Financial Restructuring and Bankruptcy

Priority of Claims in Bankruptcy

When a company enters bankruptcy, claims are paid in strict order of priority. The Series 79 expects you to know this order cold:

1. Secured creditors (senior secured debt): Paid first from the value of the collateral securing their loans
2. Administrative claims: Professional fees, DIP financing
3. Unsecured creditors: Trade suppliers, unsecured bondholders
4. Subordinated debt: Senior subordinated, then junior subordinated
5. Mezzanine (convertible debt): Hybrid instruments
6. Preferred stock: Equity-like but with priority over common
7. Common stock: Last in line — typically receives nothing in liquidation

Bankruptcy Fundamentals

Chapter 11 — Reorganization

• Company continues operating as a debtor in possession (DIP)
• DIP financing: New loans with super-priority status — incentivizes lenders to provide capital during bankruptcy by giving them first claim
• Plan of reorganization: Proposed by the debtor (120-day exclusivity period), voted on by each class of creditors, confirmed by the court
• Creditor committee: Represents unsecured creditors' interests in the reorganization process

Chapter 7 — Liquidation

A trustee is appointed to liquidate the company's assets and distribute proceeds according to the priority of claims. The company ceases to exist.

Section 363 Sales

Allows the sale of assets free and clear of liens and claims during bankruptcy. Used when a going-concern sale maximizes value for creditors better than a Chapter 11 reorganization. Popular in distressed M&A.

Loan Documents and Covenants

Credit Agreements and Indentures

• Affirmative covenants: Things the borrower must do (maintain insurance, provide financial statements, pay taxes)
• Negative covenants: Things the borrower cannot do without lender consent (additional debt, asset sales, dividends, change of control)
• Financial covenants: Quantitative tests — maximum leverage ratio, minimum interest coverage ratio, minimum liquidity
• Events of default: Covenant breaches, payment defaults, bankruptcy filing, material adverse change

Consequences of early refinancing: Call premiums, make-whole provisions, and prepayment penalties — particularly relevant for high-yield bonds.

Chapter 11 Process — Key Milestones

A Chapter 11 reorganization follows a structured timeline:

1. Filing: Voluntary (by the company) or involuntary (by creditors). An automatic stay immediately halts all collection actions, lawsuits, and foreclosures.
2. DIP operations: Company continues operating as debtor-in-possession. Existing management typically stays, but a trustee can be appointed in cases of fraud or mismanagement.
3. DIP financing: New credit facility with super-priority status. Lenders require court approval and often receive liens on unencumbered assets or priming liens on encumbered assets.
4. Exclusivity period: 120 days for the debtor to file a plan of reorganization. Can be extended for cause but not beyond 18 months.
5. Disclosure statement: Filed with the plan — provides "adequate information" for creditors to make an informed vote.
6. Voting: Each class of creditors votes. A class accepts if 2/3 in dollar amount AND more than 1/2 in number of claims vote in favor.
7. Confirmation: Court confirms the plan if it meets statutory requirements, including the "best interests" test (each dissenting creditor receives at least what they'd get in Chapter 7 liquidation).

Section 363 Sales — Distressed M&A

Section 363 of the Bankruptcy Code allows the sale of assets free and clear of liens, claims, and interests. This is the primary vehicle for acquisitions out of bankruptcy:

• Stalking horse bid: An initial bid that sets the floor price. The stalking horse bidder often receives protections — breakup fee (1–3% of deal value) and expense reimbursement — if outbid at auction.
• Auction process: Other interested buyers submit competing bids. The court oversees the auction to maximize value for the estate.
• Speed advantage: 363 sales can close in 30–60 days vs. months for a traditional Chapter 11 plan. This preserves going-concern value.
• Buyer advantage: The "free and clear" sale order eliminates successor liability — the buyer gets clean assets without the seller's liabilities attaching.

Make-Whole Provisions and Call Premiums

When companies refinance debt early, lenders lose expected interest income. These provisions protect them:

• Make-whole provision: The borrower must pay a lump sum equal to the present value of all remaining interest payments (discounted at a specified rate, typically Treasury + a small spread). This makes early repayment very expensive — essentially the lender is "made whole" for lost future income. Common in investment-grade bonds and term loans.
• Call premium: A fixed premium above par value (e.g., callable at 104% after year 3, 102% after year 4, par after year 5). Common in high-yield bonds. The premium schedule is set at issuance and declines over time.
• Non-call period: A window (typically 2–5 years) during which the bonds cannot be called at all. Often expressed as "NC/2" (non-call for 2 years), then callable at a premium.
• Why bankers care: In M&A, if the target has outstanding debt with make-whole or call provisions, the acquirer must factor these costs into the total deal price. Refinancing the target's expensive debt is a common source of post-acquisition value creation, but only if the call economics make sense.

