of 42.7% of DIP

lenders were pre-petition (usually secured) creditors. In pre-packs the mean is even

higher, at 63.2% .


The most advantageous aspect of DIP financing for a DIP lender is perhaps the

possibility of collateralising his pre-petition claims with property collateralising his post-

petition claims (Cott, 1992). In this way, the collateral for the lender’s pre-petition
                                                                                        21
claims secures the collateral for his post-petition claims and vice-versa, and he can

effectively condition post-petition financing on the concession of additional collateral for

his pre-petition loan.20 Also, when the new financing is provided by existing secured

lenders, they sometimes have to prime themselves (Kleiman, 1992); in exchange, they

can ask for (a) the conversion of their pre-petition claim into post-petition and (b) the

interest payments on pre-petition debt to be continuously paid through the bankruptcy

period. For example, Servam Corp./Service America Corp. had a pre-existing credit

agreement of $70 million with General Electric Capital Corp. This lender agreed to

provide post-petition financing of an additional $35 million conditional on the

consideration of the full amount of his loans - $105 million - as DIP financing. A

different concession was made to F&C International, where Star Bank NA, a former

creditor, lent $17.65 million as DIP financing in exchange for the full payment of his

pre-petition loan on the effective date. This evidence supports LoPucki & Whitford’s

(1990) suggestion that if the post-petition lender is a former creditor, his bargaining

power will be strengthened. Table V reveals that in 7.3% of the firms with DIP financing

there was either a situation where some liens were primed as a result of the new loans,

or the DIP lenders benefited from increased seniority of their pre-petition loans.


One should then expect to find higher recovery rates and more positive (less negative)

deviations from absolute priority rules for pre-petition (secured) creditors that are also

DIP financing providers than for secured creditors when we have a new lender, in firms

with DIP financing. Recovery rates for all classes of claimants (secured creditors,

unsecured creditors and equity-holders) and absolute priority rules do not seem to be

significantly affected by the fact that a pre-petition lender is a post-petition lender as

well (results not reported). However, the means of payment are affected. Old lenders that

                                                                                      22
also provided DIP financing get a significantly (p-value=0.063) larger proportion of cash

(mean=47.5% , median=29.5% ) and a smaller proportion of debt (mean=40.5% ,

median=18.7% ) as a means of payment settlement than in the case when the DIP lender

does not have a pre-petition relation with the DIP firm (mean=26.0% and median=3.9% ,

for cash; mean=63.8% and median=84.7% , for debt). In some way, this can actually be

considered as a larger recovery rate for these creditors that are both pre-petition and

post-petition lenders, because the debt is usually over-valued.


The amount of the lender’s commitment is not necessarily constant throughout the

bankruptcy process, as either the firm or the lender may decide to change it. Here are a

few examples: Value Merchants, Inc. obtained a $60 million loan from Congress

Financial and raised it to $65 million; Smith Corona Corp. reduced its loan from

Chemical Bank and Bank of America Illinois from $24 million to $10 million; MEI

Diversified saw its $10 million loan cancelled by LaSalle National Bank; Citibank

granted Leslie Fay Companies, Inc. a $150 million loan, and reduced it to $80 million

when the company obtained a new $80 million loan from First National Bank of Boston.

Table V indicates that in 8.9% of the DIP firms, the new loan was either terminated or

the provider was replaced.


In some cases, however, the new lender with a previous relationship with the debtor

may voluntarily agree to forgive the post-petition loan. This happened with Physicians

Clinical Laboratories, Inc., where a group of pre-petition secured lenders forgave $9.8

million in DIP financing. Also, Trans World Airlines, Inc. obtained a loan of $251 million

from Icahn & Co. units (belonging to his CEO) and never paid it back. In this case,

however, the loan did not get super-priority status. In pre-packs there were no


                                                                                    23
situations of DIP financing terminated or provider changed, nor DIP financing with

priming liens or increased seniority of pre-petition loans.



B.   DIP financing and its contribution to successful reorganisations


Chatterjee et al. (1998) found that DIP firms are more likely to reorganise with the

independence preserved than non-DIP firms (72% and 54% , respectively), they are less

likely to merge or be acquired (8% , as opposed to 18% ) and liquidate less (10% , as

opposed to 16% ).21 Dhillon et al. (1996) got more successful reorganisations with DIP

financing than without (medians of 85% and 50% , respectively). Elayan & Meyer (1999)

also report more successful reorganisations with DIP financing than without (averages of

90.0% and 78.6% , respectively). This evidence suggests that the concession of DIP

financing has a positive impact on the likelihood of a successful emergence from

bankruptcy.


Figure 2 tries to answer two questions. Firstly, given that a firm obtained (did not

obtain) DIP financing, what is the probability that it will reorganise successfully or

liquidate (Panels B and D)? This is Chatterjee et al.’ (1998), Dhillon et al.’ (1996) and

Elayan & Meyer’s (1999) point. Secondly, given that a firm reorganised successfully (was

liquidated), what is the probability that it obtained (did not obtain) DIP financing (Panels

A and C)?


I compared my sample of 135 firms that obtained DIP financing with 191 firms that did

not receive DIP financing, by type of filing and bankruptcy outcome. The values are

given as a proportion of the total cases in each box. Panels A and C show that there are

significantly fewer (p-value=0.000) liquidations than successful reorganisations in


                                                                                      24
Chapter 11, especially in the case of pre-packaged bankruptcies (28.5% liquidations in

traditional Chapter 11s and 2.7% liquidations in pre-packs). For firms that emerged

successfully, there are significantly fewer (p-value=0.000) firms with DIP financing than

without DIP financing in prepackaged bankruptcies (31.0% of firms with DIP financing),

and no significant difference (p-value=0.463) in conventional Chapter 11s (48.1% of

firms with DIP financing). Also, pre-packs use significantly less (p-value=0.050) DIP

financing than non-prepacks (31.5% of firms with DIP financing in pre-packs versus

44.3% of firms with DIP financing in conventional Chapter 11s). The fact that pre-packs

are less lengthy makes new financing during the reorganisation process not so vital as

with traditional Chapter 11s. For conventional Chapter 11s that were liquidated, the

proportion of firms with DIP financing (34.7% ) is significantly smaller (p-value=0.000)

than the proportion of firms without DIP financing. Panels B and D add that in non-

prepacks, DIP bankruptcies are significantly more successful (p-value=0.054) than non-

DIP bankruptcies (77.7% versus 66.7% ). This evidence demonstrates the important

result that if a firm did not get new financing in bankruptcy, the probability that it was

liquidated is substantially larger.




                            B.1. Failure to obtain DIP financing


In order to assess the role of DIP financing as a deterrent to liquidation, one should try

to separate the cases where firms sought for new financing and failed to obtain it from

those where firms did not try to get DIP financing. Action Auto Rental Inc. and Child

World are examples of firms that claimed to have been liquidated because they failed to

attract new financing during bankruptcy. Since it is extremely difficult to determine for

sure whether the absence of DIP financing indicates failure to obtain it or just a decision

                                                                                     25
not to get it at all, one can only wonder about the magnitude of the probabilities

involved. Using the values for conventional Chapter 11s from Figure 2 - Panels (A) and

(B),    we   can   obtain   the   upper    bounds   for     P(DIP financing failure/Successful

reorganisation) and P(DIP financing failure/Liquidation) as 0.519 and 0.653, respectively,

which are significantly different from each other at the 5.4% level. This suggests that

there is a larger scope for cases of a failed DIP financing in liquidations that in

successful    reorganisations.     We     can   reproduce    this   analysis   for   pre-packaged

bankruptcies as well, using the values from Figure 2 - Panels (C) and (D). However, due

to the very small sample of liquidations (2) it is not possible to make precise

extrapolations.




