Chapter 11 bankruptcy is also called reorganization bankruptcy. Chapter 11 is one of six types of bankruptcy, and its distinguishing feature is that it’s all about restructuring a firm’s liabilities, its debts and obligations.
First, a bit of accounting.
Balance sheet assets minus liabilities equals equity.
The assets of a company are all the resources that it owns that could be sold to satisfy claims. Its liabilities are its debts and obligations to third parties. Equity is the ownership interest in the company.
The shareholders’ equity represents the owners’ stake in the business, the portion of assets that remain after liabilities are subtracted from them.
Bankruptcy is all about one’s liabilities, one’s debts and obligations. It’s about the claims creditors have against the firm, the debts one owes them and the obligations one is bound to carry out.
Chapter 11 is often quite useful to companies and their creditors. With Chapter 11, a company can renegotiate and reorganize its debts so it can continue operating as a business. In some cases, this makes the company more profitable.
For many people, the word bankruptcy conjures up thoughts of Chapter 7 liquidation and the failure of businesses and individuals, but Chapter 7 is only one kind of bankruptcy, not bankruptcy as a whole. We’ll go through each of the six types.
The other five chapters of the Bankruptcy Code are Chapter 7, 9, 12, 13 and 15.
Restructuring banking is completely different from mergers and acquisitions.
Sometimes called “Rx banking,” restructuring banking helps companies repair themselves by renegotiating or restructuring their debt (Chapter 11 bankruptcy is an example). Mergers and acquisitions is about adding to a firm.
It may seem there’s no recovering from financial distress. But companies do.
Forms of Bankruptcy Covered by the U.S. Bankruptcy Code
Besides Chapter 11, you should also be familiar with the other five forms of bankruptcy covered by the U.S. Bankruptcy Code.
A “chapter” is actually just the title of the section in the U.S. Bankruptcy Code.
Chapter 7 is the most common kind, but if you hope to work in finance or an accounting related field, you should know them all.
Chapter 7 is called liquidation bankruptcy. The term “liquidation” means the assets of a debtor will be sold off to pay creditors.
Under Chapter 7, the business ceases operations, closes its doors, and goes out of business.
A court must find that the debtor does not earn enough to repay its debt.
Chapter 7 is the ”last resort” bankruptcy. Chapter 7 is for when the business can’t survive in any form.
All existing lenders and creditors have first priority. Shareholders must wait at the end of the line. The U.S. Trustee handles liquidation.
A full liquidation makes sense when the company has little reliable cash flow and will probably require injections of capital later.
Examples include Circuit City, Aloha Airlines, and MC Sports.
In Chapter 7, we see stores putting up “going-out-of-business” signs and selling off their inventory.
Chapter 13: paying it back over time
Chapter 13 bankruptcy is designed for individuals rather than businesses.
The debtor develops a plan to repay creditors over a three- to five-year period.
In Chapter 13, debtors propose a repayment plan to make monthly installments to creditors over 3-5 years.
Chapter 13 is very different from Chapter 7 because debtors do not liquidate their property under Chapter 13. For instance, Chapter 13 allows debtors to save their homes from foreclosure.
The size of each monthly payment is partly dependent on the debtors’ monthly income.
Municipalities are local governments within a state, such as cities and towns.
Chapter 9 is a form of bankruptcy which allows a municipality to restructure and reduce its debts.
A typical Chapter 9 plan will attempt to reduce the burden on the municipality through some combination of three things:
- (a) pushing off payments,
- (b) getting a new, better loan, or
- (c) refinancing at a lower rate.
No assets are liquidated.
Chapter 12: farmers and fishermen
Chapter 12 is an interesting form of bankruptcy reserved for “family farmers” and “family fishermen”.
Chapter 12 allows family farmers and fishermen to do what Chapter 13 allows individuals to do: borrow time. Chapter 12 works much like Chapter 13 but has more flexible terms and higher debt limits.
Chapter 11: reorganizing to survive
Companies usually choose Chapter 11 hoping to get the business back into the green zone of profitability. Chapter 11 is a way to get time to reorganize and then move the business in a new direction.
In Chapter 11, the business is being reorganized.
An investment bank helps structure and advise the debtor about the plan, but typically, it is the debtor who drafts the plan.
The company is trying to find the most promising recovery options it can.