Trustee Appointment in Bankruptcy

In most Chapter 11 cases, existing management continues operating the company as "debtor in possession." However, a trustee may be appointed in certain circumstances:

• For cause: Fraud, dishonesty, incompetence, or gross mismanagement by current management. The court or any party in interest (creditors, U.S. Trustee) can request appointment.
• In the interest of creditors: Even without misconduct, if it's in the best interest of the estate and creditors, a trustee can be appointed.
• Trustee's powers: The trustee replaces management entirely. They operate the business, control the estate's assets, investigate potential claims against former management, and propose the plan of reorganization.
• Examiner: A less drastic alternative — the court can appoint an examiner to investigate specific matters (potential fraud, conflicts of interest) without replacing management. Required if unsecured debt exceeds $5 million.

How a Bankruptcy Case Begins — Voluntary vs. Involuntary

Voluntary Petitions

Most business bankruptcy cases begin with a voluntary petition filed by the debtor itself. The filing is an order for relief — no waiting period, no trial, the case is immediately underway. Voluntary cases may be filed under Chapter 7 (liquidation), Chapter 11 (reorganization), or for individuals with regular income, Chapter 13.

Involuntary Petitions — §303

Creditors can sometimes force a reluctant debtor into bankruptcy through an involuntary petition under §303. The remedy is powerful but narrowly drawn:

• Chapter 7 or 11 only. Involuntary cases are permitted only under Chapter 7 (liquidation) or Chapter 11 (reorganization). Involuntary Chapter 13 is not permitted because Chapter 13 requires a cooperative debtor.
• Petitioning-creditor count. If the debtor has 12 or more creditors, at least three creditors holding qualifying claims must join the petition. If there are fewer than 12 creditors, one creditor alone may file.
• Qualifying claims. Each petitioning creditor must hold a claim that is noncontingent (fixed liability, not dependent on a future event) and not subject to bona fide dispute as to liability or amount.
• Dollar threshold. The petitioning creditors' aggregate unsecured claims must exceed a statutory minimum — $21,050 as of April 1, 2025 (adjusted every three years for inflation under §104).
• Grounds for relief. After trial, the court orders relief only if the debtor is generally not paying its debts as they become due (outside bona fide disputes) or if a custodian was appointed within 120 days before the petition.

Who Cannot Be Forced Into Bankruptcy

§303(a) exempts certain debtors from involuntary cases:

• Farmers and family farmers (cyclical businesses)
• Corporations that are not "moneyed, business, or commercial" — non-profits, churches, schools, charitable foundations
• Banks, insurance companies, credit unions (regulated under other insolvency regimes)
• Municipalities (only Chapter 9 is available, and it is voluntary only)

Why This Matters for Bankers

Involuntary petitions are rare in M&A practice — most distressed companies either negotiate out of court or file a voluntary Chapter 11 once they conclude a filing is inevitable. But an investment banker advising a distressed client needs to understand the creditor leverage an involuntary threat represents, especially when three or more significant creditors can credibly coordinate.

The Automatic Stay — §362

The single most powerful protection in bankruptcy law is the automatic stay under §362. The moment a petition is filed — voluntary or involuntary — virtually all collection and enforcement activity against the debtor and its property is halted by operation of law. No court order is needed. No notice to creditors is required. The stay is automatic.

What the Stay Halts

§362(a) enumerates eight categories of stayed acts. In practice, this reaches:

• Pending and new lawsuits against the debtor
• Judgment enforcement actions — garnishments, levies, attachments
• Secured-creditor foreclosures and repossessions
• Acts to create, perfect, or enforce a lien against the estate
• Setoff of pre-petition mutual debts
• Proceedings before administrative tribunals on pre-petition claims

Key Exceptions — §362(b)

The stay is broad but not absolute. §362(b) carves out:

• Criminal prosecutions against the debtor. A corporate officer cannot use the corporate bankruptcy to halt a criminal case against the officer personally.
• Most governmental regulatory and police-power actions. The SEC can continue an enforcement action, the EPA can continue environmental remediation orders, a state can continue consumer-protection litigation. Money judgments from these actions are stayed until entered, but the proceedings themselves go forward.
• Certain tax proceedings — audits, assessment of liability, and notice and demand for tax.
• Domestic support obligations (alimony, child support).

Relief from Stay

Creditors who want to proceed against estate property — typically secured lenders seeking to foreclose on depreciating collateral — must file a motion for relief from the automatic stay under §362(d). The court grants relief "for cause, including lack of adequate protection" or when the debtor has no equity in the collateral and the property is not necessary to an effective reorganization. Relief-from-stay motions are among the most frequently litigated matters in bankruptcy court.

