Page 94 - Bankruptcy Volume 1

If a company cannot complete an out-of-court workout, prepackaged, or pre-negotiated plan, it will file
its petition and proceed with a traditional Chapter 11 process. In the traditional Chapter 11 process, a
plan is developed and support is solicited during the course of the Chapter 11 case. A traditional Chapter
11 process can be beneficial to a distressed company, as the automatic stay that is immediately put into
place by the filing of the petition provides company management with time to stabilize the business and
address major problems while developing a plan. To finance the bankruptcy and continue regular busi-
ness operations, the debtor generally obtains debtor-in-possession financing, in exchange for which the
lenders may receive collateral and a superpriority claim or both. Negotiations with holders of other
claims and interests commence later in the Chapter 11 process. Several drawbacks to the traditional
Chapter 11 process include a lengthy process averaging 9–18 months, resulting in higher professional
fees, and a potentially adverse impact on business operations.

Although the Chapter 11 filing may give such debtors the breathing room they need to continue develop-
ing such a plan, in some cases debtors are unable to chart a course for reorganization or obtain sufficient
support. As a result, these businesses may end up liquidating. The Bankruptcy Code allows for liquidat-
ing plans that provide for the orderly liquidation and wind up of the debtor’s business and distributions
to creditors. Such liquidating plans may also be used in cases in which the debtor sells substantially all
of its assets during the course of the Chapter 11 proceeding and thereafter wishes to distribute the pro-
ceeds of the sale and liquidate. In order to assess whether a business should be reorganized or liquidated,
it must be determined whether the business is viable. If the viability study indicates that the business can
generate enough cash flow to sustain operations and repay certain creditor claims, a business plan usual-
ly will be prepared. Such business plans should comprehensively analyze the debtor’s business, and
management’s forecast of future operations. A plan of reorganization can then be developed based on
the business plan.

Consolidation Generally

The extent to which parent and subsidiary companies can be consolidated is a gating issue that arises in
many Chapter 11 cases and in some Chapter 7 liquidations, and may significantly influence the structure
of any plan of reorganization and the recovery received by various classes of creditors. In many Chapter
11 cases, interested parties cannot determine the terms of a plan until the court decides the extent to
which the various bankrupt entities can or should be consolidated. There are two basic types of consoli-
dation — administrative and substantive.

Administrative Consolidation

In administrative consolidation, the court combines the bankruptcy cases of two or more related entities
for purposes of maintaining court files and other recordkeeping tasks. The consolidation does not affect
the separateness of each debtor; each maintains its own assets, liabilities, and claims. Administrative
consolidation is routinely allowed — generally through the entry of an order for joint administration —
when related entities enter into concurrent Chapter 11 proceedings.

Substantive Consolidation

In substantive consolidation, the court consolidates the assets and liabilities of different entities as if the
assets were held and the liabilities were incurred by a single entity. If two or more debtor estates are
substantively consolidated, the value of the assets of those estates is aggregated and each creditor has
one claim against the combined estate (even if such creditor had claims against several debtors with re-
spect to the same debtor obligation). Substantive consolidation is not a merger of the legal entities and
generally is limited to the treatment of assets and liabilities under a plan of reorganization.

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