                        B.2. Prediction of successful reorganisations


Since Altman’s (1968) Z-score model a whole panoply of authors have studied different

distress classification models. These studies concentrate on the assessment of

probabilities of a firm going bankrupt, according to some relevant financial ratios. In

this section I examine a different issue: Once in Chapter 11, what is the probability that

a firm will reorganise successfully (either with the independence preserved or through

an acquisition in bankruptcy)? What are the main ingredients for a successful

reorganisation?


Table IX presents two logistic regressions that try to assess the probability of a firm

successfully emerging from bankruptcy. The first one is for the whole sample of both

firms with DIP and without DIP financing. The second one is for firms with DIP financing

only.



                                                                                           26
The first logistic regression22 shows that the probability of success increases with the

size of the firm (measured by the logarithm of its liabilities), which suggests that the

claimants stand to lose a lot if the firm does not reorganise successfully. Obtaining DIP

financing is a positive factor, as argued by Dhillon et al. (1996), Chatterjee et al. (1998)

and Elayan & Meyer (1999), and also seen previously, but if there is any need to prime

existing liens or the seniority of pre-petition loans has to be increased, the overall effect

is negative. Pre-packs and involuntary filings usually have positive outcomes, implying

that the firm filed for bankruptcy before there was much time to erode its value.

Chairman changes during bankruptcy and equity committee appointments impact

positively in the likelihood of success of a bankrupt firm. However, the appointment of a

trustee suggests that the firm is not very sound.


In the second logistic regression23 we can see that the more time it takes to obtain DIP

financing, the more likely is a firm to reorganise successfully in Chapter 11. This implies

that creditors should not agree to a fast DIP financing concession, and judges should

not grant new loans without careful analysis of the situation of the bankrupt firms.

Changes of chairman, the appointment of an equity committee and involuntary filings

do not seem to explain successful reorganisations with DIP financing.24



C.   Management turnover


Chatterjee et al. (1998) compared CEO turnover (and also president turnover) for 16

cases of DIP financing with Hotchkiss’ (1995) results, and obtained a significantly lower

level for this characteristic in study. 25 They also found ample monitoring by DIP

financing lenders, who charge large spreads and fees.



                                                                                       27
Table X shows that there is significantly more CEO and chairman turnover with DIP

firms, in three different circumstances: before & during, during and after bankruptcy.26

This result contrasts with Chatterjee et al. (1998) and can be supported by Gilson’s

(1989, 1990) work. Gilson (1989) found that bank lenders are often responsible for

management turnover in financially distressed firms. Gilson (1990) reported a larger

influence of bank lenders over investment and financing policies of firms in distress,

especially if they are turnaround experts.


In order to assess the disciplining role of the new lender, I compared management

turnover (changes of CEO and Chairman) during bankruptcy between a sub-sample of

53 DIP firms that obtained new financing from pre-petition creditors and a sub-sample

of 54 DIP firms that obtained new financing from one of the top five banks (in terms of

DIP financing concession in the present study). The results (not reported) are quite

significant (p-value=0.026): on average, there are 35.8% changes in top management

when the DIP lender already has a relation with the debtor, as opposed to 64.8% when

we have a new lender. One could think that pre-petition lenders are better informed

about the profitability of the firm than new lenders. In this way, we would see better

firms obtaining new financing from pre-petition lenders and so the management

turnover would be smaller in these cases. I then compared the ratio of income to total

assets prior to filing for bankruptcy between a sub-sample of 38 firms that obtained DIP

financing from pre-existing creditors and a sub-sample of 32 firms where the lender was

one of the top five banks. The ratios are 1.4 and 1.6, respectively, and are not

significantly different from each other (p-value=0.552). These results seem to support

the disciplining function of a new bank lender with some DIP financing expertise during

bankruptcy.

                                                                                  28
D.   Bankruptcy venue and time in bankruptcy


The bankruptcy venue has been the subject of some discussions in the past. Weiss’

(1990) evidence suggests that it can actually pay the debtors to “shop around” and

choose the jurisdiction they think will be more favourable for them, like the Southern

District of New York, for instance. Betker (1995) argues that the venue of a case in New

York does not affect the distribution that equity gets, when other firm characteristics

are taken into account. Skeel (1998) talks about the district of Delaware and the

Southern District of New York. He says that in New York, the bankruptcy processes are

extremely slow as opposed to Delaware, where it takes the firms less time to emerge.

Delaware’s specialities are pre-packs and speed27. The coefficient of correlation between

a venue in New York and time in bankruptcy is significantly positive 19.4% (p-

value=0.001; N=284). In the case of a venue in Delaware, this correlation is also

significant, but negative: -28.9% (p-value=0.000; N=284). If I consider traditional

Chapter 11s only, the time in bankruptcy in Delaware is significantly smaller than in

the other bankruptcy venues (mean=457.3 days in Delaware and mean=656.1 days in

other venues, p-value=0.019; median=420.5 days in Delaware and median=531.5 days

in other venues, p-value=0.009). Delaware is also faster for pre-packs, at least in terms

of medians (mean=82.9 days in Delaware and mean=116.8 days in other venues, p-

value=0.188; median=42.0 days in Delaware and median=73.0 days in other venues, p-

value=0.018).



E.   Determinants of DIP financing


The importance of obtaining DIP financing has already been established. But what are

the factors that influence the concession and size of DIP financing? Table XI presents

                                                                                   29
the results of two regressions. The first one is logistic and tries to assess the

determinants of DIP financing. The second one is OLS and explains the magnitude of

DIP financing in proportion of the estimated total debt in terms of some relevant

variables.


In the logistic regression28, we can see that the more profitable a firm is, measured in

terms of the proportion of income and revenue in the total assets, the more likely it is to

obtain DIP financing. Equity committees, which can be viewed as a proxy for firm

solvency, as they are authorised only when equity has some value, seem to be more

abundant in Chapter 11s with DIP financing. This evidence supports Chatterjee et al.

(1998), who found DIP firms more profitable, and also some previous results in this

paper.


Pre-packs are negatively associated with DIP financing, as seen before. However, some

other qualitative values increase the probability of DIP financing. Changes of CEO

during bankruptcy are positively related with DIP financing, as previously discussed,

and so is the choice of Delaware as the bankruptcy venue. During the 80’s the New York

district was very popular amongst large debtors as the choice for the bankruptcy venue.

Skeel (1998) states that since the beginning of 1990, Delaware has surpassed New York

as the bankruptcy venue choice for large companies. Delaware is a “debtor-friendly”

district, as far as judges usually approve “first day orders” (use of cash collateral,

payment to employees and DIP financing) almost immediately, without holding a hearing

to give creditors an opportunity to respond. In fact, the coefficient of correlation between

a venue in Delaware and time to obtain DIP financing is -17.1% (p-value=0.074;

N=110)29. This fact is significant, especially because many firms that file for bankruptcy


                                                                                      30
in Delaware are domiciled (incorporated) there but do not necessarily have their

corporate headquarters in that state.