Adequate Protection — §361

A secured creditor whose collateral is depreciating during the bankruptcy has the right to adequate protection of its interest. §361 lists three permitted forms:

• Periodic cash payments reflecting the depreciation
• Additional or replacement liens on other estate property sufficient to offset the loss
• Any other relief amounting to the "indubitable equivalent" of the creditor's interest

If adequate protection is not provided or becomes inadequate, the secured creditor can move for relief from stay, convert the case, or claim a priority administrative expense for the shortfall. Adequate protection is the linchpin of the balance between creditor rights and the debtor's breathing room.

The Absolute Priority Rule

The priority waterfall covered earlier in this lesson describes how distributions flow in a Chapter 7 liquidation. The absolute priority rule is the doctrinal twin: it governs what must happen in a Chapter 11 plan when a senior class of creditors votes against it.

The Rule Stated

Codified in §1129(b)(2)(B) for unsecured classes, the absolute priority rule provides: if an impaired class of unsecured claims does not accept the plan, no class junior to the dissenting class may receive or retain any property under the plan unless the senior dissenting class is paid in full.

Applied to common stockholders: if any senior unsecured class is impaired and rejects, equity holders get nothing. Period. An exception exists only through the narrow and contested "new value" doctrine — where equity holders contribute new, substantial, necessary capital in exchange for their interest, and the market tests the value of their contribution.

Why the Rule Exists

Without absolute priority, a Chapter 11 debtor could pay a small amount to common stockholders (typically the management and founders) to keep them in the equity structure, while short-changing senior creditors. The rule forces reorganization plans to respect pre-petition priorities — the economic entitlements creditors bargained for when they extended credit.

Linkage to Cramdown

The absolute priority rule is a specific component of the broader "fair and equitable" test in §1129(b). A plan cannot be crammed down on an impaired, dissenting unsecured class unless it satisfies absolute priority. This is why you sometimes see senior creditor classes willing to vote YES on a plan that gives equity a small distribution: consent avoids cramdown and absolute priority, which would otherwise wipe out equity entirely.

Secured Creditor Variant

For secured classes, §1129(b)(2)(A) expresses "fair and equitable" differently: the dissenting secured class must receive either deferred cash payments equal to the allowed amount of the claim, a sale of the collateral subject to credit bidding, or the indubitable equivalent of the claim. The secured-class variant is about how the secured claim is paid, not about whether junior classes can receive a distribution.

Confirming a Chapter 11 Plan — §1129

Even after all classes of creditors have voted, the court must independently confirm the plan. §1129(a) lists sixteen requirements. Most are technical, but a banker needs to understand the four that drive outcomes.

Best Interests of Creditors — §1129(a)(7)

Every dissenting member of an impaired class must receive under the plan at least as much as they would receive in a hypothetical Chapter 7 liquidation. This requires a "liquidation analysis" — a formal valuation exercise the debtor's financial advisor typically prepares for the disclosure statement. The best-interests test is a floor, not a ceiling: it benchmarks reorganization value against the liquidation alternative.

Feasibility — §1129(a)(11)

The court must find that the plan is "not likely to be followed by the liquidation, or the need for further financial reorganization, of the debtor." In plain English: the reorganized company has to be able to execute on the business plan the reorganization contemplates. Post-confirmation forecasts, projections, and exit-financing documentation all feed into this analysis.

Good Faith — §1129(a)(3)

The plan must be proposed in good faith and not by means forbidden by law. Courts rarely fail a plan on good-faith grounds, but egregious gerrymandering of classes to manufacture an impaired accepting class, or disguised preferential treatment of insiders, can doom confirmation.

Unanimous Class Acceptance or Cramdown — §1129(a)(8) and (b)

§1129(a)(8) requires that every impaired class vote to accept. If every class accepts, the plan is confirmed. If one or more classes reject, the debtor falls back to cramdown under §1129(b): the plan can still be confirmed if, as to each dissenting class, it is fair and equitable and does not discriminate unfairly against the class.

"Fair and equitable" means (for secured classes) one of the three §1129(b)(2)(A) alternatives, and (for unsecured classes) the absolute priority rule under §1129(b)(2)(B). "Does not discriminate unfairly" is a comparative test — the plan cannot treat similarly situated dissenting classes materially differently without a legitimate basis.

Class Voting Thresholds Recap — §1126

A class accepts a plan if two-thirds in dollar amount AND more than one-half in number of allowed claims that vote vote in favor. Both prongs must be satisfied; abstainers are not counted. A class that fails either test has rejected, triggering the cramdown analysis above.

Credit Bidding in §363 Sales — §363(k)

Credit bidding is a right uniquely available to secured creditors in bankruptcy asset sales. It fundamentally changes the bidding dynamics of distressed M&A and is tested regularly on the Series 79.

