How Investors Can Benefit From Financing Their Next Car

By Eric Jorgensen

Learn more about Eric on NerdWallet’s Ask an Advisor 

When buying a car, you have two options: take out a loan to finance the purchase or pay for it in cash. There are pros and cons for each approach, and as with any financial decision, it ultimately depends on what works best for your situation.

But one notable benefit of financing is that it frees up money for investing. So if you have good credit and plan to buy soon, while rates are low, financing your purchase could be the smarter move.

Lets look at how financing and investing could be more profitable in the long run.

How financing works

When you apply for a car loan, lenders will look at your credit score to determine how much of a risk you are as a borrower. The interest charged on the loan is driven by your credit score: The better your score, the lower the interest rate and the lower your payment. If you have an above-average credit score  — say, over 750 — it’s likely that you can get a very low interest rate; in some instances, it could be as low as 0%.

You also have to decide how long you want to make payments. Typically, the range is from three to six years, but it’s best not to go over five years. The longer you stretch out your payments, the lower the monthly payment will be — but note that longer terms can also carry higher interest rates.

Your monthly payment is also based on how much money you pay upfront as a down payment. For example, if you buy a $30,000 car with no money down, financed for five years at 3.5% interest, you can expect to pay approximately $550 a month. However, if you put $10,000 down and everything else stays the same, your payment would drop to approximately $370 a month.

So how much should you pay each month? (Note that I did not ask how much you could afford.) In reality, it’s best to keep your monthly payment below the amount you can technically afford based purely on your expenses and income. Just think of all the other costs of owning a car like maintenance, insurance, fuel and other expenses that may come up.

I recommend keeping car payments below 5% of your net income after taxes. As a financial advisor, the last thing I want to hear is that someone can’t save money because they are “car poor.”

Biggest benefit of financing: Investing

Paying cash requires disciplined saving in low-risk buckets — perhaps bond funds or high-yield savings accounts. To buy a $30,000 car, you’d need to save about $470 a month over five years, assuming a 3% rate of return, or $500 a month with a 0% interest rate. For many, that’s a pretty high amount considering other savings needs.

New cars depreciate quickly, some estimate by as much as 20% when you drive off the lot, 30% by the end of the year, and 50% within three years. It’s not a good idea to take a large amount of cash and sink it into an asset that is going to immediately lose value.

Today’s low-interest-rate environment makes financing, rather than paying cash, an attractive option.

Assume you have determined the amount you can spend each month and can purchase a car by putting down no money, or the bare minimum amount. This allows you to instead invest, or keep investing, the money you could have used as a down payment.

Using the above example: If instead of using it as a down payment, you invested $10,000 for five years at an average annual rate of 6%, your funds would grow to nearly $13,400, a potential $3,400 gain. If you used the $10,000 as a down payment on the car and then invested the $180 a month difference in your car payment ($550 $370) under the same conditions, your funds would grow to just about $12,400, a gain of $2,400 over the original down payment amount.

Note that when you invest, theres no guarantee that the market will do well and your money will grow. But the longer you keep your money invested, the better are your chances of seeing positive returns.

At the five-year mark, interest on the auto loan could cancel investment gains. However, if you withdraw $10,000 from your investment account for a down payment, youll forfeit any gains over five years and much more over your lifetime. During low interest rate environments, like the one we are currently in, it makes more sense to minimize the down payment and let your investments compound.

If you paid 100% cash, you miss out on the opportunity to invest and grow those funds and you’d have to build up new savings.

Drawbacks to financing
Interest

Besides the purchase price, the other cost to consider when you finance a car is how much money you’ll pay in interest over the years of your loan. With a five-year loan, no money down and a rate of 3.5%, you’re paying about $2,750 extra over the life of the loan, making the total cost of the car $32,750; this increases to about $6,900 at an 8.5% interest, making the total cost $36,900.

And note that if you are purchasing a new car before your old car is paid in full, in most cases you end up rolling your remaining debt into the new loan, increasing what you owe, and subsequently increasing the amount you pay each month. It also means there is the potential for a significant gap between the new car’s value (what you’ll get from insurance in the event of an accident) and what you owe. Say you buy a $30,000 car and you still owe $7,500 on your old car. This means you finance $37,500, but the best you can hope to be covered by insurance is $30,000.

Insurance costs

Also know that when you have a loan, you may be required to get complete auto insurance coverage, even for a used car that may not be worth it. When you own a car outright, you decide what amount and types of insurance to purchase. This means you don’t have an opportunity to decrease your monthly spending by purchasing insurance based on your needs rather than what the loan terms dictate.

