Conventional bankruptcy: This is usually when a business files bankruptcy in a response to a crisis. However, when a business files bankruptcy without at least some prior negotiation with creditors, no one can really be sure how a case will turn out. For example, many businesses have bank loans, and those banks have blanket liens on all the business’ assets, including cash and accounts receivable. Just to run its basic affairs after the bankruptcy, the business will need to seek permission of the creditor to use that so-called “cash collateral”. Also, the business may have filed bankruptcy as a result of a liquidity crisis and may need new cash just to continue operations. The debtor may need to quickly find and seek approval of debtor in possession (“DIP”) financing just to keep the lights on and the doors open.
Prepackaged bankruptcy: A prepackaged bankruptcy eliminates much of the uncertainty of entering Chapter 11. In this model of bankruptcy, the business negotiates agreements with creditors before the bankruptcy which are legally binding in the bankruptcy case. Section 1126(b) of the Bankruptcy Code specifically contemplates this type of case by providing that someone who accepts or rejects a plan before a Chapter 11 is deemed to have also accepted or rejected it within the bankruptcy case.
There are various reasons for attempting to enter Chapter 11 with a creditor-supported plan in hand. Some reasons relate to general uncertainty and cost; others can relate to requirements in many bond or loan syndication agreements that require unanimous consent by holders outside of bankruptcy to modify the debt. This can make bankruptcy sometimes the only practical way to re-write a loan, even if almost all creditors agree to the modification. This is because that in bankruptcy a class of claims is deemed to approve a plan as long as a majority of creditors in a class and 2/3 of the dollar amount in the class vote for the plan.
Another key advantage to a prepackaged Chapter 11 case is that the bankruptcy is short, minimizing its impact on the ongoing operations of the business. A prepackaged case can often be concluded in 30-60 days. It can also be cheaper than a conventional case because it is shorter, there is less court involvement, and certain aspects of a conventional bankruptcy are not present (for example, a creditors’ committee is not always appointed, especially if unsecured creditors and executory contracts are not impaired under the plan, which is often the case in a prepackaged bankruptcy).
There is also a hybrid of a conventional and prepackaged case called a “prenegotiated” bankruptcy. In this type of case the business may have reached plan-support deals with some but not all creditors.
Nicholas Ortiz, Boston Bankruptcy Attorney
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Last modified: May 23, 2013