
Bankruptcy Basics
Bankruptcy is often perceived as a last resort for struggling businesses, a measure taken when all other avenues for debt resolution have been exhausted. However, for businesses of all sizes, understanding bankruptcy is crucial—not only as a potential safeguard but as a strategic consideration in financial planning and risk management. This knowledge becomes increasingly important in today’s volatile global economy, where the financial resilience of a business can determine its survival and growth.
Bankruptcy is a legal framework that helps individuals and businesses unable to meet their financial obligations. When a company files for bankruptcy, it either seeks to reorganize its debts and operations or liquidate its assets to repay creditors, depending on the type of bankruptcy pursued (Chapter 7 or Chapter 11 procedures in US bankruptcy law). Bankruptcy can offer a pathway to stability, enabling companies to mitigate debt burdens, restructure, and potentially preserve jobs.
Figure 1. Number of Chapter 11 Bankruptcy Filings (2013-2022)

Source: computation by the author (data: US Courts Statistics).
Legal Definition and Purpose of Chapter 11 Bankruptcy
Chapter 11 bankruptcy, commonly known as “reorganisation bankruptcy,” is a legal mechanism under Title 11 of the United States Code that allows financially distressed businesses to restructure their debts and operations while continuing to function. Unlike Chapter 7, which focuses on liquidation, Chapter 11 aims to preserve the business as a going concern, enabling it to regain profitability while protecting creditors’ interests.
Legal Definition: Chapter 11 provides a structured process through which a debtor proposes a reorganisation plan to address its financial obligations. This plan may involve renegotiating debt terms, selling non-core assets, downsizing operations, or finding new investment capital. The reorganisation plan must be approved by the bankruptcy court and often requires agreement from creditors, ensuring fairness and feasibility.
Purpose: The primary objective of Chapter 11 is to balance two critical goals:
- Business Rehabilitation: By allowing the debtor to restructure debts rather than liquidate, Chapter 11 ensures that valuable business operations, jobs, and economic contributions are preserved. This is particularly vital for companies with potential long-term viability but temporary financial challenges.
- Creditor Protection: The process safeguards creditor interests by ensuring orderly repayment according to a court-approved priority structure. Secured creditors typically recover from collateral-backed assets, while unsecured creditors negotiate for partial repayment through the reorganisation plan.
Chapter 11 is especially beneficial for medium-to-large corporations that need significant operational restructuring or whose debt structure requires complex renegotiation. The process is overseen by a debtor-in-possession (DIP), meaning the company’s existing management continues to operate the business under court supervision while implementing the reorganization plan. The court’s role ensures transparency, equity, and adherence to legal requirements, protecting all stakeholders throughout the process.
Chapter 11 enables businesses to restructure their debt obligations and operations without halting business activities. This process can offer significant advantages, especially for companies with strong core operations but temporary cash flow or liquidity issues. In 2023, approximately 25% of business bankruptcies filed in the U.S. were Chapter 11 cases, showing its popularity among companies aiming to reorganize rather than liquidate.
Key Objectives of Chapter 11
- Debt Relief: Restructure and reduce debt obligations to improve cash flow.
- Operational Reorganization: Adjust operations to align better with financial health, often through cost-cutting, downsizing, or strategic pivots.
- Business Continuity: Unlike Chapter 7, Chapter 11 allows businesses to continue operations, retain jobs, and maintain relationships with customers and suppliers.
Eligibility and Who Can File:
- Chapter 11 is primarily available to corporations, partnerships, and sole proprietorships. However, it is most commonly used by medium to large businesses that have a chance to recover.
- For individuals, Chapter 11 is an option if they exceed the debt limits set for Chapter 13, though it is rare in personal bankruptcies due to its complexity and cost.
Common Causes of Business Bankruptcy
Chapter 11 bankruptcy is often a lifeline for businesses facing financial distress but with the potential for recovery through reorganizsation. Unlike Chapter 7, which involves liquidation, Chapter 11 allows companies to address their challenges by restructuring debts and operations. Several factors commonly drive businesses into Chapter 11 bankruptcy, reflecting a combination of internal inefficiencies and external pressures.