Rate fluctuations

However, it’s also important to remember that interest rates won’t stay low forever. This means payments will be higher in the future and could make financing the more expensive option. And remember, if you don’t have a high enough credit score, you also won’t have the benefit of getting a low rate on your loan. In these cases, you will need to put more money down to drive the monthly payment down, making financing less attractive.

There are many variables to consider when deciding how to buy a car, and it ultimately depends on your situation and how much you can realistically afford. By financing your car and investing the amount you would have used as money down, you could potentially make more than if you pay part or all of it upfront. However, this only works if you actually invest the money and don’t spend it on something else.

Eric Jorgensen is a fee-only financial planner with MainStreet Financial Planning in Silver Spring, Maryland.

This article also appears on Nasdaq.

The not-so-cheap UK Personal Loans

The not-so-cheap UK Personal Loans
Personal_Finance / Debt Loans
Jun 20, 2016 – 10:07 AM GMT

By: MoneyFacts

Unsecured personal loans can be ideal for people who have debts to consolidate or who want to make a purchase with a fixed repayment plan. Its not surprising, therefore, that in the current low interest rate environment this type of finance is proving to be popular with many borrowers.

However, these loans are not always the best option, and the latest research from Moneyfacts.co.uk reveals that anyone looking to take out a smaller loan may be shocked by how much they will be charged in interest compared to alternative forms of borrowing.

What You Should Know About Caesars Enjoyment” s Claim Currently

Caesars Palace in Southern nevada, among Caesars Amusements.
flagship residential properties. Picture resource: Caesars.com.

The drama surrounding.
Caesars Amusement.

( NASDAQ: CZR) and also its legal fight with shareholders remains to.
progress. Although the presiding judge recently gave Caesars a.
trial expansion to proceed settlements, it looks as if completion.
of this expensive video game might be coming soon.

The result could possibly mean a personal bankruptcy declare Caesars.
Enjoyment, however if it doesnt, Caesars can be in a terrific.
place to dump most of its responsibilities as well as come back on track. Or.
rivals might pick up some excellent buildings if its forced to.
market them. Either way, it could be an interesting opportunity for.
capitalists.

Exactly how did Caesars enter this debt dilemma?

In 2008, 2 investment company purchased what was then called.
Harrahs in a leveraged buyout that swelled the now-private.
firms financial obligation to virtually $24 billion. That buyout occurred.
right before the 2008 financial accident, which left Harrahs with a.
debt-heavy annual report as well as inadequate leads moving forward throughout.
the economic downturn that complied with.

The firm presumed the name Caesars Enjoyment Corp. in.
2010 and also underwent an IPO in February 2012. Its destiny really did not.
enhance a lot after going public, however, as it uploaded bottom lines.
of $2.9 billion in 2013 and $2.7 billion in 2014, with over $28.
billion in total obligations. Administration began to caution of.
financial trouble in late 2014, and also in January 2015, it put its.
biggest subsidiary, Caesars Enjoyment Operating Co.,.
right into personal bankruptcy.

Great Caesars, Bad Caesars.

Caesars gradually began evasion possessions as well as obligations around.
its numerous subsidiaries starting in 2013, relocating most of the.
less desirable obligations to its subsidiary Caesars.
Amusement Operating Co. (CEOC) while transferring more.
beneficial as well as quality properties, such as the effective online.
gambling segment, to various other subsidiaries. When that begun.
happening, the writing was on the wall surface for a coming personal bankruptcy.
applying for CEOC, which then contained most of the most awful components of.
the company, in addition to much of its debt.

After putting CEOC right into an $18.4 billion Chapter 11 bankruptcy.
protection properly seeking to eliminate parent-company.
responsibility to numerous debtholders, which now were primarily.
huge and also effective hedge funds those detrimentally impacted by the.
step started strongly fighting the activities in court. The.
plaintiffs stated Caesars asset-shuffling developed an excellent Caesars.
that the company would certainly keep and also a bad Caesars that it would let.
declare bankruptcy.

In March of this year, a bankruptcy-court-ordered.
investigation ended with pungent comments about Caesars actions.
Not just did the file claim that the shareholders remained in reality.
damaged by Caesars activities and were most likely owed greater than exactly what.
the personal bankruptcy court initially asserted, yet it additionally discovered.
some unsavory activities from individuals overseeing the CEOC activities,.
such as text messages where elderly leaders essentially called.
CEOC useless while publicly proclaiming a prospective IPO.

Where points stand currently.

