Chapter 11 Reorganizationfor Publicly Traded Companies
Overview of Chapter 11 – Corporate
A Chapter 11 bankruptcy governs corporate reorganization. Two very important things are considered throughout the process. One of those is the consideration of objectives by which reorganization rules might not be judged. The second is evaluating the standard bargaining approaches of existing rules and alternative methods.
When a corporation becomes insolvent, it decides to either go through liquidation or reorganization. For most non-small business companies, reorganization is favorable over liquidation. In a Chapter 11 bankruptcy, a publicly traded corporation goes through a pseudo-sale of the company with the participants, who exchange their claims and interests for “tickets” that represent the claims against and interests in the reorganized entity.
Indubitably, an insolvent company would want to maximize its total assets, minimize the value it dissolves, and lessen the time the reorganization process takes. During an insolvency, a company is concerned about the division of its total value. It is commonly divided among participants according to a priority ranking of participants’ classes.
Valuating the assets of a reorganized company is tremendously difficult, because of various factors like conflict of interest amongst the participants. One way the law deals with such problems is through the bargaining approach. In this approach, the classes of participants create and approve a plan for reorganization. However, empirically, the bargaining-based process fails to maximize the value of reorganization.
Dissipation of value during the reorganization process is common because of the setbacks that come along with a Chapter 11 bankruptcy. Hurdles like administrative costs, and fees owed to lawyers, accountants, and other professionals are common. Moreover, usually a company isn’t fully efficient, in terms of operating, during reorganization. Consequently, a company is faced with more expenses. Management might not realize the imperatives of maximizing reorganization value, which leads to distorted decision making and further debt in the capital structure.
Conventional Bargaining-Based Approach
The bargaining-based approach ensues the division of value be stipulated by the contractual rights of each participant. Classes of participants are organized by priority ranking. In similar fashion, some classes of participants have a higher bargaining position.
Since empirically the bargaining approach is proved to have systematic inadequacies, alternative approaches were developed. One of those arrangements is called the auctions approach, which relies on the market. A sample of the reorganized company’s interests are sold to the market. After the implementation of this sample, the rest of the interests are sold and gradually the company obtains a more accurate valuation of the company. With the auction approach, the insolvent company sells its assets to the highest bidder. Many proponents of the auction approach believe that it produces the maximum value for the assets. However, there were past instances when the reorganized company faced liquidity problems when this approach was implemented.
Another alternative is called the options approach, which seeks to eliminate bargaining. It guarantees that all participants get at least the value of their entitlement. The parties that participate are given options or so called “rights” that they exercise by a certain date. Consequently, depending on how the parties act, the value of the company is distributed accordingly. The options approach is auspicious compared to other, because it is decentralized and renders every individual participant autonomy in exercising their respective rights. The options approach, like the auctions approach, shortens the process. But unlike other approaches, the options approach offers the most democratic arrangement to decide on the capital structure and governance of the reorganized entity.
A company must be aware that a purely optimal approach does not exist, yet. Every approach has its setbacks. The classes of parties wrangle to obtain the most for their respective parties.