One major cause is an excessive debt burden, where businesses accumulate unsustainable liabilities relative to their income. This can become unmanageable during revenue declines or rising interest rates. Similarly, declining revenues caused by market shifts, competition, or external shocks often leave businesses unable to meet financial obligations. Economic downturns and external crises like recessions or global pandemics further exacerbate financial distress. In addition to economic pressures, overexpansion is another common issue. Businesses that grow too quickly without sufficient financial planning can overextend resources. Operational challenges such as inefficiencies or failure to innovate are also critical factors. Companies that fail to adapt to changing markets risk becoming obsolete. Additionally, supply chain disruptions, such as delays or rising costs, can disrupt operations, especially for businesses reliant on just-in-time systems. These issues can significantly strain cash flow and increase financial pressure.
Legal challenges often play a role in driving Chapter 11 filings as well. Large settlements, lawsuits, or regulatory fines can create sudden financial burdens that businesses struggle to manage. Cash flow management is another critical issue. Poor working capital planning can leave businesses unable to cover short-term obligations. Retailers with seasonal sales spikes often struggle during off-peak periods, leading to financial distress. Finally, industry disruption caused by technological advancements or shifting consumer preferences can force businesses into bankruptcy.
Businesses typically face bankruptcy due to a mix of internal and external factors. Key factors include:
- Excessive Debt Burden
Cause: High levels of debt relative to income can leave businesses unable to service loans, especially during periods of declining revenue or rising interest rates.
Example: Hertz Corporation filed for Chapter 11 in 2020 with over $5 billion in debt. The pandemic-driven collapse in travel demand exacerbated its inability to meet financial obligations.
- Declining Revenues
Cause: Sustained revenue declines due to market changes, competition, or external shocks can reduce a company’s ability to cover operating expenses and debt repayments.
Example: American Airlines filed for Chapter 11 in 2011 due to declining revenues from rising fuel costs and competition, using the process to restructure its debt and cut costs.
- Economic Downturns and External Crises
Cause: Recessions, global crises, or industry-specific downturns can severely impact revenues and cash flow, driving businesses into insolvency.
Example: The COVID-19 pandemic led to a wave of Chapter 11 filings in 2020, including companies like JC Penney and Neiman Marcus, which faced plummeting consumer demand during lockdowns.
- Overexpansion
Cause: Rapid growth without adequate financial controls or market analysis can stretch resources and leave businesses vulnerable to cash flow problems.
Example: Sbarro, a pizza chain, filed for Chapter 11 in 2011 and again in 2014 after overexpanding into underperforming locations, resulting in significant operational inefficiencies.
- Operational Inefficiencies
Cause: Ineffective cost management, outdated business models, or failure to innovate can erode profitability, making it difficult to sustain operations.
Example: Kodak filed for Chapter 11 in 2012 due to its inability to adapt to the digital revolution, which rendered its traditional film business obsolete.
- Supply Chain Disruptions
Cause: Delays, shortages, or rising costs in supply chains can disrupt production and increase operating expenses, especially for companies dependent on just-in-time systems.
Example: In 2022, many small-to-medium-sized manufacturers in industries like electronics and automotive struggled with supply chain issues, driving some to seek Chapter 11 protection.
- Legal Liabilities
Cause: Large settlements, regulatory fines, or lawsuits can create significant financial burdens that businesses cannot manage without restructuring.
Example: Purdue Pharma filed for Chapter 11 in 2019 as part of a settlement to resolve thousands of lawsuits related to the opioid crisis.
- Poor Cash Flow Management
Cause: Failure to manage working capital effectively can lead to cash shortages, making it difficult to pay creditors or fund day-to-day operations.
Example: A mid-sized retailer with strong seasonal sales but poor cash flow planning might file for Chapter 11 to restructure its payment obligations during off-peak periods.