Former court Joseph J. Farnan Jr. has come on as an arbitrator to.
help browse arrangements with Caesars as well as its bondholders. In.
its latest effort toward negotiation, Caesars offered $4 billion.
in a structured offer that would repay senior loan providers as well as.
senior bondholders initially, and also junior shareholders with exactly what was.
left over. Those talks seemed to have damaged down as of June.
6, when.

The Wall Road Journal.

[registration needed] reported Farnan saying, I think that.
there is currently no possibility of product progress in the.
conversations in between the [Caesars] parties and also the noteholder.
committee..

The test was intended to begin in late June.

However, on June 15, the judge managing the case released an.
injunction that will certainly delay the situation up until Aug. 29, specifically.
to allow even more time for settlements. Caesars stock leapt almost.
10% on the news, possibly because investors have new hope that a.
settlement will be struck and also Caesars will certainly come out of this legal.
fight active.

If Caesars could prevent a personal bankruptcy.

If a settlement is accepted, or the judge in the event finds.
Caesars liable for an amount that it could deal with, the company may.
have the ability to continue its course of dumping financial obligation and also preventing total.
personal bankruptcy. If that takes place, Caesars still has plenty of.
residential properties as well as operations that could be very valuable going.
forward. With much less debt expenditure and new management, Caesars could.
be back on a development course, which could ensure its present stock.
cost, below its preliminary IPO rate, resembles a steal.

The business is absolutely confident regarding its very own future. In a.
current 8-K file, it stated it sees annual earnings increasing.
to $ 9.19 billion in 2017 and around $10.47 billion by 2020,.
with EBITDA climbing from $ 1.87 billion in 2017 to $2.43.
billion by 2020.

An interesting prospect.

However even if Caesars can not prevent this crushing financial obligation worry and.
eventually does go bankrupt, or is forced to begin selling some.
of its more than 50 properties worldwide to pay shareholders, that.
could possibly additionally be an interesting scenario for financiers. For example,.
if.
MGM Resorts International.

( NYSE: MGM) had the ability to acquire Caesars Royal residence on the Las Vegas.
Strip, helping MGM to proceed dominating the Strip, that could.
be an important play.

Caesars loyalty program, called Total amount Benefits, which keeps.
data on a reported 45 million consumers, would certainly also be unbelievably.
attractive to competitors. This and many various other lucrative assets.
were not in the initial for-sale plan when CEOCs bankruptcy.
started, but in a complete business personal bankruptcy, they most likely would.
be. So whether your home can win in this wager or not, its.
something for financiers to take a close eye on.

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present/gt;gt;.

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Pottsville attorney tries to move Mootz case forward

The family that once owned the former Mootz Candies in Pottsville is hoping its case against three of the contractors hired to build the city’s Union Station will go to trial in early 2017, the attorney for Mootz, Albert J. Evans, Pottsville, said Monday.

“We’re hoping we’ll have a trial date by the end of this year or the beginning of next year, or as soon as possible,” Evans said.

The Buckley family, who ran the landmark chocolate factory, claimed construction of the bus station in 2010 damaged the Mootz store at 220 S. Centre St. As a result, the store closed July 20, 2010. And, in January 2012, the family filed a $2,750,000 lawsuit in county court against those contractors.

On her behalf, Evans filed a “Motion for Scheduling Conference” in county court June 2.

The owner, Joseph E. “Ned” Buckley, died on Feb. 19, 2012, at age 54. And, recently, Buckley’s wife, Sharon J. Ege Buckley, Orwigsburg, filed for personal bankruptcy with United States Bankruptcy Court, Middle District of Pennsylvania, Harrisburg.

“To date, the defendants have conducted no deposition, despite knowledge of the involvement of several Mootz candy employees and Plaintiff Sharon Buckley. Given that this litigation commenced almost 5 years ago, and that the present counsel for the plaintiff has conducted numerous depositions over the past two years, with the defense failing to conduct any depositions, the plaintiff is legitimately concerned that the defendants failures to move forward with discovery will unnecessarily delay the resolution of this matter, to the plaintiff’s great prejudice,” Evans said in the motion.

“The closure of the Mootz candy business has left Plaintiff Sharon Buckley without income, and she has been forced to file for personal bankruptcy. A Bankruptcy Court hearing is scheduled for July 14, 2016, in response to creditors motions to lift the automatic bankruptcy stay and foreclose on her personal residence. Unfortunately, delays in resolution of the instant litigation will cause further prejudice, as Ms. Buckley’s ability to prevent foreclosure to her house in bankruptcy proceedings is dependent on the proceeds from the instant litigation,” Evans said in the June 2 motion.

“For these reasons, plaintiff is requesting that this Honorable Court Order that a Scheduling Conference be conducted,” Evans said in the motion.