In the OLS regression, the size of DIP loans in terms of the estimated total debt

decreases with the total debt of the firm (given by its log-liabilities), and increases with

the profitability of the firm, measured by its current ratio and income as a proportion of

the assets.


When a firm has a large proportion of its assets encumbered, it should be more difficult

to obtain new financing once in Chapter 11, as this is essentially asset-based. The

negative coefficient for the proportion of secured debt in terms of fixed assets

corroborates this idea. Priming liens and a pre-petition lender granting the new

financing are positively associated with the size of DIP financing, and so is obtaining

new financing from one of the top five banks (in terms of total amount of DIP financing

provided in my sample). Activities that need larger amounts of DIP financing seem to be

manufacturing consumers and retail. This agrees with Chatterjee et al. (1998), who

found that the companies with DIP financing are mostly wholesale and retail firms, as

they need working capital to continue their activities.




                                    VI. Conclusion


Debtor-in-possession financing does seem to have a positive role in the bankruptcy

process. Its presence does not significantly affect recovery rates and deviations from

absolute priority, but when its size is considerable there is a positive impact on recovery

rates. This evidence, together with the fact that DIP financing contributes decisively

towards a successful reorganisation in Chapter 11, by lowering the probability of a

                                                                                      31
liquidation, explains the positive stock and bond price response found by Chatterjee et

al. (1998) and Dhillon et al. (1996). DIP firms show higher management turnover,

especially if the DIP lender has no pre-petition relation with the debtor-in-possession.

This fact is consistent with Gilson’s (1989, 1990) disciplining and monitoring role of the

new lender and contrasts with the findings of Chatterjee et al. (1998).


Judges should be more careful when agreeing to DIP financing. They should refrain from

hastening their (favourable) decision, as quick approvals have been shown to be

associated with liquidations.




                                                                                    32
                         Appendix A: Types of DIP financing


“Ordinary course” unsecured credit


Under Subsection 364(a) the Court may authorise the debtor to obtain unsecured credit

in the ordinary course of his business. This covers utilities, inventory, rent and freight

charges, but not debt service, buying a capital asset, unusually large purchases of

supplies or any advance of funds, under the supposition of either buying the debtor in

the event of a reorganisation plan or assisting in the liquidation of the business. This

claim will be treated as an administrative priority which is the lowest priority for post-

petition debt, and is usually confined to trade suppliers. If the debtor wants some credit

out of the ordinary course of his business, Subsections 364(b), (c) or (d) should be seen

instead.



Credit outside the “ordinary course”


Under Subsection 364(b) the debtor-in-possession is authorised to obtain unsecured

credit outside the ordinary course of his business, unless the Court orders otherwise, to

the extent that the repayment can be a priority over any or all administrative expenses.

In practice, lenders will always seek protection for their claims beyond the

administrative priority, and so they will attempt to proceed under the following sections.



Secured post-petition credit


In case the company cannot obtain new financing as an administrative priority, the

Court can then grant additional protection in the form of a lien on collateral of the




                                                                                    33
debtor. The debtor has to present a record demonstrating that alternative sources of

funding were sought. There are three possibilities for such protection:



a) Super-priority rights, under Subsection 364(c)(1) of the Code, meaning it has priority

  over administrative expenses and pre-petition unsecured claims; it grants a first

  claim on the proceeds of all unencumbered assets and also on the residual proceeds

  from the liquidation of assets with pre-existing liens (usually, a carve-out for a limited

  amount of legal fees is provided).


b) Lien on unencumbered assets of the debtor, under Subsection 364(c)(2) of the Code,

  not subject to pre-petition liens. This option is seldom used as far as, by the time a

  debtor files for Chapter 11, he usually has few remaining unencumbered assets.


c) Junior lien, under Subsection 364(c)(3), on property already encumbered. This

  approach is used only if there is substantial equity or as a supplement to other

  sources of repayment considered in Section 364 of the Code.


Priming liens


In case the debtor has a fully liened balance sheet, i.e. a high level of encumbered

assets, obtaining debtor-in-possession financing might be difficult, because of lack of

protection afforded to the lender. However, it is still possible to get new financing under

the provisions of Subsection 364(d) of the Bankruptcy Code. The existing lien-holders

may then be primed (effectively subordinated) to new debt, if and only if they are

adequately protected, providing there is substantial equity in the collateral. As Fitch

Research (1991) points out, adequate protection, however, does not require timely

payment of such creditors. This new lien - the priming lien or super-priority lien - is


                                                                                      34
then equal or senior in priority to the existing liens on those assets. The debtor bears

the burden of proof on this matter: he has to prove that the secured creditor is over-

secured, and so he will not be harmed by his position being subordinated in this way.

Another possibility can be the provision of adequate protection by giving liens on

different assets, or even paying current interest.




                                                                                  35
                 Appendix B: The ranking of claims in bankruptcy

Upon the emergence from bankruptcy, claims get satisfied according to their rank in the

hierarchy. Gilson (1995) presents the relative position of all claims in the queue for the

distribution of the firm value.


1. Secured claims


2. Super-priority claims


3. Priority claims


            Administrative expenses
            Wages, salaries or commissions
            Employee benefit claims
            Claims against facilities that store grain or fish produce
            Consumer deposits
            Alimony and child support
            Tax claims
            Unsecured claims based on commitment to a federal depositary institutions
            regulatory agency

4. General unsecured claims


5. Preferred stock


6. Common stock




                                                                                    36
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                                                                                  37
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                                                                                 38
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                                                                                      39
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                                                                                 40
Endnotes



1   However, because they considered larger loans than I did, there were not many cases

where obtaining a small amount of DIP financing or not getting anything at all would not

make much difference in terms of the abnormal returns of the securities of such firms.


2   In this paper a firm “reorganises successfully” when it emerges from bankruptcy with

either its independence preserved or is acquired or merged. The reason why mergers

and acquisitions are considered as a successful outcome is because the characteristics

of the claims settlement are more similar to those firms that organised independently

than to those that were liquidated.


3   R. H. Macy & Co., for instance, received an interim DIP financing of $60 million two

days after filing for bankruptcy, and two weeks later the Court approved its $600 million

DIP financing line; Wherehouse Entertainment, Inc., on the other hand, got its interim

financing of $30 million 50 days after the filing, and the final approval one month later.


4   The debtor-in-possession can also use the cash that is collateral for the secured

claims. Miller et al. (1990) say that the debtor has to prove that the secured parties’

interests in the cash are or can be adequately protected.


5   This study is contemporary to mine, and so we reached our conclusions independently.


6   However, they did not study pre-packs and non-prepacks separately, and so their

results may suffer from some sample bias (i.e. the sample of DIP firms may have

comparatively more pre-packs than the sample of conventional Chapter 11s).



                                                                                     41
7    This restriction conditions the results of my analysis to large publicly-traded Chapter

11s.


8   When a firm filed for Chapter 11 more than once, all its filings were treated separately.

My sample includes 15 “Chapter 22s”, i.e. 15 firms filed twice for Chapter 11 from 1986

to 1997.


