How Chapter 11 helped save the economy

April 12, 2013 5:47 pm Published by

During the financial crisis of 2008, many companies in New York and across the United States benefited from Chapter 11 bankruptcy. Indeed, one Harvard Business School professor recently stated that Chapter 11 saved the U.S. economy. At one point during the financial crisis, a staggering $3.5 trillion in corporate debt was either distressed or in default. During 2008 and 2009, $1.8 trillion in public company assets entered bankruptcy under Chapter 11. As a result, financially troubled companies once thought to be on the brink of extinction were able to manage down their debt, restore their balance sheets and avert liquidation.

Chapter 11 bankruptcy helps distressed companies remain viable by giving them more options for raising cash. After filing for Chapter 11 bankruptcy, a company does not have to pay interest on pre-bankruptcy debts. It may reject unprofitable leases and renegotiate unfavorable supply contracts and collective bargaining agreements. Through debtor-in-possession financing, it is able to attract new lenders who are given priority in the capital structure over pre-existing creditors. It may then sell assets via a competitive, court-supervised auction.

While some have criticized Chapter 11 as being too slow and costly, the process has evolved and adapted to deal with large, complex cases. Many companies are opting for pre-packaged or pre-negotiated bankruptcies in which negotiated restructuring agreements are reached with creditors prior to filing. This helps to keep down the costs of bankruptcy while minimizing the problem of creditor holdouts through Chapter 11’s relaxed voting rules.

Bankruptcy may not be right for all companies. The companies that may benefit the most from bankruptcy are those that lease many of their assets, like commercial airlines or large retail chains, as well as those that have large unionized workforces. Financial companies that have significant debt under derivatives contracts, which is not frozen by bankruptcy, may choose to address their financial challenges in another way. Any company considering bankruptcy should first seek the advice of a skilled bankruptcy attorney in deciding whether to proceed.

Source: Forbes, “How Chapter 11 Saved the US Economy,” Kim Girard, March 25, 2013

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