Evans hopes a litigation schedule can be assembled in time to list the matter for trial in early 2017. On Monday, he said he hadn’t received a response from the attorneys representing the three defendants. He’s hoping the county court schedules a trial.

“One of the judges will have a hearing on our motion. And at that time the court will order a discovery deadline. It will be a local judge who will enter a scheduling order. Usually after 30 days we get a notice from the court,” Evans said.

Evans has received no response from the attorneys representing the contractors.

The prime contractor, William H. Lane, Binghamton, New York, is being represented by attorney Andrew B. Cohn, Blue Bell.

A subcontractor, HT Sweeney amp; Co. Inc., an excavator from Brookhaven, is being represented by Michael A. Boomsma, an attorney based in Lancaster.

Another subcontractor, Berkel amp; Co. Contractors Inc., a driller from Pasadena, Maryland, is being represented by Adam M. Sorce, an attorney from King of Prussia.

Those attorneys could not be reached for comment this week.

“And they haven’t tried to schedule Mrs. Buckley’s deposition or depositions for anybody at Mootz’s,” Evans said.

Once a landmark in the city, the former Mootz store at 220 S. Centre St. has remained vacant since it closed in July 20, 2010.

Evans said the Buckley family still owns it and is uncertain about its future.

More information about the case is available in the archives in the lower level of the Schuylkill County Courthouse, under file S-1521-2011.

Hillary Clinton Must Debunk the Notion That Donald Trump’s Wealth Qualifies Him for President

Without the wealth, however, Trump is no more than just another loud-mouth.

So Hillary Clinton must address and debunk this aspect about Trump. It is absolutely crucial. Clinton must present a clear and convincing case as to why Trumps vast riches do not qualify him to be president.

Clinton recently attempted to do just that. Disturbingly, however, she utterly failed. Clintons approach was to reference a past quote from Trump about how he had hoped the housing market would crash because then he could buy-up assets on the cheap and make a lot of money for himself. She attempted to shame him by saying that Trump selfishly cared only about his own personal profits and not about the millions of Americans who lost their homes in the crisis.

Clintons approach was a blunder. Trump shot right back by saying that as a businessman he knows how to identify opportunities for success even in bad situations, and that as president he would employ this skill for the benefit of ordinary Americans.

BAM! Trump hit it out of the park. Home run.

This is exactly why his supporters believe that Trump will be better for the nation than Clinton. It demonstrated to many people that Trump knows how to be successful, and that Clinton has no clue how to be successful.

Clinton has attempted some other approaches as well. She referenced that Trump had a few companies that failed and wound-up in bankruptcy, and she stated that therefore Trump as president would lead the nation into bankruptcy.

But again, this utterly misses the point. Trump is super rich. Trump has been tremendously successful. It doesnt matter that a few of his ventures failed. Overall, he has been spectacularly successful. And his success is on full display for everyone to see with Trump giving interviews from his gleaming penthouse apartment and flying around to campaign stops in his own massive jet. Clintons lame attacks seem to underscore her own inadequacy, and Trumps supremacy.

Clinton also attempted to ridicule Trump for his failed casino by asking rhetorically how anyone could possibly lose money running a casino. This just rings false and hollow. Trumps casino is surely not the worlds only example of a failed casino. In fact, the entire casino industry in Atlantic City has suffered grievously. This just makes Clinton seem as if she has no solid arguments against Trump, which makes Trump appear ever stronger.

Clinton must do better. Clinton must make the case as to why Trumps wealth does not qualify him to be president.

One potential argument seems apparent.

Lets ask ourselves, how, in fact, did Trump make his money? Did he invent a new product, say, the way Steve Jobs invented the iPhone? No. Did Trump create a new computer application to make life easier for millions of people, say, the way Bill Gates created Windows? No. Did Trump develop a new way for people to better communicate with each other, say, the way Mark Zuckerberg developed Facebook? No.

So what did Trump do? Well, Trump built or bought a handful of luxury real estate properties. Thats all. Nothing more than that. There is nothing particularly special or unique about Trumps properties. They are just luxury properties designed for wealthy people, some commercial and some residential, no different than all of the other luxury properties designed for wealthy people.

So if Trump did not do anything special, how did Trump become so wealthy? Simple. The market went up. Thats all. And Trump had absolutely nothing to do with that. Luxury real estate has skyrocketed in price, and Trump benefitted from it.

As further evidence of this, when the luxury real estate market went down in the late 1980s, so too did Trump. If Trump were the genius he proclaims, he would have foreseen this and avoided it.

