U.S. bankruptcy law, governed by Title 11 of the U.S. Code, provides the legal framework for resolving insolvency — balancing the interests of debtors seeking relief from unsustainable debt burdens with the interests of creditors seeking to recover what they are owed. For credit professionals, understanding the bankruptcy process, the rights it confers on different creditor classes, and the strategic dynamics of restructuring negotiations is essential knowledge.
Chapter 11 of the Bankruptcy Code provides for reorganization — the debtor continues operating while developing and negotiating a plan of reorganization to restructure its debts. The filing triggers an "automatic stay" — an injunction that immediately halts all collection actions, lawsuits, and enforcement proceedings against the debtor. The automatic stay gives the debtor breathing room to negotiate with creditors without the threat of asset seizure or judgment enforcement, though it also prevents creditors from acting unilaterally to improve their position.
In Chapter 11, the debtor operates as a "debtor-in-possession" (DIP) — retaining control of its business while subject to court oversight and creditor scrutiny. The debtor typically needs DIP financing to fund operations during bankruptcy; DIP lenders receive super-priority administrative expense status, giving them the highest-priority claim on assets in the bankruptcy estate, ahead of even pre-petition secured lenders. This super-priority, combined with adequate protection requirements, makes DIP lending a specialized and relatively low-credit-risk activity for experienced lenders.
Creditors' committees — typically the unsecured creditors' committee and sometimes secured creditor groups — play important roles in negotiating the plan of reorganization. The plan of reorganization defines how value is distributed to each creditor class: secured creditors may receive new debt or equity in the reorganized company; unsecured creditors may receive a partial recovery; equity holders typically receive nothing unless all creditors are paid in full. The "absolute priority rule" requires that creditors receive full value before equity holders receive anything, though this rule can be modified by consent.
Chapter 7 provides for liquidation — a trustee is appointed to sell the debtor's assets and distribute proceeds to creditors in priority order. Chapter 7 is used when the business has no going-concern value — when continued operation would simply burn more value than an immediate asset sale. For credit professionals, the key question in any distress situation is whether the company is worth more as a going concern (reorganization) or dead (liquidation) — the answer determines which path is pursued.