Fixing Businesses Through Chapter 11 Bankruptcy Boosts the Economy, Says New Study

Despite the image and stigma associated with bankruptcy, financial reorganization of failing businesses (and nonprofit organizations) through Chapter 11 bankruptcy is actually helping the economy by giving companies a chance to find new financing, reject onerous contracts, renegotiate leases, and expedite the sale of assets.

Harvard Business School recently published an article reviewing comments made by Stuart C. Gilson, a Harvard business professor and advocate of Chapter 11 bankruptcies in his new book, "Creating Value Through Corporate Restructuring: Case Studies in Bankruptcies, Buyouts, and Breakups." Gilson believes that the first step is getting the public to realize that Chapter 11 is not about "dying companies," but about "reviving" them.

During the financial crisis of 2008, debt restructuring and Chapter 11 played a heroic role in reviving the US economy. Not only does it speed up a company's reorganization process, but it focuses in on what is necessary to "rehabilitate" the company rather than focusing solely on paying back creditors and stakeholders. (US bankruptcy laws differ from other countries in that they strive to restore the companies facing bankruptcy in order to make them viable and competitive rather than simply liquidating them.)

Restoring Chapter 11's Image

Chapter 11 was often seen as slow and expensive, however, it is emerging and evolving in a way that allows "managers and financiers to work with companies facing bankruptcies and deal with them effectively and appropriately."

For example, one of the ways Chapter 11 is evolving is through the use of the "prepackaged bankruptcy." A "prepackaged bankruptcy" combines the traditional notions of a Chapter 11 bankruptcy while incorporating "out-of-court" restructuring. Companies are able to negotiate restructuring plans with creditors to give them assurance that once they file the actual bankruptcy, the creditors all will be on the same page.

Allowing for prepackaged bankruptcies gives companies the flexibility and assurance from creditors that they will "vote for the restructure plan once the firm officially enters into chapter 11." By choosing this path, it allows companies a chance to "avoid the steep costs associated with spending [time] in bankruptcy court."

Another emerging frequent use of Chapter 11 is for a bankrupt company to sell its assets in a competitive auction that is supervised by the courts under Section 363 of the Bankruptcy Code. Companies who utilize this option can expedite the sell-off of their assets free and clear.

In addition to expedited asset sell off, Chapter 11 gives companies other options for generating income. During Chapter 11, the company pays no interest on any "pre-bankruptcy debts," they can "reject unprofitable leases" and "new lenders are given priority in the capital structure" using what is known as "debtor in possession financing" by new lenders gain super priority and stand ahead of pre-existing creditors. This priority encourages banks and other lenders to lend to companies in Chapter 11 rather than discourage it.

Should My Company Seek Advice From a Bankruptcy Attorney?

Chapter 11 is changing and becoming an integral part in saving US companies and the economy. If you feel your company or organization could benefit from filing for Chapter 11 it is advisable to speak with an attorney, and in particular an attorney familiar with bankruptcy practice in Maryland, Virginia and Washington, DC. An attorney will evaluate your company's situation and determine whether you would benefit from reorganizing. Additionally, an attorney will aid you throughout the process as well as assist you through the restructuring process to meet your goals.