The Right Itself

Under §363(k), when estate property that secures an allowed secured claim is sold, the secured creditor may bid the face amount of its allowed secured claim as consideration for the collateral, instead of bidding cash. If the credit bid wins, the secured creditor takes ownership of the collateral and its claim is satisfied by the bid amount. No cash changes hands.

Why This Matters

A secured lender holding a $500 million claim on a business worth $300 million in a distressed sale has two options:

• Sit back, let the sale proceed, and accept $300 million of recovery on its $500 million claim
• Credit bid up to $500 million — outbidding any cash bid below that level — and take ownership of the business itself, potentially realizing the "gap" between the sale-day valuation and longer-term enterprise value

The credit bid is often the floor that determines whether any cash bidder can win the auction. Cash bidders must price above the secured creditor's economic breakpoint to make their bids attractive.

Limits on the Right

§363(k) permits the court to deny credit bidding "for cause." The leading Supreme Court authority — RadLAX Gateway Hotel v. Amalgamated Bank (2012) — confirmed that secured creditors cannot be denied credit bidding in a §363 sale conducted under a Chapter 11 plan simply because the debtor or a junior class prefers a different buyer. "For cause" requires something more — typically evidence that the claim amount is disputed, the lien is invalid, or the credit bidder has engaged in inequitable conduct.

Strategic Implications for Bankers

When a distressed client is shopping for assets in a §363 sale, the banker must identify whether a secured lender can credit bid. If yes, the banker's cash bid must clear the secured creditor's credit-bid level (or reach separate economic accommodation with the lender) to have any chance of winning. A secured creditor's credit-bid capacity is often decisive to deal structure.

Out-of-Court Restructuring Alternatives

Chapter 11 is expensive, slow, and publicly visible. Distressed companies and their advisors routinely consider out-of-court alternatives first. The banker's job includes identifying when an out-of-court path can work and when it cannot.

Distressed Exchange Offer

The issuer invites bondholders to swap their existing notes for new securities, typically at a discount to face and with modified economic or structural terms. A typical distressed exchange might offer:

• New notes at 70 cents on the dollar of old face amount
• A higher coupon rate on the new notes
• Security on previously unsecured debt (effectively priming non-participating holders)
• Extended maturity
• Equity "kickers" — warrants or convertibility features

The mechanism succeeds if enough bondholders participate to relieve the issuer's debt service burden. Holdout holders — those who do not exchange — can be squeezed through exit consents: participating holders amend the indenture of the old notes (typically removing covenants and collateral) as a condition of exchanging, leaving holdouts with worthless paper.

Consent Solicitation / Covenant Amendment

A lighter-touch alternative: the issuer solicits noteholder consent to amend specific indenture covenants — for example, loosening a debt-incurrence test or allowing asset sales that would otherwise be restricted. Most indentures require a majority or supermajority vote for material amendments. Consent solicitations often include a consent fee paid to consenting holders. They are cheaper and faster than full exchange offers but do not reduce principal.

Prepackaged Bankruptcy

The hybrid approach: the debtor negotiates a plan of reorganization with its major creditor constituencies before filing, solicits votes on the plan before filing, and files Chapter 11 with the voting complete and the plan ready for confirmation. A "prepack" typically closes in 30 to 45 days post-filing — far faster than a traditional Chapter 11, which averages 12 months or longer.

Prepacks combine the certainty and binding force of bankruptcy (cramdown on holdouts, automatic stay, §363 sale authority) with much of the speed and confidentiality of an out-of-court deal. The trade-off is that the debtor still files a bankruptcy case, with attendant disclosure, public scrutiny, and stigma.

Pre-Negotiated Bankruptcy (Pre-Arranged)

A lighter version of the prepack: the debtor negotiates the plan terms with key stakeholders pre-filing but does not solicit votes in advance. Voting takes place post-filing. Slightly slower than a true prepack but avoids some pre-filing solicitation compliance issues. Confirmation typically occurs in three to six months.

When Out-of-Court Cannot Work

Several situations generally require a bankruptcy filing:

• Litigation claims the company needs to discharge
• Unprofitable real-estate leases that the debtor wants to reject (only §365 in bankruptcy allows lease rejection)
• Highly fragmented bondholder bases where sufficient consent cannot realistically be obtained out of court
• Transactions requiring free-and-clear asset sales that a non-bankrupt seller cannot offer

In those situations, a bankruptcy filing is not a failure of restructuring — it is the restructuring tool itself.

Chapter Comparison — Reorganization, Liquidation, and Cross-Border

The US Bankruptcy Code has multiple chapters, each designed for a specific set of debtor circumstances. The exam focuses on the three chapters most relevant to corporate practice.