Now, Trump bristles at the suggestion that he was bankrupt. His denials of bankruptcy led to an uproar of accusations that he was flat-out lying about it. In a half-truth, half-deception, Trump conceded that several of his companies filed for bankruptcy, but Trump boasted that he never filed for bankruptcy himself, personally.

While it is true that Trump never filed for personal bankruptcy, this assertion is highly deceptive. Trump himself even said so much. In a story that Trump appears to have told in many variations, Trump and Marla Maples, now one of his former wives, were walking down a New York City street and Trump pointed to a homeless man and said to Maples that this homeless man was worth $1 billion more than Trump. What Trump meant by this was that while the homeless man owned nothing at all, Trump was far worse off than the homeless man because Trump had incurred $1 billion more in debts than he owned in assets.

The reason Trump was spared from having to file a legal claim in court for his own personal bankruptcy was because the banks bailed him out with an emergency rescue loan package. The banks rescued Trump not to save him for any reason, but for their own benefit. If Trump had filed for personal bankruptcy, all of his assets would have been sold in a fire-sale auction and this would have depressed the prices and resulted in great losses to the banks.

So Trump is not any sort of a genius. When the market goes up, Trump goes up, and when the market goes down, Trump goes down. Thats all. Trump tells us how smart he is and how great he is, and this appears to be backed-up by his extraordinary wealth. But the reality is that Trump had very little to do with it. The art of the comeback? Thats a joke. There was no artfulness by Trump. The overall market is what came roaring back and Trump just so happened to be along for the ride by dumb luck.

Clinton could turn Trump into a prime example of all that is wrong in our economic system that has resulted in such drastically unfair wealth inequality. Trump is a guy who was born into wealth and privilege, he merely went into his fathers already established real estate business, and then, without doing anything extraordinary himself to benefit society, Trump became fabulously wealthy when income inequality took-off like a rocket for the benefit of the wealthy and at the expense of everyone else. When a cartoon character like Trump can become filthy rich without contributing much of anything to society, this proves that our system is in dire need of an overhaul.

But if Clinton fails to make the case as to why Trumps wealth does not qualify him for the White House, then we will all suffer through the reasons in real life under President Trump.

Wedbush Advises Investors To Tread Clear Of Alphabet Inc (GOOGL) And Twitter Inc (TWTR) Among Others

Wedbush tech team published a report of itsrecent findings regarding the top technology stocks. The list includes high profile stocks that have shown deteriorating fundamentals and are likely headed towards a slump.

Alphabet Inc. (NASDAQ:GOOGL) has reached a point of saturation, such is the beliefof Wedbushs tech team. According to the analysts, the risk associated with the stock, especiallyduring the 2H will be at its peak as the companys search monetization hits the peak. In the long term, the risk is largely associated with newly employed marketing strategies that may push consumers to look for alternatives. The positives for the stock is monetization improvement and ad growth on YouTube. However, concerns remain regarding emerging competition for YouTube from social media video platforms and TV networks going online.

Twitter Inc. (NYSE:TWTR) has been struggling for a while, and given its presence on the list, it most likely will continue to do so. The growth in advertisement remains nonexistent and part of it can be attributed to the degree of difficulty consumers face while using the service. The companys progress is sluggish and advertiser circles remainunconvinced.

Square Inc. (NYSE:SQ) is heading down a road that possibly ends from where it began. The company is working to establish a business that might never provide profitability. In addition, the SMB loan broker business remains a risky bet. There are some regulatory concerns on the horizon regarding the companys loans.

Workday Inc. (NYSE:WDAY) is on its way down thanks to a major deal that was broken in its core HCM business. The companys business model remains successful but the problem lies in fast fading number of consumers which may in part be due to Oracles aggressive selling tactics.

Groupon Inc. (NASDAQ:GRPN) is going to struggle in near term as it has gone under a process of restructuring and it will prevent growth for the next few quarters. The restructuring is likely to help in growth but near term prospects remain dull despite the fact that it is one of the top channels for brick and mortar stores to acquire traffic.

The analysts cautioninvestors to tread carefully when trading with above tickers as the risk associated outweighs rewards.

DBS Indonesia Sets Strategy to Push Fee-Based Income

“We are targeting a 50:50 portion between net interest income and fee-based income for the next three years,” Peter said.

DBS Indonesia now earns three quarters of its income from interests charged to debtors. The lenders net-interest income was recorded at Rp 603 billion in March this year, up 14 percent from Rp 529 billion in the corresponding period last year.

The banks fee-based income was at Rp 376 billion in March this year, up 13 percent from Rp 333 billion in the same period last year.

