Bankruptcy in the U.S is permitted by the United States Constitution, which authorizes Congress to enact uniform laws on the subject of bankruptcies throughout the United States. Bankruptcies are initiated with a petition filed by the debtor or on behalf of creditors (involuntary bankruptcy) in an attempt to recoup a portion of the debt or force a restructuring. Although some law relevant to bankruptcies can be found in other parts of the United States code, the Bankruptcy Reform Act of 1978 is the most recent addition to the United States Code, Reform Act of 1978 is commonly referred to as Bankruptcy Code.

Chapters of Bankruptcy

Depending on the circumstances, private companies under the Bankruptcy code may file a petition for relief under different chapters of the code. Title 11 is comprised of nine chapters, of which six chapters are designated for filing petition. The remaining three chapters provide rules to govern those petitions.

Bankruptcy filing specifications differ widely among various countries, leading to higher and lower filing rates, depending on how easily a private company or a person can complete the process.

Chapter 7: Liquidation

Chapter 7 is one of the two primary options available to private companies in distress. Chapter 7 is also referred to as Liquidation. A Chapter 7 proceeding is one in which a business or firm is terminated or stops operating. The business assets are sold and proceeds of the sale are distributed to creditors.

As does a public company, a private company qualifies for filing a Chapter 7 bankruptcy. The portion of the debt that cannot be repaid through liquidation is absolved. Private companies generally try to avoid Chapter 7 bankruptcy, because it terminates all business operations with no opportunity to reinstate at a later date. Income generated after the bankruptcy filing is considered in the proceedings.

Example: Secured creditors take less risk because the credit that they extend is usually backed by collateral, such as revenue or other assets of the private company. After all debts with secured creditors have been settled, the subordinated levels of debt, such as unsecured creditors, can claim repayment. After all the private companys debt is settled, equity investors are able to stake a claim on assets.

Chapter 11: Reorganization

Chapter 11 is a complex form of bankruptcy and is generally filed by private and other corporations who aim to restructure their capital allocation to operate more efficiently and effectively, primarily by eliminating debts and contracts (such as office leases or union contracts) that they can no longer afford. Chapter 11 involves the reorganization of a debtor private companys business affairs, assets and liabilities. The bankruptcy gives the debtor a fresh start, subject to the debtors fulfillment of its obligations under its plan of reorganization (like public companies, a private company must file a Plan of Reorganization for the Bankruptcy Courts approval demonstrating it will be viable after exiting bankruptcy.) Chapter 11 bankruptcy can also be used to liquidate some of the assets of a private company and pay the creditors from the proceeds of the sale (these are referred to as Section 363 sales transactions; PrivCo tags M&A transactions resulting from a bankruptcy order as a Section 363 sale).

Chapter 11 is available to companies (corporations, partnerships or sole proprietorships) that are plagued by severe financial distress. Permission for filing Chapter 11 bankruptcy is given, if debt repayments can be abated or postponed. The private company is protected by an automatic stay that is initiated upon approved filing of the petition. As a result, creditors cannot take any action against the debtor. The stay eases the financial burden of the debtor, during which negotiations can also take place to try to resolve the difficulties in the debtor’s financial situation.

After filing for bankruptcy, the debtor is relieved of payments for 120 days, during which, the debtor must formulate and file a plan of reorganization with the court of bankruptcy. If the debtor fails to submit a plan during the 120 day period, or if creditors fail to adhere to the debtor’s plan during the first 180 days, creditors are allowed to submit a plan of reorganization. Sometimes compromises must be made on behalf of the debtor and associated creditors when the bankruptcy court is faced with conflicting plans of reorganization. Often creditors of the companies such as banks and lenders take some or all of the stock of the private company upon exit from Chapter 11 and essentially become the new owners of the company. In some cases the private company and its creditors agree in advance on what the outcome will be and will file what is referred to informally as a prepackaged bankruptcy, which also will tend to be completed much faster than an ordinary bankruptcy since the private company and its creditors agree in advance and dont need to duke it out in court over what a fair outcome will be.

Example: Private company Merisant Worlwide, Inc. and its affiliates filed for protection under Chapter 11 bankruptcy in the U.S Bankruptcy Court for the District of Delaware. This move was intended to restructure the private companys balance sheet and improve its long-term growth and financial well-being. The private companys operations in the US and worldwide proceeded without interruption after the bankruptcy filing. Merisant Worlwide, Inc. felt that restructuring its balance sheet was the ideal way to increase the success of its products in the market.

Private Company Restructuring

Corporate restructurings can also take place without the involvement of a bankruptcy court, saving the significant legal costs to both the private company and to the creditors of a formal court process.

Corporate restructurings all aim to create shareholder value. A restructuring is a adjustment of ownership, operations, assets, or capital structure of a private company in order to improve operating performance, optimize capital structure and enhance public perception. Before known as a simple balance sheet reconfiguration, restructurings now include a variety of financial transactions from mergers, asset sales and special dividends to share repurchases. Restructurings have been used to lever and de-lever the balance sheet, concentrate equity ownership, or realize value of a subsidiary.

Over the past 20 years, corporate restructurings have been on the rise as institutional investors become more active and vocal. Institutional investors have begun to make demands of management and the board of directors. In some cases, institutional investors wage proxy battles in order to enhance shareholder value.

Given the prevailing market conditions over the past three decades, hostile take over activity such as leveraged buyouts and hostile acquisitions have been on the rise. Nevertheless the value of acquired private companies is not always reflected in the stock price of the acquirer. Therefore, private companies have been focusing on improving core businesses, divesting poor performing assets and highlighting strong performers.

Creating Value in Restructuring

Corporate restructuring comes in many flavors, including financial and transactional methods. Corporate restructuring can include a reconfiguration of the balance sheet via issuing a special dividend, share repurchases, or recapitalizations. Financial restructurings are designed to make the capital structure more efficient or can be used to defend against a takeover effort. Transactional restructurings include a reconfiguration of assets or operations. Such methods are typically divestitures, spin-offs, split-offs, and equity carve-outs. Other less common transactions are tacking stock, leveraged buyouts, leveraged ESOPs, or complete liquidations.