Chapter 11 Operational Mechanics

The defining operational feature of Chapter 11 is that the business continues to operate. Existing management typically serves as the debtor-in-possession (DIP), retaining authority to run the business subject to bankruptcy court oversight on major decisions. The DIP signs checks, hires and fires employees, manages inventory, and makes routine business decisions, while major actions — DIP financing, §363 asset sales, reorganization plan proposals, and material contracts — require court approval.

Chapter 7 Mechanics

Upon filing Chapter 7, the US Trustee appoints a Chapter 7 trustee who takes over the debtor's estate. The trustee:

• Takes possession of the debtor's assets
• Liquidates assets for the highest reasonable value
• Reviews claims filed by creditors
• Distributes proceeds according to the §507 priority scheme

Existing management has no continuing role. The corporation typically ceases to exist after its assets are liquidated and the proceeds distributed.

The §507 Priority Waterfall

When assets are liquidated — whether in Chapter 7 or as part of a Chapter 11 plan — the distribution follows a strict priority order:

1. Secured creditors (to extent of collateral value)
2. DIP financing (superpriority administrative claim)
3. Administrative expenses (§503 — post-petition professionals,
   wages, critical vendor payments)
4. Priority unsecured claims (§507 — wages up to cap, taxes,
   consumer deposits)
5. General unsecured creditors
6. Subordinated claims
7. Equity holders (last in line)

Equity holders are the lowest priority class in the waterfall — they receive nothing until every claim above them has been paid in full or otherwise satisfied. In most Chapter 7 liquidations and many Chapter 11 reorganizations, the waterfall breaks before reaching equity, and common shareholders recover zero.

When a Company Chooses Chapter 11 vs Chapter 7

A company with meaningful going-concern value above its liquidation value generally prefers Chapter 11 — the reorganization option preserves enterprise value, jobs, and supplier relationships that would be destroyed in a liquidation. Chapter 7 is the appropriate path when the business cannot be profitably continued even after a restructuring. Some Chapter 11 cases convert to Chapter 7 when the debtor fails to confirm a plan, runs out of DIP financing, or cannot achieve a sustainable going-concern outcome.

Debtor-in-Possession Financing

When a company enters Chapter 11, its existing cash and working capital are usually insufficient to fund continued operations throughout the restructuring process. Debtor-in-possession (DIP) financing is court-approved post-petition lending that provides the debtor with working capital to stabilize operations and fund the reorganization.

Why DIP Financing Exists

Without some form of post-petition financing, many Chapter 11 debtors would fail immediately — vendors stop shipping, payroll checks bounce, and the business liquidates in days. DIP financing solves this by providing fresh capital that is protected against the risks inherent in lending to a bankrupt entity. The protections are the key — without them, no lender would rationally extend credit to an enterprise already in default on existing obligations.

Superpriority Treatment

DIP loans typically receive superpriority administrative expense status under §364 of the Bankruptcy Code. This places DIP lenders above nearly all pre-petition creditors in the priority waterfall, including:

• Pre-petition unsecured creditors
• Pre-petition secured creditors (through §364(d) priming, if the court finds their existing liens are adequately protected)
• Other administrative claims except the court's determined superpriority status

The superpriority allows DIP lenders to be confident that their loan will be repaid in full at emergence or through asset sales before any other creditor class receives full recovery.

§364 — The Four-Tier Approval Framework

The Bankruptcy Code structures DIP financing authorization in increasing levels of lender protection, each requiring more stringent court findings:

• §364(a) — unsecured credit in the ordinary course; rarely used for real DIP facilities
• §364(b) — unsecured credit with court approval for non-ordinary course borrowing; also rarely the vehicle for meaningful DIP
• §364(c) — credit with administrative priority, liens on unencumbered property, or junior liens on already-encumbered property; appropriate when unsecured is insufficient
• §364(d) — credit with priming liens that leap ahead of existing pre-petition liens; requires a finding that existing secured creditors are adequately protected. Most aggressive structure and used when other alternatives fail.

Roll-Ups

A common DIP feature is a roll-up, where a portion of the existing pre-petition debt owed to the same lenders is "rolled up" into the post-petition DIP facility. This gives the rolled-up portion the same superpriority status as the new money. Roll-ups are controversial because they effectively convert pre-petition unsecured or lower-priority debt into superpriority debt without fresh scrutiny of value — but they are common because existing lenders often require the roll-up as a condition of providing new DIP capital.