Chapter 11 has four main steps, starting with restructuring operations by selling assets and assuming or rejecting contracts.
The paperwork behind a Chapter 11 filing
- Monthly reports showing cash receipts and disbursements.
- The court docket, which shows what has happened in court since the bankruptcy was filed.
- List of all professionals seeking fees and applications for their payment.
- DIP proposals for financing.
- List of all creditors.
- Debtor’s general explanation of why they’re seeking Chapter 11 relief.
After restructuring operations, a plan of reorganization is drafted. The plan calls for each interest holder to vote on the plan, and then, the bankruptcy court formally confirms it.
Chapter 15: when the case crosses borders
Chapter 15 is designed for bankruptcies involving debtors, assets, claimants, and other parties from more than one country.
Chapter 15 bankruptcy was created in 2005.
Chapter 15 allows foreign debtors to file for bankruptcy in a U.S. court.
Chapter 15 is a rarely used chapter.
DIP Financing
How debtor-in-possession financing works
Any company that has filed under Chapter 11 of the bankruptcy code is called a debtor-in-possession, or DIP.
DIP financing is financing you can get after you’ve filed for bankruptcy, but not before. The bank knows it’ll rank at the top of the ladder of capital, senior to almost all other lenders.
DIP is seen as relatively safe because the lender will get lots of collateral and strict loan terms.
For many companies, being able to draw from a DIP credit line is one of the best perks of Chapter 11.
Chapter 11 and DIP financing allow a company to continue operating during the bankruptcy.
The whole point of Chapter 11 is to emerge from bankruptcy, and the access to DIP capital alone helps increase the odds of getting there.
The availability of DIP financing also gives a signal to the business’s vendors, suppliers, creditors and customers that it has a way to pay for goods and services.
Rx Banking
Restructuring (or Rx) banking is one of the most niche, most misunderstood corners of banking.
Yet, it’s one that many college students in the U.S. find attractive.
Rx banking requires creativity, and much of it requires looking for the cheapest long-term fix.
One example: swapping notes payable for a longer-dated secured instrument.
Restructuring work is generally done by specialists at boutique banks rather than by the big bulge bracket banks like Goldman Sachs, Morgan Stanley and J.P. Morgan.
The leading restructuring boutiques are:
- Evercore
- Moelis
- Lazard
- PJT
- Houlihan Lokey
Clients tend to want a sharper focus for bankruptcy work, and many companies won’t give a restructuring job to a firm that it’s worked with previously. This is because they want to avoid conflicts of interest.
Let’s say the restructuring is $500 million worth of the company’s debt, and that J.P. Morgan holds the debt. If the company does business with J.P. Morgan, they likely can’t call on the bank for restructuring advice. The company may want an independent adviser rather than one with a stake in the outcome of the restructuring.
The Rx banker’s mission is: (1) to help keep the company alive in the short run, and (2) to help it thrive under the new capital structure that will eventually emerge from the Chapter 11 filing.
One of the most important interview questions you may get will be: Does a distressed company always file for bankruptcy?
The answer is no, and it quickly shows who really understands Rx banking.
Chapter 11 work is only one part of the job for a Rx bank. Actually, a lot of the work is about helping the company avoid filing altogether.
Rx bankers hope to craft something that will hold for years.
Every company is different, but here are some things to look for:
- Not enough cash to operate
- Shares falling: equity is tanking (for public companies)
- Too much debt: high leverage, above the industry average
- Credit rating downgrades
Chapter 11 isn’t a sure bet. The odds of success aren’t great.
Here are five companies that came back from the brink.
Apple really was on the brink in 1997. Things had gotten so bad that rival Microsoft pumped $150 million into Apple, its longtime rival.
We often think of General Motors as “Government Motors,” especially after its government bailout.
Sbarro, the pizza chain, filed Chapter 11 twice, first in 2011, then again in 2014.
Six Flags filed for bankruptcy when it could not repay $2.7 billion of debt that was growing higher and higher.
Marvel Entertainment, the business that produced The Avengers series of movies, filed for bankruptcy in 1996.
About Delancey Street
Delancey Street is a premier, and award winning, business debt settlement company that helps business owners nationwide. Our goal is simple: help you escape debt in a safe and legal manner. Based out of New York, we can help in 49 of 50 states. We tell you how it is; because your business and future is on the line.
