MT Masterclass - Chapter 11

What is it? Chapter 11 of the US Bankruptcy Code allows a company in severe difficulties to reorganise and restructure, leaving existing management in place instead of being removed by its creditors. It is very different from the European approach, where creditors pull the plug much earlier.

Cynics suggest that Chapter 11 has become a device for bludgeoning the workforce with the support of the bankers. During the process, management draws on 'debtor in possession' finance, giving them time to carry out restructuring, but without dragging out the process indefinitely. In this way, the legislation helps businesses deal with problems that elsewhere are left to governments.

Where did it come from? The Land of the Free introduced its Bankruptcy Act in 1898, and Chapter 11 descends from that legislation. Its 'pro-debtor bias' has given US businesses time and space to drive through change without going under. It has arguably supported their risk-taking culture, and encouraged entrepreneurship and more dynamic economic growth across the US. But Chapter 11 has also been exploited, most obviously by US airlines, who have hidden behind its terms and conditions to slash costs and cut debt. Outgoing BA chief Sir Rod Eddington has suggested America be renamed 'the Land of the Free Ride'.

Where is it going? In October, the US government announced a tightening of Chapter 11 practices. An 18-month time limit has been put on management's right to control restructuring, preventing the drawn-out use of Chapter 11 protection. It now stops firms paying managers huge bonuses just for carrying out the necessary restructurings. But the amendments threaten a cultural change in US business: some fear a shift to a more European style of bankruptcy; others worry about missing out on large advisers' fees.

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