DIP Financing Pricing

DIP loans typically bear high interest rates reflecting both the credit risk and the illiquid specialty nature of the lending. Common pricing features:

• Spread of 500–1000 bps over SOFR for larger, credit-quality DIPs
• Upfront fees of 2–5% of the commitment
• Unused commitment fees
• Success fees or other fees tied to exit or plan confirmation
• Short tenor — typically matched to the expected Chapter 11 timeline (6–18 months)

Court Approval Process

DIP financing requires court approval through a first-day motion filed at case commencement. Typical process:

• The debtor files an emergency motion for interim DIP approval at case filing — this authorizes a limited draw (e.g., $25M out of a $200M commitment) to fund immediate operations
• A full hearing on the final DIP order takes place several weeks later, after other creditors have had opportunity to object
• Committees and other parties often negotiate changes to DIP terms during this window — budget, adequate protection for pre-petition secured lenders, carve-outs for professional fees
• The final DIP order grants the full facility and its associated liens and priorities

§363 Asset Sales — Stalking Horse Mechanics

Section 363 of the Bankruptcy Code authorizes sales of estate assets outside the ordinary course of business, subject to court approval. In Chapter 11, §363 sales are the dominant mechanism for divesting business units, selling distressed assets, and (through "363 sales of substantially all assets") effectively liquidating the business in an auction format that delivers the assets free and clear of existing liens.

The Stalking Horse Bidder

Before the formal §363 auction, the debtor typically identifies an initial bidder — the stalking horse — that executes an asset purchase agreement (APA) establishing the floor price and deal terms. The stalking horse:

• Sets a credible minimum price that anchors subsequent bidding
• Conducts detailed diligence that validates the asset's value
• Negotiates representations, warranties, and closing conditions that become the template for competing bids
• Is publicly identified at the time the sale motion is filed with the court

Why the Stalking Horse Agrees to the Role

Being a stalking horse is a risky position. The bidder does substantial diligence and negotiation only to have its terms publicly revealed, then potentially outbid at auction. To compensate, the stalking horse receives court-approved bidder protections:

Reasonableness of Break-up Fees

Courts scrutinize break-up fees for reasonableness. A 10% break-up fee would be universally rejected as chilling the auction — no competing bidder would match a stalking horse price plus an extra 10%+ overbid. Standard market practice is 2–3% of the purchase price, occasionally rising to 4% in smaller transactions or when the stalking horse provided exceptional value. The court must find that the break-up fee and related protections are reasonable and necessary to induce the stalking horse's participation and that they do not unfairly chill competing bidding.

The §363 Auction Process

After the court approves the stalking horse APA and the bid procedures order:

• Debtor markets the asset broadly, soliciting competing bids from other strategic and financial buyers
• Bid deadline arrives; qualifying bids are identified
• Auction is held — typically at the law firm offices of debtor's counsel — where qualifying bidders compete in ascending-bid format
• Highest bid at the conclusion of the auction becomes the winning bid, subject to court approval at the sale hearing
• Court holds final sale hearing, typically within 1–2 weeks, to approve the winning bid and authorize closing

Free and Clear Delivery

A key advantage of §363 sales is that the court can authorize transfer of assets free and clear of all liens, claims, and interests under §363(f). The liens attach to the sale proceeds rather than the sold assets. This clean delivery is impossible in most non-bankruptcy distressed sales, where competing lien claims can complicate or block a transfer. The free-and-clear benefit is one of the main reasons companies seeking to sell distressed businesses often prefer a §363 process over an out-of-court sale.

Cramdown — Confirming a Plan Over Dissenting Creditors

A Chapter 11 plan of reorganization ordinarily requires the consent of each impaired creditor class. An impaired class accepts the plan if holders of at least two-thirds in dollar amount and one-half in number of the allowed claims in that class vote to accept. When one or more impaired classes reject the plan, the debtor can still seek confirmation through cramdown — §1129(b) — which allows the bankruptcy court to confirm the plan over those dissents if specific tests are met.

Prerequisites for Cramdown

Before cramdown is available:

• At least one impaired class must have voted to accept the plan (not counting insider votes)
• The plan must satisfy all the standard §1129(a) confirmation requirements (best interests of creditors, feasibility, good faith)
• The plan must be fair and equitable to each dissenting class
• The plan must not discriminate unfairly against any dissenting class

The Fair-and-Equitable Test

The specific content of the fair-and-equitable test depends on the class type:

Absolute Priority in Action

The absolute priority rule is the practical engine of cramdown over dissenting unsecured classes. Classic fact pattern: senior unsecured creditors receive only 60% recovery (and therefore are impaired), but the plan proposes that existing common shareholders retain their equity. Unsecured creditors vote to reject the plan. The debtor cannot cram down over their dissent because the plan violates absolute priority — a junior class (equity) is receiving property while a senior class (unsecured creditors) is not being paid in full.

The remedy is to either:

• Increase unsecured recovery to 100% (eliminating their impairment)
• Strip all equity from existing shareholders
• Negotiate acceptance from the unsecured class (e.g., through plan modifications that raise recovery to an acceptable level)
• Propose a "new value" contribution from existing shareholders providing substantial new equity capital in exchange for the retained interest (though new-value exceptions are narrowly construed)

Non-Discrimination Requirement

A plan cannot "discriminate unfairly" among similarly situated classes. If two classes of unsecured creditors with similar priority are treated differently, the plan proponent must justify the differential on reasonable grounds. Preferring trade creditors (typically unimpaired) over bondholders (impaired) is usually defensible on going-concern grounds; preferring one set of similarly situated bondholders over another typically is not.