9   It should be noted, although, that this procedure provides only a lower bound estimate

in the majority of the cases, as far as the options under consideration are essentially

American and not European. However, the absence of dividends until maturity makes

this point irrelevant.


10   The category “Equity” includes preferred stock, options, rights, warrants and common

stock.


11   The Bankruptcy Code provides a classification for the different types of creditors and

the treatment of their claims (see Appendix B and also Miller et al. (1990)).


12    If a class of creditors receives less than payment in full on its claim, the class is

impaired; in that case a plan of reorganisation cannot be confirmed over its objection,

except for a cram-down (see Subsections 1123(a)(2) & (3)). Subsection 1129(b) allows

cram-down as to any dissenting class, as long as the Court finds that the “non-

consensual plan” does not discriminate unfairly, and is fair and equitable, with respect

to each class of claims or interests that is impaired under, and has not accepted the

plan. In other words, the absolute priority rule holds for the dissenting class and for

more junior classes. In this way, the non-assenting class is forced to accept the



                                                                                       42
proceeds that it would have the right to, had the firm been liquidated instead.


13   The category “Options” includes options, rights and warrants.


14   The fair and equitable requirement mentioned in Subsection 1129(b) of the Code is

usually referred to as the absolute priority rule. Under this rule, a plan should be fair

and equitable even if unsecured classes of creditors do not realise the full value of their

claims, providing no class junior to them receives or retains anything on account of their

claims or interests. This rule is however qualified, as far as it only applies when there is

a class of claimants that is impaired under the reorganisation plan and has not

accepted it.


15   The time spent in reorganisation is measured from the filing date to the date that the

plan of reorganisation is confirmed by the judge of the bankruptcy Court, regardless of

the outcome.


16   For pre-packs: mean=133.1 (median=69.0) days for 22 DIP firms and mean=87.5

(median=46.0) days for 49 non-DIP firms, p-value=0.183 (0.274); for conventional

Chapter 11s: mean=601.7 (median=483.5) days for 86 DIP firms and mean=619.3

(median=494.0) days for 91 non-DIP firms, p-value=0.783 (0.761).


17   There is a significantly positive correlation of 62.7% (p-value=0.000; N=105) between

the amount of DIP financing and the size of the firm, given by its total assets, measured

at the year end prior to filing for Chapter 11. This suggests that larger firms are able to

obtain bigger amounts of DIP financing.


18   We should, note, however that in pre-packs there is a substitution of time spent in


                                                                                      43
Court by time spent negotiating prior to the filing, as documented by Tashjian et al.

(1996).


19   Smaller proportions made this comparison not significant at conventional levels.


20   The Court generally performs a test for the approval of cross-collateralisation clauses:

(a) the debtor’s business operations would not survive if it were not for the proposed

financing; (b) the debtor cannot obtain alternative financing on acceptable terms; (c) the

lender would not accept less preferential terms; (d) the proposed financing is in the best

interest of the creditors.


21   Chatterjee et al. (1998) also found that firms with DIP financing show a significant

larger probability of not being involved in posterior filings. In my sample of 135 firms

with DIP financing and 191 firms without DIP financing, seven DIP firms and eight non-

DIP firms filed for bankruptcy again, suggesting no meaningful differences in the

probability of subsequent filings for Chapter 11.


22   The overall accuracy of this logistic model is 90.8% , with 93.0% correct predictions

for firms that successfully emerged from bankruptcy and 82.5% correct predictions for

firms that were liquidated, with the optimal cut-off of 50% .


23   This logistic model has an overall accuracy of 91.2% , with 96.0% correct predictions

for firms that successfully emerged from bankruptcy and 70.6% correct predictions for

firms that were liquidated, using the optimal cut-off of 45% .


24   Curiously, obtaining DIP financing from top banks (in terms of total amount of DIP

financing in my sample - Chemical Bank, General Electric Capital Corp., CIT


                                                                                        44
Group/Bus Cred, Bankers Trust and Foothill Capital Corp.) does not make it more/less

likely for a firm to successfully reorganise. This shows that the reputation of the lender

does not influence the bankruptcy outcome for a DIP firm.


25   As pointed out before, one should note that this comparison may not be fair, as

Hothckiss’ sample might have some cases of DIP financing as well, and so the samples

are not necessarily independent.


26   CEO and chairman turnover before filing for bankruptcy are not significantly different

for my sample of bankrupt firms with and without DIP financing.


27   There is a high correlation of 35.2% (p-value=0.000; N=326) between a venue in

Delaware and pre-packs.


28   This logistic model has an overall accuracy of 70.4% , with 70.8% correct predictions

for firms with DIP financing and 70.1% correct predictions for firms without DIP

financing, using the optimal cut-off of 40% .


29   New York displays an insignificant positive correlation of 10.8% (p-value=0.264,

N=110).




                                                                                     45
                                            Table I: Time-series distribution of bankruptcies by filing date

Firm bankruptcies by year and bankruptcy outcome. The figures are based on 135 Chapter 11s with DIP financing, 191 Chapter 11 s without DIP financing and 63
unknown or pending cases. The sample period is from January 1986 to December 1997.


           Years       Independence      Acquired or merged Liquidated in        Converted to        Dismissed         Sub-total       Unkn/    Total
                           preserved                         Chapter 11            Chapter 7                                          Pending
                      DIP        Non-DIP   DIP     Non-DIP  DIP     Non-DIP    DIP      Non-DIP    DIP     Non-DIP   DIP    Non-DIP
            1986        1            -      -          -     -          -        -           -       -         -      1        0        1        2
            1987         -          1       -          -     -          -        -           -       -         -      0        1        2        3
            1988         -           -      1         1      -         3         -           -       -         -      1        4        0        5
            1989        1           8       -          -     -         6         -           -       -         -      1       14        4       19
            1990        8          13       1         2      -         3         -          2        -         1      9       21        2       32
            1991        15         28       1         5      4         7         1          1        -         -     21       41        8       70
            1992        10         24       1         2      2         7         -          2        1         -     14       35        2       51
            1993        12         18       6         4      -         4         -          2        -         -     18       28        4       50
            1994        10          8       1         2      4         3         3           -       -         -     18       13        2       33
            1995        13         10       6         1      4         3         -           -       1         -     24       14        6       44
            1996        12          9       4         1      3         1         2           -       1         -     22       11        9       42
            1997        5           6       1          -     -         3         -           -       -         -      6        9        23      40
            Total   87 (65%) 125 (66%) 22 (16%) 18 (9%) 17 (13%) 40 (21%)     6 (4%)     7 (4%)   3 (2%)    1 (0%)   135      191       63      389




                                                                                                                                                         46
                                                 Table II: Distribution of bankruptcies by type of filing

Firm bankruptcies by type of filing and bankruptcy outcome. The figures are based on 135 Chapter 11s with DIP financing and 1 91 Chapter 11s without DIP
financing. The sample period is from January 1986 to December 1997.