DBS Indonesias outstanding loans now stand at Rp 39.7 trillion, relatively unchanged from last year as demand for company loans has yet to recover.

The lender disbursed 80 percent of its loans to companies in the plantation, automotive, pharmaceuticals amp; chemicals, fast-moving consumer goods, food and beverage, and infrastructure sectors. The remaining portion of the loans are channeled to consumer business companies.

Appeals Court Denies Tilton’s Challenge to SEC Case

A federal appeals court in New York refused Wednesday to stand in the way of a fraud case that the US Securities and Exchange Commission brought against former distressed-company financier Lynn Tilton.

Ms. Tilton sought to raise a constitutional challenge to the SEC administrative securities fraud action, which focuses on the $2.5 billion collection of distressed company loans she controlled until recently.

The Second…

Bankruptcy 101 for Investors: Salvaging Your Investments from the Ruins of a Portfolio Company Bankruptcy

That intriguing little tech company in which you invested has just filed bankruptcy. Will you ever be able to recover any of that investment? Maybe. It depends upon the form of your investment. And because recoveries depend upon the form of the investment, you may want to consider how you document your investments in the future.

The harsh reality is that almost all businesses that file bankruptcy are insolvent in the most basic sense of that term: they have more debts than assets. This means that the asset pie is too small, and not everyone will be paid the amounts to which they are entitled.

Bankruptcy is a process designed to divide up that too-small pie among creditors and equity holders in the fairest way possible under the circumstances. All creditors and interest holders must file proofs of their claims or interests that document the basis for their right to distribution from the company, so that their claims may be allowed as valid both as to nature and amount of the claim.

For allowed claims, the Bankruptcy Code establishes a hierarchy for payments that takes account of contract rights, state law, and bankruptcy principles. Those at the front of the line secured and priority creditors have a decent chance of at least partial recovery. Those at the very end — equity holders — rarely receive anything.

But these allocations are not set in stone. In a chapter 11 case, the debtor and creditors are permitted to modify the treatment of claims, if the affected parties consent to the terms of a proposed plan of reorganization. So, if you think that the company has value worth fighting for (as opposed to simply writing off losses), then you may want to enter into negotiations with other constituencies in the case to try to improve your outcome.

The Front of the Line: Secured Claims

If you lent money to the company on a secured basis, good news: you probably will recover some amount. Secured creditors stand the best chance of achieving substantial recovery in bankruptcy, to the extent that their pledged collateral has value. If you are fully secured, you should be paid in full eventually. If you are undersecured, at least your secured portion should be paid, and you may recover something on account of the unsecured portion of your claim.

Typically, secured creditors have lent money to the company subject to a security interest in either real estate or other assets, such as receivables, equipment, or intellectual property. Under state law, a secured creditor has the right to foreclose on the asset and sell it to repay the debt. Bankruptcys automatic stay prevents foreclosures from proceeding, but in exchange, secured creditors are entitled to be repaid the equivalent value of their collateral and to retain their liens until that payment is made.

Bank lenders fit the classic stereotype of secured lenders, but private equity or individual lenders are increasingly commonplace. In addition to secured claims arising from loans, vendors may hold purchase money security interests in the goods or equipment they sold to the company.

Major Issues for Secured Creditors:

  • Value of the collateral: A loan may be secured by the companys headquarters building, but it is a secured claim for purposes of bankruptcy only to the extent of the current value of that real estate. In other words, a US$500,000 loan secured by a lien on a property now worth only US$400,000 will be treated as a US$400,000 secured claim and a US$100,000 unsecured claim for the amount of the debt that exceeds the collateral value.
  • Treatment: A plan of reorganization usually provides for repayment of secured claims over a period of years, during which the creditor will be paid interest at a specified rate. If you as a secured creditor expected payment at maturity on a three-year loan, you would probably be unhappy to find that the plan proposes to repay you over a ten-year period, especially if the plan proposes an interest rate substantially below that specified in your loan agreement.