The Single Accepting Class Requirement

Cramdown requires at least one impaired class to accept the plan, excluding any insider votes. This prevents the debtor from manufacturing acceptance by stocking a class with affiliated parties. In practice, debtors typically structure the plan to ensure a non-insider accepting class — often trade creditors or a consensual bondholder class — is available to support cramdown against other dissenting classes.

The Official Committee of Unsecured Creditors

In most Chapter 11 cases of meaningful size, the US Trustee appoints an Official Committee of Unsecured Creditors (commonly called the UCC or creditors' committee) to represent the interests of general unsecured creditors as a class.

Composition

The committee typically consists of seven members (or fewer in smaller cases), drawn from among the largest unsecured creditors of the debtor who are willing to serve. Common members include:

• Major trade vendors and suppliers with the largest unpaid invoices
• Bondholders or indenture trustees for unsecured debt
• Landlords with large lease rejection claims
• Pension funds and ERISA claimants
• Counterparties to rejected contracts with large damage claims

The committee does not include secured creditors, equity holders, or insiders. It represents only the general unsecured class — other stakeholder groups may form their own ad hoc committees but are not appointed by the US Trustee and do not have the UCC's formal status.

The Committee's Role

The committee serves several important functions:

• Fiduciary oversight — committee members owe fiduciary duties to the entire unsecured creditor body, not just their own employers or organizations
• Investigation — can investigate the debtor's pre-petition conduct, financial condition, and potential claims (including fraudulent transfers, preferences, and breach of fiduciary duty by management)
• Plan negotiation — is a key counterparty in plan of reorganization discussions; committee support greatly increases the odds of plan confirmation
• Objecting to motions — can object to DIP financing, §363 sales, executive compensation programs, or other motions the committee views as detrimental to unsecured creditors
• Information access — has broad rights to receive information about the debtor's operations and strategy

Retention of Professionals

The committee is authorized to retain its own professionals — counsel, financial advisors, and investment bankers — at the expense of the debtor's estate. These professional fees are administrative expenses paid in priority to most other claims. The committee's professional retentions require court approval and the fee applications are subject to review by the US Trustee and other parties.

Ad Hoc Committees vs Official Committee

Beyond the official UCC, other stakeholder groups often form ad hoc committees to coordinate their collective action:

• Ad hoc bondholder committees — groups of institutional holders of a specific bond class, organized informally to negotiate jointly
• Ad hoc equity committees — formed when shareholders believe they have meaningful recovery; the US Trustee may formally appoint an official equity committee in exceptional cases

Ad hoc committees do not have automatic fee coverage from the estate and typically pay their own professionals. They can apply for reimbursement as part of plan confirmation if they made a substantial contribution to the case.

Plan of Reorganization and Disclosure Statement

The path to emerging from Chapter 11 runs through two interrelated documents that together formalize the restructuring: the Plan of Reorganization and the Disclosure Statement.

Plan of Reorganization

The plan is the definitive legal document that categorizes the debtor's outstanding claims into classes and sets out the proposed treatment of each class. Required plan content includes:

• Claim classification — every claim and interest is sorted into a class; similar claims go into the same class
• Treatment of each class — what each class receives (cash, new debt, new equity, or some combination) and whether the class is impaired
• Means of implementation — how the plan will be funded (exit financing, rights offering, asset sales, operating cash flow)
• Governance and management — who will run the reorganized company; board composition; employment agreements
• Executory contracts — which contracts will be assumed and which rejected
• Discharge and injunction provisions — release of the debtor from discharged claims; channeling injunctions for certain liabilities

Impairment and Class Voting

A class is impaired if the plan alters the legal, equitable, or contractual rights of the claim. Unimpaired classes are deemed to accept automatically. Classes that receive nothing are deemed to reject automatically. Only impaired classes that are receiving something under the plan actually vote.

Acceptance by an impaired class requires votes from holders of at least two-thirds in dollar amount and more than one-half in number of the allowed claims that actually vote. Failing that threshold for any impaired class forces the debtor to either modify the plan to secure acceptance or pursue cramdown.

Disclosure Statement

The disclosure statement is the document that accompanies the solicitation of votes on the plan. Before the debtor can solicit votes, the bankruptcy court must approve the disclosure statement under §1125 as containing adequate information — sufficient detail to allow a hypothetical investor of the relevant class to make an informed judgment about the plan.