               Type of      Independence      Acquired or merged   Liquidated in      Converted to      Dismissed           Sub-total      Total
                filing        preserved                             Chapter 11         Chapter 7
                            DIP     Non-DIP     DIP     Non-DIP    DIP     Non-DIP   DIP     Non-DIP   DIP   Non-DIP   DIP       Non-DIP
            Voluntary
              Pre-pack      15       40         6         6         -        1        1        -       -        -      22          47      69
              Non-Prepack   66       65         14        12       17        34       5        7       3        1      105         119     224
              Total         81       105        20        18       17        35       6        7       3        1      127         166     293
            Involuntary
              Pre-pack       1        3          -         -        -        -        -        -       -        -       1           3       4
              Non-Prepack    5        17         2         -        -        5        -        -       -        -       7           22      29
            Total            6        20         2         0        0        5        0        0       0        0       8           25      33




                                                                                                                                                     47
                                                             Table III: Financial ratios and other characteristics

  Selected characteristics at year end prior to filing for Chapter 11, in successful reorganisations. A firm reorganises successfully when it emerges from bankruptcy
  with either its independence preserved or is acquired or merged. The figures are based on 135 Chapter 11s with DIP financing and 191 Chapter 11s without DIP
  financing. The sample period is from January 1986 to December 1997. P-values are shown in brackets.


  Bankruptcy        Current assets         Total assets           Face value             Face value             Revenue             Income a        Equity committee         Time in
                          over                 over                    of                      of                  over                over             appointed          bankruptcy
      outcome      current liabilities   total liabilities   long-term debt ($m)    total liabilities ($m)    total assets        total assets              (%)                (days)
                    DIP      Non-DIP     DIP       Non-DIP      DIP       Non-DIP      DIP        Non-DIP    DIP      Non-DIP   DIP       Non-DIP    DIP       Non-DIP    DIP      Non-DIP
Reorganisation       94         131       95          134        94         133        135          191      93          132     94          132     109          143     108         140
 Mean               1.4         1.2      1.2          1.1      339.0       264.3      726.7 1,052.970        1.4         0.9    -0.1        -0.2     20.2         9.8    506.3      433.2
                        (0.430)              (0.446)                (0.360)                 (0.219)              (0.000)             (0.081)              (0.025)             (0.184)
 Median             1.1         0.8      1.1          1.0       92.1        81.1      191.2        225.0     1.3         0.7    -0.1        -0.1      0.0         0.0    457.0      313.5
                        (0.030)              (0.259)                (0.432)                 (0.133)              (0.000)             (0.070)              (0.020)             (0.050)
  a   Income is Earnings Before Interest, Depreciation and Taxes (EBIDT).




                                                                                                                                                                                      48
                                                            Table IV: Characteristics of DIP lenders

DIP financing providers by amount, number of loans, average loan and number (%)a of liquidations. The figures are based on 124 Chapter 11s with DIP financing
from January 1986 to December 1997.


                                 DIP financing providers      Amount ($m)   Number of loans   Average loan ($m)   Number (%) of liquidations
                          Bank America Bus Cred                  220.000         2                110.000            0               (0%)
                          Bank of NY                             199.000         3                 66.333            0               (0%)
                          Bankers Trust                          605.000         5                121.000            1              (20%)
                          Chase Manhatan                         275.900         4                 68.975            1              (25%)
                          Chemical Bank                         4,586.000        10               458.600            0               (0%)
                          CIT Group/Bus Cred                    1,081.000        16                67.563            7              (44%)
                          Citibank                               225.000         2                112.500            0               (0%)
                          Citicorp USA, Inc.                     110.000         2                 55.000            0               (0%)
                          Congress Financial Corp.               204.973         8                 25.622            2              (25%)
                          First Nat Bank Boston                   69.000         3                 23.000            0               (0%)
                          Foothill Capital Corp.                 489.550         13                37.658            4              (31%)
                          General Electric Capital Corp.        1,439.000        10               143.900            1              (10%)
                          LaSalle National Bank                   25.000         2                 12.500            0               (0%)
                          Manufacturers Hanover Trust Co.        238.200         4                 59.550            1              (25%)
                          Wells Fargo                            202.000         2                101.000            0               (0%)
                          Secured Lenders                         70.800         4                 17.700            0               (0%)
                          Othersb                               1,130.300        30                37.677            6              (20%)
                          Unknown                                110.000         4                 27.500            1              (25%)
                          Total                                11,280.723       124                90.974            24             (19%)
a   In terms of the number of loans provided by each DIP lender.
b“Others” include BT Commercial Corp., Canadian Imperial Bank of Commerce, CIBC, Continental Bank, ITT Comm Fin Corp, LTCB Japan, Mellon Bank NA,
Morgan Guaranty Trust, National Bank of Canada, NCNB, Norwest Business Credit, Inc, Pittsburgh National Bank, Societe Genera le SA, Star Bank NA, Sterling
National Bank & Trust Co NY and Transamerica Bus Cred Corp.




                                                                                                                                                          49
                                                      Table V: Characteristics of DIP financing by type of filing

DIP financing and its importance in terms of some selected characteristics. Total assets and total liabilities are measured at year end prior to filing for Chapter 11.
Estimated total debt and total distribution are measured at the time of the reorganisation. The figures are based on 135 Chap ter 11s with DIP financing from
January 1986 to December 1997.


Panel A: Pre-packs                                                                  Mean    Stand. deviation   Lower quartile   Median   Upper quartile   Sample size
DIP financing ($m)                                                                  54.9          54.4             17.0          35.0        85.0            19
DIP financing / Total assets (%)                                                    17.2          14.7              6.8          10.8        23.5            18
DIP financing / Total liabilities (%)                                               14.6          12.5              6.7           9.1        23.4            18
DIP financing / Estimated total debt (%)                                            21.2          15.0             10.2          17.2        33.1            12
Days until DIP financing                                                            42.1          80.9              1.0          21.0        30.0            17
DIP financing from pre-petition lenders (%)                                         63.2          49.6              0.0         100.0       100.0            19
DIP financing terminated or provider changed (%)                                      -            -                 -             -           -             19
DIP financing with priming liens or increased seniority of pre-petition loans (%)     -            -                 -             -           -             19
Panel B: Non-Prepacks                                                               Mean    Stand. deviation   Lower quartile   Median   Upper quartile   Sample size
DIP financing ($m)                                                                  97.5         255.4             15.0          35.0        80.0            105
DIP financing / Total assets (%)                                                    15.2          13.5              5.1          12.1        22.1            87
DIP financing / Total liabilities (%)                                               20.7          22.6              5.8          13.1        31.0            87
DIP financing / Estimated total debt (%)                                            29.8          46.2              6.4          19.2        37.1            60
Days until DIP financing                                                            85.7         186.8             21.5          34.0        57.0            88
DIP financing from pre-petition lenders (%)                                         39.0          49.0              0.0           0.0       100.0            105
DIP financing terminated or provider changed (%)                                    10.5          30.8              0.0           0.0         0.0            105
DIP financing with priming liens or increased seniority of pre-petition loans (%)    8.6          28.1              0.0           0.0         0.0            105
Panel C: Total                                                                      Mean    Stand. deviation   Lower quartile   Median   Upper quartile   Sample size
DIP financing ($m)                                                                  91.0         236.3             15.0          35.0        82.5            124
DIP financing / Total assets (%)                                                    15.6          13.7              5.2          11.3        22.2            105
DIP financing / Total liabilities (%)                                               19.7          21.3              5.9          11.5        24.5            105
DIP financing / Estimated total debt (%)                                            28.4          42.7              6.6          18.9        37.0            72
Days until DIP financing                                                            78.6         174.6             18.0          30.0        54.0            105
DIP financing from pre-petition lenders (%)                                         42.7          49.7              0.0           0.0       100.0            124
DIP financing terminated or provider changed (%)                                     8.9          28.5              0.0           0.0         0.0            124
DIP financing with priming liens or increased seniority of pre-petition loans (%)    7.3          26.1              0.0           0.0         0.0            124




                                                                                                                                                                    50
                                              Table VI: Recovery rates by type of filing in bankruptcy reorganisations

Percentage recovery rates for each claimant classa, by type of filing, in successful reorganisations. A firm reorganises successfully when it emerges from bankruptcy
with either its independence preserved or is acquired or merged. The figures are based on 72 Chapter 11s with DIP financing a nd 100 Chapter 11s without DIP
financing. The sample period is from January 1986 to December 1997. P-values are shown in brackets.


