The Effects of Chapter 11 Bankruptcy

Chapter 11 bankruptcy gives businesses a chance to reorganize.

Chapter 11 bankruptcy is usually filed by businesses. Under a Chapter 11 bankruptcy, a business attempts to reorganize under a plan approved by interested parties so that it can continue to operate. The rationale is that creditors will benefit more from the business continuing to earn income than from a sale of the company's assets. Chapter 11 bankruptcies affect many different stakeholders, including creditors, shareholders, bondholders, employees and even customers.

Effects for Creditors

Creditors are affected most immediately when a company files for bankruptcy. As a creditor, one of the things you fear most is that a company that owes you money will file for bankruptcy. In that event, you lose the immediate ability to go after debts owed to you, and you may not be able to go after them even in the future. Secured creditors take on the least risk because their interests are backed by a security interest in the company's assets.

Effects for Bondholders

Corporate bondholders are a certain type of creditor. These creditors have made an intermediate-to-long-term loan to a company in the hopes of getting regular interest payments. During Chapter 11 reorganization, bondholders will likely have the opportunity to vote on a reorganization plan. Bonds, like stocks, can continue to trade even in bankruptcy.

Effects for Shareholders

Shareholders are also negatively impacted by a bankruptcy. A Chapter 11 bankruptcy very often turns into a Chapter 7 bankruptcy. In a Chapter 7 bankruptcy, which is liquidation rather than a reorganization, shareholders have last priority behind bondholders and other creditors, and will often be left with little or nothing. Even under a Chapter 11 bankruptcy, there is a high chance that equity shares will be canceled.

Effects for Employees

Employees are often concerned when a company files for bankruptcy because they are worried that it will result in job losses. While this is certainly a valid concern, a Chapter 11 filing doesn't automatically mean the loss of jobs. If the employees have a union, the union can represent workers' rights in the bankruptcy.

Considerations

Large Chapter 11 cases have effects that can extend to whole cities and even whole economies. During the financial crisis of recent years, the government attempted but ultimately failed to prevent big automakers from having to file for bankruptcy, the fear being that it would hurt the overall U.S. economy. Bankruptcy is bad for a company's image, but people do continue to buy from bankrupt companies.

References

• U.S. Courts: Chapter 11: Reorganization Under the Bankruptcy Code
• SEC.gov: Corporate Bankruptcy
• Bloomberg.com: GM, Chrysler May Win Reprieve with Access to Tarp Aid