Typical disclosure statement content:

• Background on the debtor, its business, and the events leading to bankruptcy
• Detailed summary of the plan's treatment of each class with projected recoveries
• Liquidation analysis comparing plan recoveries against what creditors would receive in a Chapter 7 liquidation (for purposes of the §1129(a)(7) best-interests test)
• Feasibility analysis and financial projections for the reorganized debtor
• Summary of litigation, avoidance actions, and other claims preserved by the estate
• Risk factors associated with the plan securities and the reorganized debtor
• Tax consequences to creditors of plan implementation

Solicitation and Voting Process

After the disclosure statement is approved, ballots and the disclosure statement are sent to holders in each impaired class. The solicitation period is typically 30–60 days. Ballots are tallied and the results inform the confirmation hearing.

Confirmation Hearing

At the confirmation hearing, the court hears objections and applies the §1129 confirmation tests. If satisfied, the court enters a confirmation order and the plan becomes binding on all parties. The effective date — when plan securities are distributed and the reorganization closes — typically occurs shortly thereafter, once any remaining closing conditions are met.

Prepackaged and Pre-Arranged Plans

A prepackaged plan solicits votes before the Chapter 11 filing — the disclosure statement and ballot process occur out of court. If a creditor class accepts, the plan goes in at filing with the accepting-class vote already in hand, dramatically compressing the in-court timeline (sometimes to 30–45 days). A pre-arranged plan is intermediate — key terms are agreed with key creditors before filing, but formal voting happens after filing through the normal disclosure statement process.

Avoidance Actions — Clawing Back Pre-Petition Transfers

The Bankruptcy Code gives the debtor-in-possession (or a Chapter 7 trustee, or creditors' committee in some cases) the power to avoid — to unwind — certain pre-petition transfers that unfairly benefited particular creditors at the expense of the estate. These "avoidance actions" are a meaningful value recovery mechanism in many restructurings.

Preferences — §547

A preference is a payment or other transfer made by the debtor to a creditor shortly before bankruptcy that gives that creditor more than they would have received in a Chapter 7 distribution. The classic fact pattern: a company knows it will file in 90 days and pays down its senior trade creditors while leaving others unpaid.

Elements of a §547 preference:

• Transfer of an interest of the debtor in property
• To or for the benefit of a creditor
• For or on account of an antecedent debt (existing before the transfer)
• Made while the debtor was insolvent
• Within 90 days before filing (or one year for transfers to insiders)
• That allows the creditor to receive more than it would in a Chapter 7 distribution

Preference Defenses — §547(c)

The Code provides specific defenses that shield transfers from avoidance even when the basic elements are met:

• Contemporaneous exchange — the transfer was intended to be and was in fact a substantially contemporaneous exchange for new value (e.g., cash on delivery of goods)
• Ordinary course of business — the debt was incurred and the transfer made in the ordinary course of business between the parties or consistent with industry norms
• New value — the creditor gave new, unencumbered value after receiving the preference
• Small transfer — consumer debts under $600 or business debts under $7,575 are not avoidable

Fraudulent Transfers — §548

A fraudulent transfer is a pre-petition disposition of property for less than fair value or with intent to hinder creditors. Two types:

• Actual fraud — transfers made with actual intent to hinder, delay, or defraud creditors. Intent is proven through "badges of fraud" (transfers to insiders, concealment, near insolvency, transfer of substantial assets, retention of control)
• Constructive fraud — transfers made for less than reasonably equivalent value while the debtor was insolvent, was rendered insolvent by the transfer, was operating with unreasonably small capital, or intended to incur debts beyond its ability to pay. No intent required

§548 covers transfers made within two years before filing. State fraudulent-transfer statutes, accessible to the debtor in possession through §544(b), typically have longer lookback periods (often four to six years).

Common Fraudulent Transfer Targets

Classic transactions frequently challenged as fraudulent transfers:

• Dividend recapitalizations done shortly before insolvency that left the company with inadequate capital
• Leveraged buyouts where the debtor incurred substantial debt to fund shareholder distributions and quickly became distressed
• Spinoffs of valuable divisions to affiliates at below-market prices
• Transfers to insiders for less than fair consideration

Recovery and Strategic Use

Avoidance actions can produce meaningful recoveries — often in the tens or hundreds of millions of dollars for large Chapter 11 cases. The debtor-in-possession or a litigation trust formed under the plan typically pursues these actions post-confirmation. For defendants, avoidance-action risk is a reason to evaluate pre-filing transactions carefully in distressed situations and to ensure the protections of the §547(c) safe harbors are available.

Insider Transactions and Expanded Lookback

Transfers to insiders (officers, directors, controlling shareholders) are subject to a longer one-year preference lookback under §547(b), compared with the 90-day window for non-insiders. The rationale: insiders have better information about the debtor's financial condition and are better positioned to extract preferential treatment as insolvency approaches.