                                    Type of       DIP Fin.   Secured creditors     Unsecured creditors   Equity-holdersb     Equity-holdersb c
                                     filing         ($m)      DIP       Non-DIP      DIP      Non-DIP    DIP       Non-DIP    DIP      Non-DIP
                               Pre-packs             14        14           32       14           32      14           32     14          32
                                 Mean               39.1      94.0         93.3     43.2         68.8     6.3         12.0    1.8         3.3
                                                      -            (0.885)               (0.014)              (0.219)             (0.278)
                                Median              28.5     100.0       100.0      51.1         70.5     2.1          4.4    0.9         1.5
                                                      -            (0.548)               (0.024)              (0.333)             (0.264)
                               Non-Prepacks          58        58           68       58           68      58           68     58          68
                                Mean               120.9      93.1         89.4     49.1         49.2    12.0         24.9    5.7         7.6
                                                      -            (0.344)               (0.990)              (0.020)             (0.473)
                                Median              37.5     100.0       100.0      36.1         42.5     1.8          1.6    0.2         0.6
                                                      -            (0.227)               (0.752)              (0.420)             (0.461)
                               Non-Prepacksd         25        25           68       25           68      25           68     25          68
                                Mean               199.6      96.0         89.4     72.6         49.2    15.7         24.9    6.3         7.6
                                                      -            (0.078)               (0.050)              (0.161)             (0.705)
                                Median              75.0     100.0       100.0      68.3         42.5     5.1          1.6    0.7         0.6
                                                      -            (0.047)               (0.048)              (0.741)             (0.541)
                               Total                 72        72          100       72          100      72          100     72          100
                                 Mean              105.0      93.3         90.7     48.0         55.5    10.9         20.8    4.9         6.2
                                                      -            (0.401)               (0.212)              (0.019)             (0.518)
                                Median              35.0     100.0       100.0      36.8         53.0     1.9          2.9    0.3         1.3
                                                      -            (0.440)               (0.076)              (0.264)             (0.207)
aRecovery rates for each class are given by the amount received by all the creditors of that class divided by the estimated allowed claim at face value for that class.
Recovery rates for equity were obtained as a percentage of the ownership retained by pre-existing share-holders, after dilution.
b   “Equity-holders” include holders of preferred stock, options, rights, warrants and common stock.
c This column reflects a different metric for equity recovery rates: the percentage recovery rate for equity-holders is given by the proportion of their payments over the
total distribution to claimants.
d   The proportion of DIP financing in the estimated total debt is at least 20%.




                                                                                                                                                                       51
                                                 Table VII: Means of payment in bankruptcy reorganisations

Percentage of the total payments received by all stake-holders in the form of cash, debt, preferred stock, options a or common stock, in successful reorganisations. A
firm reorganises successfully when it emerges from bankruptcy with either its independence preserved or is acquired or merged. The figures are based on 72
Chapter 11s with DIP financing and 100 Chapter 11s without DIP financing. The sample period is from January 1986 to December 1997.


                                Claimants              Cash                Debt          Preferred stock        Options         Common stock
                                                 DIP       Non-DIP   DIP       Non-DIP   DIP      Non-DIP   DIP       Non-DIP   DIP       Non-DIP
                           Secured creditors      67          88      67          88      67         88      67          88      67          88
                             Mean                31.4       23.3     58.6        66.6      -         0.6     0.1         0.0     9.9         9.5
                                                      (0.176)             (0.228)               -                (0.585)             (0.922)
                             Median               9.9         2.4    76.0        87.2      -         0.0     0.0         0.0     0.0         0.0
                                                      (0.267)             (0.318)               -                (0.996)             (0.607)
                           Unsecured creditors    71          99      71          99      71         99      71          99      71          99
                            Mean                 31.8       36.0     16.5        29.8    2.7         1.4     1.3         1.3    47.7        31.5
                                                      (0.487)             (0.009)            (0.357)             (0.981)             (0.006)
                             Median              18.3       13.7      0.0         6.6    0.0         0.0     0.0         0.0    46.1        10.8
                                                      (0.660)             (0.036)            (0.213)             (0.140)             (0.007)
                           Total creditors        72          100     72          100     72         100     72          100     72          100
                             Mean                30.2       29.3     34.0        47.3    1.7         1.0     0.5         0.9    33.7        21.5
                                                      (0.870)             (0.006)            (0.506)             (0.478)             (0.003)
                             Median              17.1       12.4     25.9        49.7    0.0         0.0     0.0         0.0    30.5        14.1
                                                      (0.417)             (0.014)            (0.669)             (0.226)             (0.002)
                           Equity-holdersb        42          65      42          65      42         65      42          65      42          65
                             Mean                 1.0       10.0      3.4         0.7      -         1.9    43.3       12.9     52.4        74.5
                                                      (0.019)             (0.317)               -                (0.000)             (0.009)
                             Median               0.0         0.0     0.0         0.0      -         0.0    21.2         0.0    70.1       100.0
                                                      (0.047)             (0.332)               -                (0.000)             (0.012)
                           Total                  72          100     72          100     72         100     72          100     72          100
                             Mean                27.9       27.1     32.5        44.8    1.5         1.6     1.8         1.0    36.3        25.5
                                                      (0.854)             (0.010)            (0.935)             (0.326)             (0.008)
                             Median              16.1       11.6     25.0        46.1    0.0         0.0     0.0         0.0    34.9        18.0
                                                      (0.366)             (0.023)            (0.974)             (0.001)             (0.005)
a   The category “Options” includes options, rights and warrants.
b “Equity-holders” include holders of preferred stock, options, rights, warrants and common stock.




                                                                                                                                                                   52
                               Table VIII: Deviations from absolute priority by type of filing in bankruptcy reorganisations

Percentage deviations from absolute priority for each claimant class a, by type of filing, in successful reorganisations. A firm reorganises successfully when it emerges
from bankruptcy with either its independence preserved or is acquired or merged. The figures are based on 72 Chapter 11s with DIP financing and 100 Chapter 11s
without DIP financing. The sample period is from January 1986 to December 1997. P-values are shown in brackets.