- High Fixed Costs
Cause: Businesses with significant fixed costs, such as long-term leases or equipment financing, face challenges when revenues fall, as these costs cannot easily be reduced.
Example: JC Penney faced mounting lease expenses and declining store traffic, ultimately filing for Chapter 11 in 2020 to renegotiate terms and restructure operations.
- Industry Disruption
Cause: Technological innovation, shifting consumer preferences, or the entrance of disruptive competitors can weaken traditional business models.
Example: Blockbuster filed for Chapter 11 after streaming services like Netflix and Hulu fundamentally disrupted the home entertainment industry.
Key Steps in a Chapter 11 Filing
- Filing the Petition and Automatic Stay
- Filing: The Chapter 11 process begins when the debtor files a petition in bankruptcy court. This petition includes comprehensive details about the company’s financial status, such as assets, liabilities, income, expenses, and financial history.
- Automatic Stay: The moment the petition is filed, an automatic stay takes effect, immediately halting all collection actions by creditors. This stay provides the company with breathing room to reorganize without the threat of foreclosure or asset seizure. The automatic stay is crucial for companies in Chapter 11, as it allows operations to continue while management restructures.
- Development and Approval of the Reorganization Plan
- Plan Development: The debtor, acting as a “debtor-in-possession” (DIP), typically retains control over business operations. The company is tasked with drafting a reorganization plan, which outlines how it will repay creditors, restructure operations, and achieve profitability.
- Creditor Negotiations: The company works with creditors to gain their support for the reorganization plan. In most cases, the plan must be approved by at least one class of impaired creditors (those not expected to be fully repaid). This approval can involve debt rescheduling, asset sales, or reductions in debt.
- Court Approval: Once creditors approve the plan, the bankruptcy court must confirm it. The court assesses whether the plan is feasible, fair, and in the best interests of creditors. This phase can be complex and costly, as it often requires multiple hearings and potential modifications to satisfy all parties.
- Execution and Emergence from Bankruptcy
- Implementation: After court approval, the company begins implementing the reorganization plan, following all terms outlined to repay creditors over time. Changes may include asset sales, layoffs, new debt issuance, or equity restructuring.
- Emergence from Chapter 11: Once the company fulfils the terms of the reorganization plan, it officially exits Chapter 11. This process can take several months to years, depending on the company’s complexity and debt structure. For instance, American Airlines emerged from Chapter 11 after two years of restructuring, merging with US Airways to enhance market competitiveness.
Benefits of Restructuring vs. Liquidation
- Preserving Business Value: Reorganization allows the company to maintain operations, preserving its market presence, assets, and workforce. For example, Hertz used Chapter 11 in 2020 to restructure over $5 billion in debt, allowing it to continue operating and ultimately emerge stronger after the pandemic.
- Maximizing Creditor Recoveries: Creditors are often more willing to negotiate in Chapter 11, as reorganization usually yields better recoveries than liquidation. According to research, Chapter 11 cases result in creditor recoveries averaging 20-25% higher than Chapter 7 cases due to continued asset generation.
- Opportunity for Operational Efficiency: Companies can use Chapter 11 to optimize operations by renegotiating leases, reducing payroll, and streamlining production. These changes help improve financial health and long-term viability.
Risks and Challenges in the Reorganization Process
- Cost and Complexity: Chapter 11 can be extremely costly, especially for larger businesses. Legal fees, administrative expenses, and consulting costs can run into millions. A 2019 study revealed that legal and administrative expenses for large Chapter 11 cases average between $1 million and $10 million. For example, Lehman Brothers’ bankruptcy case, the largest in U.S. history, accrued $2.2 billion in fees over its restructuring period.
- Extended Time Frame: Chapter 11 cases can be lengthy, taking months or even years to complete. This time commitment may strain cash flow and delay recovery, particularly if the business is in a highly competitive industry. In Hertz’s case, the Chapter 11 process lasted 17 months, and the company only emerged after securing additional financing and renegotiating debt terms.
