Economically difficult times can lead to dwindling liquidity, potential covenant breaches and near-term maturities. Business managers may consider reorganization under chapter 11 bankruptcy over termination under chapter 7 bankruptcy.
Chapter 11 bankruptcy has a few benefits. Below is a review of the critical steps a business should take after filing for chapter 11 bankruptcy.
How to enter and exit chapter 11 bankruptcy
There are two groups to consider in a bankruptcy: debtors and creditors. Fortunately, the bankruptcy code protects both.
The company that files for bankruptcy is known as the debtor. There are two groups of creditors: pre-petition and post-petition. Each group is treated differently.
The process of declaring bankruptcy begins when the debtor files a petition in a bankruptcy court. Chapter 11 bankruptcy does not require the appealing company to have total insolvency, a situation where the total liabilities exceed the debtor’s assets.
Pre-petition creditors are compensated as directed by the court. Generally, the aim is to enable debtors to continue operations by offering ideal conditions for existing and new creditors. The bankruptcy court may prohibit the debtor from paying prepetition debtors outside the process. Post-petition creditors are protected under special provisions to encourage them to continue business relations with the debtor.
Goals of reorganization
The Bankruptcy Code prioritizes reorganization over liquidation. Ultimately, the code offers debtors a fresh start while ensuring that creditors are compensated. Also, stakeholders such as employees are protected in such issues as retaining their jobs.
Protecting the debtor’s estate
The debtor’s estate refers to the assets held by the company at the date of filing the bankruptcy petition. Possession of the assets is disregarded since some assets are in the hands of creditors. Particular provisions of the bankruptcy code protect the estate’s value.
The reorganization process under chapter 11 bankruptcy
First, the debtor can continue with their ordinary course of business. Approval from the bankruptcy court is required for decisions outside the ordinary course of business, such as seeking additional financing.
Secondly, the debtor restructures operations to return to solvency. The bankruptcy court approves the reorganization plan once creditors review and vote for it. The debtor can only propose a reorganization plan for a specific period. The court may accept reorganization plans from creditors when the debtor fails to make one in good time.
Priority of claim and the rate of recovery
The bankruptcy code requires creditors to be compensated fairly. Thus, creditors are placed in classes with varying priorities to determine the order in which they will receive payment.
Typically, debtor-in-possession (DIP) loans are paid first. The debtor then pays the first lien creditors, followed by the second lien ones. Priority administrative expenses are paid next, then unsecured loans. Equity holders are paid after this, starting with the ones with preferred equity.