                                              Type of      DIP Fin.    Secured creditors    Unsecured creditors   Equity-holdersb
                                               filing        ($m)       DIP       Non-DIP     DIP       Non-DIP   DIP       Non-DIP
                                         Pre-packs            14         14           32       14           32     14          32
                                           Mean              39.1       -1.6         -1.5     -0.2         -0.4   1.8          1.9
                                                               -             (0.882)               (0.899)             (0.969)
                                           Median            28.5       0.0          0.0      -0.2         0.0    0.9          0.9
                                                               -             (0.738)               (0.534)             (0.952)
                                         Non-Prepacks         58         58           68       58           68     58          68
                                          Mean              120.9       -4.9         -4.2     4.6          0.5    0.3          3.7
                                                               -             (0.803)               (0.206)             (0.080)
                                           Median            37.5       0.0          0.0      0.0          0.0    0.0          0.0
                                                               -             (0.357)               (0.295)             (0.303)
                                         Non-Prepacksc        25         25           68       25           68     25          68
                                          Mean              199.6       -1.9         -4.2     3.6          0.5    -1.7         3.7
                                                               -             (0.200)               (0.409)             (0.056)
                                           Median            75.0       0.0          0.0      0.0          0.0    0.0          0.0
                                                               -             (0.061)               (0.649)             (0.326)
                                         Total                72         72          100       72          100     72          100
                                           Mean             105.0       -4.2         -3.3     3.6          0.2    0.6          3.1
                                                               -             (0.653)               (0.156)             (0.089)
                                           Median            35.0       0.0          0.0      0.0          0.0    0.0          0.0
                                                               -             (0.533)               (0.473)             (0.322)
a   Deviations from absolute priority for each class measure the net dollar deviations as a percentage of the value of the securities that were restructured.
b   “Equity-holders” include holders of preferred stock, options, rights, warrants and common stock.
c   The proportion of DIP financing in the estimated total debt is at least 20%.




                                                                                                                                                                      53
                                                             Table IX: Determinants of successful reorganisations

Logistic regressions of the determinants of a successful reorganisation in Chapter 11. A firm reorganises successfully when it emerges from bankruptcy with either
its independence preserved or is acquired or merged. A firm has an unsuccessful reorganisation when it is either liquidated in Chapter 11 or its case is converted to
Chapter 7. The figures are based on 135 Chapter 11s with DIP financing and 191 Chapter 11s without DIP financing. The sample period is from January 1986 to
December 1997.


                                                      Independent variables                             Dependent variables (p-values in brackets)
                                                                                               Successful reorganisation (1)a Successful reorganisation (2) b
                             Constant intercept                                                            1.146                         -1.256

                             Log(Total liabilities)                                                        0.247                           0.749
                                                                                                          (0.069)                         (0.020)
                             Time to obtain DIP financing after filing for bankruptcy (days)                                               0.021
                                                                                                                                          (0.082)
                             Dummy DIP financing                                                           0.911
                                                                                                          (0.047)
                             Dummy Priming Liens                                                          -1.778                          -2.042
                                                                                                          (0.086)                         (0.059)
                             Dummy Pre-pack                                                                2.034                          12.526
                                                                                                          (0.003)                         (0.053)
                             Dummy Involuntary filing                                                      1.314
                                                                                                          (0.077)
                             Dummy New chairman during bankruptcy                                          2.150
                                                                                                          (0.036)
                             Dummy Equity committee                                                        2.131
                                                                                                          (0.009)
                             Dummy Trustee                                                                -3.786                          -3.447
                                                                                                          (0.000)                         (0.000)
                             R2                                                                           49.433                          50.560
                             Sample size                                                                    292                              91
a   Logistic regression for all the firms.
b   Logistic regression for DIP firms only.




                                                                                                                                                                  54
                                                   Table X: Management turnover by bankruptcy outcome

Management turnovera for firms that successfully reorganised or were liquidated in bankruptcy. A firm reorganises successfully when it emerges from bankruptcy
with either its independence preserved or is acquired or merged. A liquidation can occur in Chapter 11 or as a conversion to Chapter 7. The figures are based on
135 Chapter 11s with DIP financing and 191 Chapter 11s without DIP financing. The sample period is from January 1986 to December 1997. P-values are shown
in brackets.


                   Bankruptcy         New CEO             New CEO               New CEO          New Chairman        New Chairman        New Chairman
                                  before and during         during             right after      before and during         during             right after
                     outcome         Chapter 11          Chapter 11          Chapter 11            Chapter 11          Chapter 11          Chapter 11
                                   DIP       Non-DIP   DIP       Non-DIP   DIP        Non-DIP    DIP       Non-DIP   DIP       Non-DIP   DIP        Non-DIP
                 Reorganisation    109          143    109          143    109           143     109          143    109          143    109           143
                  Mean             34.9        18.9    25.7         9.8    21.1         12.6     19.3       14.7     12.8         6.3    18.3          8.4
                                        (0.009)             (0.001)              (0.078)              (0.362)             (0.087)              (0.025)
                   Median           0.0         0.0     0.0         0.0     0.0          0.0      0.0         0.0     0.0         0.0     0.0          0.0
                                        (0.002)             (0.001)              (0.070)              (0.350)             (0.075)              (0.019)
                 Liquidation        23          47      23          47       -             -      23          47      23          47       -             -
                   Mean            56.5        10.6    39.1         4.3                          17.4       10.6      8.7         2.1
                                        (0.004)             (0.003)                                   (0.603)             (0.312)
                   Median           0.0         0.0     0.0         0.0                           0.0         0.0     0.0         0.0
                                        (0.000)             (0.000)                                   (0.904)             (0.212)
                 Total             135          191    135          191    109          143      135          191    135          191    109          143
                   Mean            40.0        16.8    28.1         8.4    21.1       12.6       19.3       13.6     12.6         5.2    18.3         8.4
                                        (0.000)             (0.000)             (0.078)               (0.226)             (0.026)             (0.025)
                   Median           0.0         0.0     0.0         0.0     0.0         0.0       0.0         0.0     0.0         0.0     0.0         0.0
                                        (0.000)             (0.000)             (0.070)               (0.299)             (0.018)             (0.019)
a   Changes in CEO and Chairman.




                                                                                                                                                              55
                                                                Table XI: Determinants of DIP financing

Determinants of debtor-in-possession financing and of its magnitude in terms of the estimated total debt. The first regression is logistic and the second one is OLS.
The figures are based on 135 Chapter 11s with DIP financing and 191 Chapter 11s without DIP financing that reorganised as independent firms. The sample period
is from January 1986 to December 1997. P-values are shown in brackets.


                                        Independent variables                                Dependent variables (p-values in brackets)

                                                                                       DIP financing               DIP Financing / Estimated total debt (%)

                    Constant intercept                                        -0.465                                     18.779               (0.086)
                    Log(Total liabilities)                                                                               -3.523               (0.018)
                    Current assets / Current liabilities (%)                                                             0.042                (0.054)
                    Income / Total assets (%)                                 0.021                    (0.001)           0.279                (0.024)
                    Log(Revenue / Total assets)                               0.663                    (0.000)
                    Log(Secured debt / Fixed assets)                                                                     -3.657               (0.002)
                    Dummy Pre-pack                                            -0.839                   (0.022)
                    Dummy Priming Liens                                                                                  29.402               (0.004)
                    Dummy Pre-petition lender                                                                            8.570                (0.049)
                    Dummy Top 5 Banks that provided DIP financing                                                        13.717               (0.002)
                    Dummy New CEO during bankruptcy                           1.464                    (0.000)
                    Dummy Equity committee                                    0.764                    (0.083)
                    Dummy Bankruptcy venue in Delaware                        1.447                    (0.000)
                    Dummy Manufacturing-consumers                                                                        15.593               (0.009)
                    Dummy Retail                                                                                         7.515                (0.091)

                    R2                                                                    18.789                                   63.763
                    Sample size                                                            287a                                      54
a   Includes 113 firms with DIP financing (39.4% of the sample).