- Uncertainty in Creditor Approval: Creditors must approve the reorganization plan, which can be challenging if there are conflicting interests among different creditor classes. If major creditor groups reject the plan, the court can enforce a “cramdown,” but this is often a contentious and uncertain process.
- Risk of Conversion to Chapter 7: If a reorganization plan fails, or the business cannot achieve sustainable operations, the case may be converted to Chapter 7, leading to liquidation. This outcome results in further losses for stakeholders, as assets are sold off, and the business ceases operations.
Debtor-in-Possession (DIP) Financing: Definition, Purpose, and Relevance in Chapter 11 Filings
Debtor-in-Possession (DIP) financing is a specialized form of funding that allows businesses undergoing Chapter 11 bankruptcy to secure the liquidity needed to continue operations during the reorganization process. The term “debtor-in-possession” refers to the debtor retaining control of its assets and operations while the bankruptcy case is under court supervision. Unlike standard loans, DIP financing is uniquely designed for companies in financial distress and requires court approval to ensure fairness and transparency.
Definition and Features
DIP financing is a post-petition loan that takes precedence over most existing debts, including secured loans, under U.S. bankruptcy law. This super-priority status ensures that DIP lenders are repaid before pre-petition creditors, making the financing attractive even for lenders dealing with financially distressed companies. The terms of DIP financing often include strict covenants, requiring the debtor to adhere to the reorganization plan and meet operational milestones.
Purpose of DIP Financing.
The primary purpose of DIP financing is to provide businesses with the liquidity needed to continue essential operations during the reorganization process. This includes paying employees, suppliers, and other operating expenses. Without this funding, many companies would face operational paralysis, undermining the feasibility of reorganization.
- Maintain Operations: Fund day-to-day activities such as payroll, supplier payments, and utility bills to prevent operational shutdown.
- Stabilize the Business: Provide working capital to preserve the company’s going-concern value, ensuring it can generate revenue during the restructuring process.
- Support Creditor Confidence: By maintaining operations, DIP financing reassures creditors that the debtor is working toward recovery and maximising the value of their claims.
Relevance in Chapter 11 Bankruptcies
DIP financing plays a pivotal role in Chapter 11 filings, bridging the gap between insolvency and reorganization. A business in financial distress often lacks the liquidity to continue operations, which is critical to preserving asset value and employee morale during bankruptcy. Without DIP financing, many companies would be forced to liquidate under Chapter 7, leading to the loss of jobs, assets, and creditor recoveries.
For creditors, DIP financing ensures that the company retains its going-concern value, which typically leads to higher recoveries than a piecemeal liquidation. The court-approved nature of DIP financing also provides a transparent framework for ensuring that new and existing creditors are treated fairly.
Case Study: Hertz Global Holdings – A Successful Chapter 11 Reorganization
Background
Hertz Global Holdings, one of the largest car rental companies in the world, filed for Chapter 11 bankruptcy on May 22, 2020, during the height of the COVID-19 pandemic. Founded in 1918, Hertz operated a fleet of over 700,000 vehicles across 12,000 locations worldwide. Despite its strong market presence, the company faced mounting financial pressures exacerbated by the collapse of global travel during the pandemic.
Causes of Financial Distress
- Revenue Collapse: The COVID-19 pandemic caused a dramatic decline in travel demand, with global car rental revenues dropping by nearly 50% in 2020. Hertz’s core business was severely affected, leading to unsustainable losses.
- Excessive Debt: Hertz entered the pandemic carrying over $19 billion in total debt, including vehicle leasing obligations. The revenue shortfall made it impossible for the company to service its debt.
- Operational Challenges: Hertz struggled with a bloated fleet and high fixed costs. The sudden drop in demand left thousands of vehicles idle, further straining the company’s cash flow.
The Chapter 11 Filing
Hertz filed for Chapter 11 protection to restructure its debts and operations while continuing to operate. The reorganization aimed to address several key issues:
- Debt Restructuring: Hertz sought to renegotiate terms with creditors to reduce its debt load and extend repayment periods.
