Business Bankruptcy

Chapter 7

According to the U.S. bankruptcy code, the firm's management has the right to file under the liquidation procedure, chapter 7, or under the reorganization procedure, chapter 11. Creditors rarely file. In both procedures, all claims are stayed; that is, there are no interest or principal payments. There are only minor exceptions, for example, lease payments. Under chapter 7, a trustee sells all assets and shuts down the firm. The bankruptcy court appoints the trustee. Secured creditors have a right to claim a particular asset or its value. The remaining proceeds of the sale are divided according to an order called the “absolute priority rule.” First, administrative expenses of the bankruptcy process itself are paid. Second, claims of statutory priority, such as tax or rent claims, are served. Third, unsecured creditor claims, such as those typically made by trade creditors and holders of damage claims, are handled. Fourth, claims with an even lower priority are paid, such as those resulting from subordinated agreements. Shareholders receive the remainder, if there is any left over. Liquidation procedures in Germany, France, Sweden, and the United Kingdom are similar to chapter 7.

Chapter 11

Under chapter 11, incumbent managers usually remain in control. A trustee takes control only in cases of mismanagement or fraud. The management has the exclusive right to propose a feasible reorganization plan within 120 days and has another 60 days to obtain creditor approval. The court can and often does extend this exclusivity period. Under the usual procedure, all classes of creditors and shareholders have to approve the reorganization plan. The required voting margin of each creditor class is at least one-half in [Page 150]number of votes and at least two-thirds in face value of claims; for shareholders, it is at least two-thirds of all shares. In case one or more creditor classes do not agree, the court can still adopt the reorganization plan if it thinks that no debt class is worse off compared with liquidation (“cram down”). If creditors do not grant approval and the court does not adopt the plan, the creditors are allowed to offer a plan of their own. Should the judge not adopt the creditors' plan, the firm can be sold as a going concern or the assets are liquidated piecemeal. In the case of reorganization, new debt issued in bankruptcy receives superpriority. Interest continues to accrue on fully secured debt only.

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