                                                                                                                                                                  56
   (A)                                              DIP
                                                    N=58
                                                    Mean=49.1
                                                    Median=36.1
                       Successful reorganisation
                       N=126                        P-Value Means=0.990
                       Mean=49.1                    P-Value Medians=0.752
                       Median=39.3
                                                    Non-DIP                     P-Value Means=0.328
                                                    N=68                        P-Value Medians=0.258
                                                    Mean=49.2
                                                    Median=42.5
   Non-Prepacks        P-Value Means=0.029
   N=147               P-Value Medians=0.010
                                                    DIP
                                                    N=5
                                                    Mean=28.9                   P-Value Means=0.043
                                                    Median=23.0                 P-Value Medians=0.037
                       Liquidation
                       N=21                         P-Value Means=0.982
                       Mean=28.7                    P-Value Medians=0.967
                       Median=14.1
                                                    Non-DIP
                                                    N=16
                                                    Mean=28.6
                                                    Median=11.7



   (B)                                              Successful reorganisation
                                                    N=58
                                                    Mean=49.1
                                                    Median=36.1
                       DIP
                       N=63                         P-Value Means=0.328
                       Mean=47.5                    P-Value Medians=0.258
                       Median=36.0
                                                    Liquidation                 P-Value Means=0.990
                                                    N=5                         P-Value Medians=0.752
                                                    Mean=28.9
                                                    Median=23.0
   Non-Prepacks        P-Value Means=0.738
   N=147               P-Value Medians=0.807
                                                    Successful reorganisation
                                                    N=68
                                                    Mean=49.2                   P-Value Means=0.982
                                                    Median=42.5                 P-Value Medians=0.967
                       Non-DIP
                       N=84                         P-Value Means=0.043
                       Mean=45.3                    P-Value Medians=0.037
                       Median=39.7
                                                    Liquidation
                                                    N=16
                                                    Mean=28.6
                                                    Median=11.7




           Figure 1: Recovery rates for unsecured creditors for DIP and Non-DIP firms


Percentage recovery rates for unsecured creditors by type of filing and bankruptcy outcome. A firm
reorganises successfully when it emerges from bankruptcy with either its independence preserved or is
acquired or merged. A liquidation can occur in Chapter 11 or as a conversion to Chapter 7. The values a re
given as a proportion of the total cases in each box. The figures are based on 63 conventional Chapter 11s
with DIP financing and 84 conventional Chapter 11s without DIP financing. The sample period is from
January 1986 to December 1997.
                                                                                                        57
58
   (A)                                             * DIP
                                                    N=87
                                                    Mean=48.1
                                                    Median=0.0
                     * Successful reorganisation
                       N=181                        P-Value Means=0.463
                       Mean=71.5                    P-Value Medians=0.463
                       Median=100.0
                                                   * Non-DIP                      P-Value Means=0.054
                                                    N=94                          P-Value Medians=0.054
                                                    Mean=51.9
                                                    Median=100.0
   Non-Prepacks        P-Value Means=0.000
   N=253               P-Value Medians=0.000
                                                    DIP
                                                    N=25
                                                    Mean=34.7                     P-Value Means=0.054
                                                    Median=0.0                    P-Value Medians=0.054
                     * Liquidation
                       N=72                         P-Value Means=0.000
                       Mean=28.5                    P-Value Medians=0.000
                       Median=0.0
                                                    Non-DIP
                                                    N=47
                                                    Mean=65.3
                                                    Median=100.0



   (B)                                             * Successful reorganisation
                                                    N=87
                                                    Mean=77.7
                                                    Median=100.0
                     ** DIP
                       N=112                        P-Value Means=0.000
                       Mean=44.3                    P-Value Medians=0.000
                       Median=0.0
                                                   * Liquidation                  P-Value Means=0.054
                                                    N=25                          P-Value Medians=0.054
                                                    Mean=22.3
                                                    Median=0.0
   Non-Prepacks        P-Value Means=0.010
   N=253               P-Value Medians=0.010
                                                   * Successful reorganisation
                                                    N=94
                                                    Mean=66.7                     P-Value Means=0.054
                                                    Median=100.0                  P-Value Medians=0.054
                     ** Non-DIP
                       N=141                        P-Value Means=0.000
                       Mean=55.7                    P-Value Medians=0.000
                       Median=100.0
                                                   * Liquidation
                                                    N=47
                                                    Mean=33.3
                                                    Median=0.0




                    Figure 2: Bankruptcy outcome for DIP and Non-DIP firms


Firm bankruptcies by type of filing and bankruptcy outcome. A firm reorganises successfully when it
emerges from bankruptcy with either its independence preserved or is acquired or merged. A liquidation can
occur in Chapter 11 or as a conversion to Chapter 7. The values are given as a proportion of the total cases
in each box. The figures are based on 135 Chapter 11s with DIP financing and 191 Chapter 11s without DIP
financing. The sample period is from January 1986 to December 1997. * and ** denote that the means and
the medians in the boxes in Panel A (B) are significantly different from the corresponding boxes in Panel C
(D) at the 1% and 5% level.
                                                                                                          59
(C)                                       * DIP
                                           N=22
                                           Mean=31.0
                                           Median=0.0
            * Successful reorganisation
              N=71                         P-Value Means=0.000
              Mean=97.3                    P-Value Medians=0.000
              Median=100.0
                                          * Non-DIP                     P-Value Means=0.574
                                           N=49                         P-Value Medians=0.585
                                           Mean=69.0
                                           Median=100.0
Prepacks      P-Value Means=0.000
N=73          P-Value Medians=0.000
                                           DIP
                                           N=1
                                           Mean=50.0                    P-Value Means=0.574
                                           Median=50.0                  P-Value Medians=0.585
            * Liquidation
              N=2                          P-Value Means=1.000
              Mean=2.7                     P-Value Medians=0.665
              Median=0.0
                                           Non-DIP
                                           N=1
                                           Mean=50.0
                                           Median=50.0



(D)                                       * Successful reorganisation
                                           N=22
                                           Mean=95.7
                                           Median=100.0
            ** DIP
              N=23                         P-Value Means=0.000
              Mean=31.5                    P-Value Medians=0.000
              Median=0.0
                                          * Liquidation                 P-Value Means=0.627
                                           N=1                          P-Value Medians=0.585
                                           Mean=4.3
                                           Median=0.0
Prepacks      P-Value Means=0.000
N=73          P-Value Medians=0.000
                                          * Successful reorganisation
                                           N=49
                                           Mean=98.0                    P-Value Means=0.627
                                           Median=100.0                 P-Value Medians=0.585
            ** Non-DIP
              N=50                         P-Value Means=0.000
              Mean=68.5                    P-Value Medians=0.000
              Median=100.0
                                          * Liquidation
                                           N=1
                                           Mean=2.0
                                           Median=0.0




           Figure 2: Bankruptcy outcome for DIP and Non-DIP firms (cont.)


                                                                                                60

				
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