Drawbacks of Chapter 11 reorganization

Although reorganizing under chapter 11 can be very beneficial, these benefits do come with some burdens. Below is a partial list of some of the most common burdens of chapter 11 reorganization.

Stigma: Historically, reorganization under chapter 11 carried some stigma. But after General Motors, Chrysler, and United Airlines all successfully completed their highly-publicized reorganization, the stigma of chapter 11 reorganization has been substantially reduced. Nonetheless, many debtors still resist exercising their rights under chapter 11 because they believe that doing so will affect their reputation.

Loss of privacy: Debtors seeking to reorganize under chapter 11 must file with the bankruptcy court, voluminous and detailed documents, listing substantial financial information. These documents are public record, and are available to anyone who reviews the court files. However, certain confidential information (such as social security numbers or certain account numbers) need not be disclosed. Ultimately, the loss of privacy may be a small price to pay for the benefits of reorganizing under chapter 11.

Financial record keeping and reporting requirements: Closely related to the loss of privacy issue is the requirement that debtors maintain and report detailed financial records. The nature of the records that need to be maintained and reported varies based on the nature of the debtor. For example, debtors whose primary assets are commercial real estate need to maintain and report detailed rental information. Corporate debtors need to maintain and report revenue and expense information. Debtors that have extensive history of operating a business usually find that the record keeping requirements are not excessively burdensome.

Profitability requirements: Debtors seeking to reorganize under chapter 11 must show profitable operation when their debts and obligations are reorganized. While chapter11 reorganization can help profitability by reducing expenses, debtor must nonetheless be confident that reorganization can return them to profitability.

Some loss of control over business operations: Debtors in chapter 11 reorganization can generally continue operation by performing those activities that are in the “ordinary course of business.”  But those activities that are not in the ordinary course of business require court approval. This generally means that activities like selling, purchasing, refinancing, or leasing major capital assets require court approval.

Restrictions on compensation of debtor’s insiders: Where a corporate debtor seeks reorganization under chapter 11, restrictions may be imposed on consideration paid to the corporation’s insiders (such as certain officers, directors, or major shareholders).

Possible loss of shareholder control: Under certain circumstances, the original shareholders of a corporation that is reorganizing under chapter 11 may lose their position completely. For example, after General Motors completed its reorganization under chapter 11, the value of its old stock went to zero, and most of the old shareholders lost their investments. But in the case of small corporations, a well-planned chapter 11 reorganization may be able to preserve the control of the old shareholders.

Cost: Chapter 11 is an extremely complex process. Understandably, the process is not cheap. But for most debtors, a chapter 11 reorganization is a once-in-a lifetime process. The process should be carefully evaluated, planned and executed. Like any once-in-a-lifetime event, obsessing on cost is unwise. For example, few patients would focus only on cost in determining whether to hire the services of a heart surgeon. Likewise, a wise debtor should not be solely concerned with cost in deciding whether to hire a law firm for chapter 11 reorganization.