From Debtor to Dynamo: The Power of Chapter 11

Chapter 11 is the part of the United States Bankruptcy Code which permits reorganization under US bankruptcy laws. Chapter 11 bankruptcy is available to all types of businesses, but is mainly used by corporate entities.

Chapter 11 of the United States Bankruptcy Code gets a lot of attention in the press, and rightly so because it has a wide-ranging impact that stretches way beyond the company filing for protection. A Chapter 11 can change an entire industry: when Chrysler declared bankruptcy, its suppliers had to suffer non-payment, which impacted their ability to supply parts to other auto manufacturers such as GM, which left GM in a weakened position. With Chrysler and GM in the infirmary, foreign manufactures can steal a march on the American auto industry.

Beyond suppliers and customers, another big group affected is employees, especially when pensions and stock options are at stake.

What makes Chapter 11 so powerful is that it changes all the rules, and a business that files for protection has a new set of rules for the way it deals with everyone from lenders to vendors. Losses can be reduced and assets can be protected.

The goal of a Chapter 11 filing is to provide creditors with an acceptable return, and to reorganize the company into a viable business. Traditionally this was a process of cutting costs, restructuring debt and renegotiating supply contracts, but increasingly Chapter 11 has evolved into a mechanism to protect and sell assets. Just take a look at the Chrysler example where after just 42 days the company sold most of its business to Fiat. This is quite different from the more traditional work-out which takes over a year to complete.

This trend to quick asset sales is often driven by lenders who tire of complex, extended work-outs, and it can sometimes benefit suppliers and employees by minimizing periods of uncertainty.

A Chapter 11 is a highly complex process and a company needs to call on the services of highly qualified specialists, the most important of which is a bankruptcy attorney. Everything that a company does in a Chapter 11 is subject to the United States Bankruptcy Code, which in turn has the authority to govern the process by the First article of the United States Constitution. An experienced attorney will know these laws, and their applications, inside out. A close second in importance is the accountant who will rise from bean counter to strategist during a Chapter 11 workout.

Because of the detailed work required in a Chapter 11 attorney fees tend to be massive. Let’s take a look at some examples…

After Lehman filed for Chapter 11 bankruptcy, declaring $639 billion in assets and $613 billion in debts, the job of debtor’s counsel went to law firm Weil, Gotshal & Manges. This New York-based based firm asked a federal bankruptcy judge to approve a $55.1 million payment for its work representing Lehman. Not bad work if you have the experience, and this is just the start as it is estimated that professional fees for lawyers, accountants and financial advisers in the Lehman case may reach $906 million.

Back in 2004, three years into Enron’s bankruptcy case, Weil Gotshall & Manges was paid $149.4 million in fees after requesting $164 million, and this was from a total of $760 million that was requested for advisors. The creditors in Enron got around 25 cents in the dollar.

Chapter 11 protection is not a complete get out of jail card, and debts not discharged include:

• debts for alimony and child support
• certain taxes
• debts for some educational benefit overpayments or loans made or guaranteed by a governmental unit
• debts for willful and malicious injury by the debtor to another entity or to the property of another entity
• debts for death or personal injury caused by the debtor's operation of a motor vehicle while the debtor was intoxicated from alcohol or other substances
• debts for certain criminal restitution orders.

The debtor continues to be liable for these types of debts to the extent that they are not paid in the Chapter 11 process.

As noted the goal of a Chapter 11 filing is to provide creditors with an acceptable return, and to reorganize the company into a viable business. If meeting this goal is unrealistic a Chapter 7 liquidation, or a surrender of assets to creditors, followed by an out-of-court workout, are the most common alternatives. Debtors can file for protection under chapters 7, 9, 11, 12, 13 and 15.

A case filed under chapter 11 of the United States Bankruptcy Code is frequently referred to as a "reorganization" bankruptcy.