Possible Responses:

  • Contesting valuation: A dispute about the fair market value of real estate or receivables will usually be resolved by the bankruptcy court based upon competing appraisals. More challenging, however, is the valuation of intellectual property, such as patents, copyrights or trademarks, which are often the only assets available to a tech start-up for securing a loan. If the IP hasnt yet generated any revenues, then valuation will essentially be speculative, although, whatever its value, the IP is probably the only asset of any material value. Such disputes are typically resolved by settlement, with the secured creditor allowing the other creditors a portion of the value, whether that value is realized by sale or from revenues of the business after reorganization.
  • Contesting treatment: Debtors often provide for a protracted payment period for secured claims and a low interest rate because that combination means lower payments that leave some amount of net cash flow available to pay (or at least promise) to unsecured creditors. The Bankruptcy Code requires that secured creditors receive discounted stream of payments that at least equal the current fair market value of the collateral. If you want to contest treatment, you will need to file an objection to confirmation of the plan as well as vote against the plan. Contested confirmation hearings usually require evidentiary hearings, and are thus expensive. However, most such objections are settled by re-trading the deal embodied in the proposed plan.
  • Leverage: If you are willing to advance more money to the company as a DIP (debtor in possession) lender, so that it has the cash necessary to stay alive during the case, you may be able to increase your leverage over the plan process. DIP lenders are entitled to be paid in full, with interest and fees, ahead of even prepetition secured creditors. Some courts allow a roll-up of prepetition secured debt into the DIP loan for inventory and receivables collateral as it is used by the debtor, in effect elevating the status of the prepetition loan into the even higher priority of the DIP loan and insuring against any attack on the original loans validity or security. Moreover, if the company continues to lose money during the case, a DIP lender may effectively have a stranglehold on the case. Of course, it will also have sunk more good money into what may still be a black hole of need, but at least the company will be the DIP lenders very own money pit. This may make sense as a bet on the long-range value of the IP, but can be a highly risky proposition.

Lessons/Considerations for the Future:

  • Because of the likelihood of disagreements over the value of collateral, you should consider whenever possible seeking a blanket security interest covering all assets, rather than just one category. If you have a lien on everything, then other creditors cannot contend that the real value of the company lies in the assets to which your lien doesnt apply.
  • If your collateral is IP, be especially careful to take all necessary steps to perfect your interest by filing with the US Patent and Trademark Office, Copyright Office, and the state of incorporation. Otherwise, the creditors committee, acting on behalf of the unsecured creditors, may seek to invalidate your security interest. It is up to the creditor to assure proper recording.
  • A security interest granted within 90 days before the bankruptcy filing to provide additional assurances (usually after a payment default) to a previously unsecured creditor can be avoided and set aside on the grounds that the granting of the security interest gave an unfair extra edge compared with other unsecured creditors. However, the possibility of a challenge should not deter you; you should almost always seek such improvement in your position to provide better leverage in the event of bankruptcy. It is important to seek advice to structure such enhancements in a manner that offers the best possible defenses to any later attack.

The Middle of the Pack: Unsecured Claims

Unsecured creditors include bond or commercial paper lenders without collateral (or with insufficient collateral), trade creditors, employees, personal injury claimants, and other general creditors. By law, certain unsecured creditors have priority over others. Wage and benefit claims, tax claims, obligations for goods delivered on the eve of bankruptcy, and certain other types of claims are entitled to be paid before other unsecured claims, subject to statutory caps on the priority amounts. With the exception of pension claims in some cases, priority claims usually constitute a small percentage of the overall debt.

As an investor, you probably wont hold any priority claims. More likely, you may have made unsecured loans to the company or entered into other contractual arrangements that give rise to general, nonpriority unsecured claims.

A creditors committee will usually be appointed to represent the interests of unsecured creditors collectively. Typically, the largest non-insider unsecured creditors are selected, but the US Trustee seeks to have representation of the various types of claims, so appointments are not strictly by size. If you want to be active in the case and you are representative of a grouping of similarly situated claims, you can apply to be appointed to the committee. Partially secured creditors will usually not be considered. Bear in mind that members take on fiduciary responsibility to maximize recovery for all unsecured creditors as a group. These obligations might limit the strategies you would otherwise want to pursue in the case.

Major Issues for Unsecured Creditors:

  • Fraud claims against insiders: The committee or trustee often pursues claims for fraud, mismanagement, breach of fiduciary duty, or negligence against management or the directors, particularly where recovery on director and officer liability insurance is a possibility. Be aware that, if you have played a major role in the company, you may be among the targets for such litigation. On the other hand, if you are not a target, then you may benefit from any such recoveries as a member of the class.
  • Defending against claims objections and preference claims: In most larger chapter 11 cases and many chapter 7 liquidation cases, the committee or trustee will review the filed proofs of claim to determine whether the claim is well founded and the amount is accurate. If not, the committee or trustee will file an objection to claim and the creditor will have the ultimate burden of proving its claim against the debtor. The committee and trustee are also likely to sue unsecured creditors who have received payment on their accounts within the 90 days before the bankruptcy filing, just as creditors who received a late security interest might be sued. Many defenses exist. Most preference actions are settled.
  • Plan treatment: Plans of reorganization often separate various types of unsecured claims into different classes that will then receive different distributions under the plan. The Bankruptcy Code confers on debtors considerable discretion to create multiple classes of unsecured claims. Some classification limitations do apply. Most importantly, first, all claims in a particular class (or subclass) must be legally similar in character. Second, all claims in a class must be treated the same way. Third, between classes, any differences in treatment must not unfairly discriminate against one or more classes. As you might expect, the third requirement generates the most litigation.

