FINANCING REORGANIZATIONS 1. Readjustment of capital account.—Any change in the plan of capitalization of an operating company is entitled a "readjustment of capital account." Suc cessful companies make such changes to remedy ex isting defects in the financial structure or to meet some new or unforeseen requirement of the business. This may be termed a recapitalization. Usually, however, such readjustments of the control, risk and income of the various stockholders and creditors follow a default or general insolvency, and constitute a reorganization of the company for the purpose of placing it upon a profitable basis.
Reorganization may be said to consist of the rehab ilitation of an insolvent business film the adoption of a new financial plan. Insolvency consists of ina bility to pay maturing obligations in cash. The busi ness may have a great excess of assets over liabilities, but if it cannot meet its obligations in cash, it is never theless insolvent.
2. Bankruptcy versus receivership.—Bankruptcy is the judicial settlement of debt, and involves wind ing up immediately the business of the debtor for the benefit of creditors. Receivership, on the other hand, is the judicial conservation and operation of property for the protection of creditors. It recognizes a state of temporary insolvency, but looks forward to a reor ganization which shall readjust or settle the claims of the various parties at interest without terminating the business. Receivership is a practical necessity where the business is insolvent and the value of assets depends primarily upon a continuance of operation, as in the case of railroads.
If the properties affected, or the parties at interest, reside in different states, the receiver is usually ap pointed by a Federal court in order to prevent con flicts of authority between state courts and inequali ties in the settlement of claims. A receiver is an agent or officer of the court, and he takes absolute pos session of the property and management of the busi ness subject to the policy and direction of the court. A receiver will not be appointed unless the court can be shown that there is an actual default and that a re ceivership is necessary to prevent loss or injury to creditors.
Under the receivership, the legal remedies of the individual creditors are set aside in order that equal justice may be extended to all. The receiver may affirm or disaffirm existing leases and may operate all of the properties or only part of them. Since the property usually comes into his hands badly run down, and the business short of working capital, he has the power, under orders of the court, to borrow upon receiver's certificates for the purpose of making needed repairs and financing efficient operation.
These certificates may take such priority over ex isting company debts, secured or unsecured, as the court may assign to them. In fact they may super sede all claims except taxes. Before the issue of such certificates is authorized, bondholders and other cred itors are given an opportunity to appear and plead for or against them. Then the court, being in pos session of full information, determines the size, tenor, priority, rate of interest and the selling price of the issue. They usually bear six per cent interest, mature in from two to five years, with right of redemption, and sell readily around par.
3. Receivership of industrial caution should be exercised by directors and owners in consenting to the appointment of receivers for indus trial companies. Stockholders usually have a better chance of reorganization under bankruptcy proceed ings, where they may bring the properties to imme diate sale and purchase them at a fraction of their operating values and free from debt. Usually a large part of the equity of the stockholders may be pre served in this way, as others are not likely to bid as much as the properties are worth to the stockholders. Of course, the stockholders must be able to raise the money to buy the plant in, and often they are able to do so when they could not secure outside support with which to rehabilitate the old company with all its debts.