- When a business files for Chapter 11 reorganization bankruptcy protection, its leaders hope to modify their operations and finances to correct the problems causing the necessity for bankruptcy. They are not asking to be liquidated (all assets sold) and receive a total discharge of existing debts. However, the debtor usually needs to control major company assets (real estate, equipment, computers, autos, and other assets) to manage the business. Therefore, the business becomes a debtor in possession of assets for which one or more creditors have a legal claim to recapture. These creditors must be given adequate protection that these assets will not be misused or destroyed.
- The function of adequate protection is to safeguard the assets in which creditors have rights. For example, a business in Chapter 11 bankruptcy has a store or office it owns, but on which a lender has a mortgage. Prior to the bankruptcy filing, the lender could have foreclosed on the property. Once a bankruptcy petition is filed, an "automatic stay" goes into effect. All collections activity must cease, including the suspension of the lender's typical rights to foreclose. However, the lender does have the right to receive adequate protection to ensure that this property is not sold, leased, or otherwise damaged.
- While the company is under the protection of the bankruptcy, creditors having valid security interests in assets needed to operate the business are normally barred from recovering these assets. Should the company successfully reorganize and return to profitability, it will be discharged from bankruptcy court oversight. At that time, creditors will again have all rights and remedies restored.
- Should the company in Chapter 11 not provide adequate protection to a secured creditor, the bankruptcy court may allow the creditor "relief" from the automatic stay provisions. This effectively removes bankruptcy protection from this asset and allows the creditor to take all legally allowed actions to recover the property in which it has a lien. To effectively reorganize the company, it behooves the business to provide the adequate protection the creditors deserve.
- The adequate protection provision offers benefits for both the company in bankruptcy and the creditors. Having the right to adequate protection of those company assets in which they have a security interest, creditors have a reasonable expectation of those assets maintaining their value at the time of the bankruptcy filing. The company receiving bankruptcy protection is expected to keep these assets working at their highest and best use. This typically helps the company reorganize successfully.