Possible Responses:

  • If you are sued, whether on fraud allegations, objections to your claims, or preference actions, you will have to deal with the defense just as with any lawsuit. However, more options may exist for fashioning a settlement, as such disputes are often settled as part of the general horse-trading process to achieve a global resolution of the case under a plan that satisfies most creditors as essentially fair.
  • The flexibility of the similar claims and not unfairly discriminate standards offer considerable leeway for fashioning creative global settlements. Ultimately, however, particular creditors or classes of creditors upset with their treatment may be able to extract additional value by filing objections to the plan, which may prevent the debtor from achieving a consensual plan. Occasionally, such disputes lead to confirmation battles when the amount at stake justifies the extremely high cost of such litigation.

Lessons/Considerations for the Future: Unsecured lenders usually wish they held secured claims, but that is not always possible, especially if secured credit has already been maxed out. And trade creditors usually wish they had monitored their accounts receivable more conservatively to avoid undue exposure. In short, unless they supply an absolutely critical component for the debtors products, trade creditors individually dont have much leverage.

The Back of the Line: Equity Interests

In most cases, it is obvious from the outset that equity interests are entirely out of the money. Most plans simply wipe out old equity. Equity holders rarely find it worth participating in the case, with only a few exceptions as discussed below.

Major Issues for Equity:

  • Asserting equity value: Occasionally, initial estimates of asset value and outstanding claims indicate the possibility of a recovery for equity. In most cases, it will turn out to be an illusion, when later, more reliable data shows that the initial asset values have been overstated and claims understated. But if a material possibility of equity recovery exists, then the court may be willing to appoint an equity committee, in addition to the creditors committee. And in such cases, the debtor or trustee bears the additional fiduciary duty to maximize the value of the estate for the equity holders, not just the creditors.
  • Subordination of securities fraud claims: In the cases of publicly held companies, bankruptcy filings are often entangled with allegations of securities fraud, often with pending class actions as a major cause of the bankruptcy filing itself. In bankruptcy, unlike under state or federal securities laws, securities fraud claims are not treated like typical claims. Instead, Bankruptcy Code sect;510(b) specifically requires fraud claims seeking damages arising from the purchase or sale of securities to be treated as subordinate to the class of that security. So such damages claims are last in line behind the stock or other equity interest and therefore never have value in the bankruptcy case.
  • Tax and control issues: For tax pass-through entities, the recapture of depreciation as the result of a bankruptcy filing can be expensive, even if no equity value remains as of the time of filing. In some cases, equity owners are simply far more optimistic than creditors about the long term prospects for the company or its IP, and correspondingly loath to cede control.

Possible Responses:

  • Even a relatively attenuated argument of equity value will likely lead to some value left on the table for equity in the plan bargaining process. It is almost always cheaper to give equity the hope of some recovery in the future if the reorganized company performs better than expected.
  • The conflicting goals of securities law enforcement actions seeking forfeiture of corporate assets and the bankruptcy process sometimes offer leveraging options if the securities regulators are willing and able to go to bat for the victims of securities fraud.
  • It is possible for old equity to become the new equity even though creditors are not being paid in full. To do so, old equity must contribute substantial new value to the plan so that they can come out of the case still owning the equity. If enough new cash comes into the distributional pot, of course, creditors may be quite happy to allow old equity to emerge as the new owners. Alternatively, a third-party buyer with the participation of some old equity may take ownership through a reorganization plan, subject to full disclosure. Complicated rules govern the circumstances where old equity can emerge as the new owners.

Lessons/Consideration for the Future: If your investments are primarily in equity, you must be prepared for a complete loss in the event of a bankruptcy filing, unless you are willing to buy back the company from its creditors. If you also have a senior secured position, however, you may not care about your equity, as you may end up owning all or most of the assets or new equity on account of your secured claim.

Final Comments

The opportunity to cut deals about priority and treatment of claims and interests really only exists in chapter 11. Chapter 7 liquidations are governed by a relatively strict interpretation of priorities and proper treatment. If a feasible plan can be proposed, a case may be converted from chapter 7 to chapter 11 to make the deal possible through a plan.

Next in the series: Doing business through special purpose entities to limit bankruptcy risk.