- Fleet Optimization: The company planned to sell off a portion of its vehicle inventory to generate cash and align fleet size with demand.
- Securing Financing: Hertz needed additional liquidity to sustain operations during the reorganization process.
Key Steps in the Reorganization Process
- Debtor-in-Possession (DIP) Financing: Hertz secured $1.65 billion in DIP financing to fund its operations during bankruptcy. This financing provided the necessary cash flow to continue serving customers and paying employees while restructuring.
- Asset Sales: Hertz sold off approximately 200,000 vehicles from its fleet, generating liquidity and reducing carrying costs. This move also allowed the company to focus on optimizing its remaining assets.
- Debt Negotiations: Hertz renegotiated with creditors to eliminate nearly $5 billion in debt. Creditors received equity and cash payments in exchange, ensuring some recovery while allowing the company to stabilize.
- Strategic Investment: In May 2021, Hertz exited bankruptcy after receiving a $5.9 billion equity injection from a group of institutional investors, including Knighthead Capital and Certares Management. This recapitalization provided a strong financial foundation for the company’s post-bankruptcy growth.
Outcome
Hertz emerged from Chapter 11 on June 30, 2021, as a leaner and more competitive company. The reorganization allowed the company to:
- Reduce Debt: Hertz significantly reduced its debt obligations, creating a more sustainable financial structure.
- Optimize Operations: The sale of excess vehicles and strategic investments in fleet technology enhanced efficiency.
- Leverage New Opportunities: Post-reorganization, Hertz announced plans to invest in electric vehicles (EVs), including a major purchase of 100,000 Teslas in 2021, positioning itself as a leader in the EV rental market.
Impact on Stakeholders
- Creditors: Creditors recovered a portion of their investments through equity stakes and cash payments, avoiding the complete loss often associated with liquidation.
- Employees: The reorganization preserved thousands of jobs, allowing Hertz to retain its workforce while stabilizing operations.
- Customers: Hertz continued serving customers without major disruptions, ensuring the brand’s market presence remained intact.
- Investors: The post-bankruptcy equity investment attracted new institutional investors, reflecting confidence in Hertz’s growth potential.
Lessons for Students
- Importance of DIP Financing: Securing DIP financing is critical for maintaining operations during reorganization. Hertz’s ability to secure $1.65 billion ensured stability during a turbulent period.
- Strategic Asset Management: Selling non-core assets, such as excess fleet vehicles, is a practical way to generate liquidity and reduce costs in Chapter 11 cases.
- Investor Confidence: Attracting strategic investors during reorganization can provide not only financial resources but also market credibility.
- Adaptability and Innovation: Post-bankruptcy, Hertz’s pivot toward electric vehicles demonstrates the importance of aligning business strategies with future market trends.
Why Should I Be Interested in This Post?
Understanding Chapter 11 bankruptcy is essential for anyone aspiring to excel in business, finance, law, or management. It is not merely a legal process but a strategic tool capable of reshaping businesses, preserving jobs, and driving economic recovery. This post provides an in-depth exploration of its mechanics, real-world applications, and strategic insights, offering immense value to students and professionals alike. By studying Chapter 11, you can gain a deep understanding of corporate reorganization frameworks, enhancing your ability to evaluate restructuring strategies and navigate complex financial scenarios. Expertise in this area is highly sought after in fields such as corporate finance, restructuring consulting, investment banking, and insolvency law, with knowledge of concepts like DIP financing, creditor negotiations, and reorganization plans opening doors to careers in distressed asset investing, turnaround consulting, and credit risk management. Moreover, learning about Chapter 11 develops critical skills in assessing financial health, managing liabilities, and evaluating risk—skills that are vital for credit analysis, equity research, and financial strategy roles. Additionally, with the globalization of business, understanding Chapter 11 principles provides transferable insights into international insolvency frameworks, laying a strong foundation for analyzing and adapting reorganization strategies across jurisdictions.
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