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M.B.A. II Year – 2011‐12
Elective Subject

BA6036 - STRATEGIC INVESTMENT AND

FINANCING DECISIONS

Unit V

UNIT V FINANCIAL DISTRESS 
Consequences, 
Issues, 
Bankruptcy, 
Settlements, 
Reorganization,
Liquidation in Bankruptcy. Reference 6 – 32.4

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TEXT BOOKS

1. Prasanna Chandra, Financial Management, 7th Edition, Tata McGraw Hill, 2008.
2. Prasanna Chandra, Projects : Planning, Analysis, Financing Implementation and Review,
10th Edition, Tata McGraw Hill, New Delhi, 2009.

REFERENCES

3. Bodie, Kane, Marcus : Investment, Tata McGraw Hill, New Delhi2002.

4. Brigham E. F & Houston J.F. Financial Management, Thomson Publications, 2003.
5. I. M.Pandey, Financial Management , Vikas Publishing House, 2003. – 10th Edition
6. M.Y.Khan and P.K.Jain, Financial Management Text and Problems, Tata McGraw Hill.
Publishing Co, 2003. – 5th Edition

Additional References
7. Security Analysis and Portfolio Management – Punithavathi Pandian
8
8. M.Y.Khan
M Y Khan and P.K.Jain,
P K Jain Financial Management Text and Problems,
Problems Tata McGraw Hill
Hill.
Publishing Co, 2003. – 6th Edition
9. Financial Management – E.Gnanasekaran- Second Edition Feb 2010

Prepared By S.Nagarajan / Professor / MBS 
3
/ Sudharsan Engineering College

Financial Distress

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

Definition of Terms
• Default • Financial Distress
– FFailure to meet an 
il t t – IIncludes default and 
l d d f lt d
interest payment, or bankruptcy, but also 
– Violation of debt  – Threat of default or 
agreement bankruptcy and its effect 
• Bankruptcy on the company
– Formal procedure for 
p – Defined to capture the 
working out default costs and benefits of 
db f f
using large amounts of 
– Does not automatically  debt finance
follow from default.

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Insolvency
• Stock‐base insolvency; the value of the firm’s assets is 
less than the value of the debt.

Solvent firm Insolvent firm

Debt Debt
Equity
Assets Assets

Equity Debt

Note the negative equity

Insolvency
• Flow‐base insolvency occurs when the firms cash flows are 
insufficient to cover contractually required payments.

Cash flow
shortfall
C t t l
Contractual
obligations
Firm cash flow

Insolvency time

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What Happens in Financial Distress?

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

What Happens in Financial Distress
No financial
restructuring
49%

Financial Private
distress workout
47%
51%
Financial Reorganize
restructuring and emerge
83%
53%
Legal bankruptcy 7% Merge with
Chapter 11 another firm

10%
Liquidation

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

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

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Liquidation Value
Liquidation value represents the price at which each individual asset can be sold if
business operations are discounted in the wake of liquidation of the firm.

In operation
p terms,, the liquidation
q value of a business is equal
q to the sum ((i))
reliable value of assets and (ii) cash and bank balance minus the payments
required to discharge all external liabilities..

In general among all measures of value the liquidation value of an asset / or

business is likely to be the least.

Definition of 'Bankruptcy‘

A legal proceeding involving a person or business that is unable to repay

outstanding debts.

The bankruptcy process begins with a petition filed by the debtor (most common)
or on behalf of creditors (less common).

All of the debtor's assets are measured and evaluated, whereupon the assets
are used to repay a portion of outstanding debt.

Upon the successful completion of bankruptcy proceedings, the debtor is

relieved of the debt obligations incurred prior to filing for bankruptcy.

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Financial Distress – Laws Governing in India

What is BIFR ?

CHAPTER I: GENERAL FRAMEWORK OF INSOLVENCY LAWS IN INDIA

CHAPTER II: A FRAMEWORK FOR REHABILITATION OF COMPANIES
CHAPTER III: ASSET RECONSTRUCTION: SARFAESI ACT, 2002
CHAPTER IV: CORPORATE DEBT RESTRUCTURING
CHAPTER V: ENFORCING CREDITORS’ RIGHT
CHAPTER VI: WINDING UP OF COMPANIES
CHAPTER VII: DEALING WITH DEFUNCT COMPANIES
CHAPTER VIII: REFORMS IN INSOLVENCY LAWS AFFECTING THE
CORPORATE SECTOR

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