What is a 'Prepackaged Bankruptcy'

A prepackaged bankruptcy is a plan for financial reorganization that a company prepares in cooperation with its creditors that will take effect once the company enters Chapter 11. This plan must be voted on by shareholders before the company files its petition for bankruptcy, and can result in shorter turnaround times.

BREAKING DOWN 'Prepackaged Bankruptcy'

The idea behind a prepackaged bankruptcy plan is to shorten and simplify the bankruptcy process in order to save the company money in legal and accounting fees, as well as the amount of time spent in bankruptcy protection. A proactive company in distress will notify its creditors that wishes to negotiate terms of bankruptcy before it files for protection in court. These creditors — lenders, inventory suppliers, service providers, etc. — naturally do not like the distressed situation of the company, but will work with it to minimize time and expenses associated with bankruptcy reorganizations.

The creditors are more apt to be amenable during the negotiations to rework terms since they will have a voice before the bankruptcy filing; the alternative would be a surprise and then a scramble to deal with the delinquent debtor with more uncertainty about how long the process will take. A company and its creditors can expect a resolution within a much shorter time frame under a prepackaged bankruptcy than a conventional one. Three to nine months is typical. The sooner the company can emerge from bankruptcy, the sooner it can implement its reorganization in an attempt to return to healthy business operations.

Pros and Cons of a Prepackaged Bankruptcy

As mentioned above, the advantages are savings of expenses and time. The process of entering and exiting Chapter 11 is smoother, with creditors onboard with a reorganization plan beforehand. In addition, the company can avoid some of the negative publicity that results from a longer drawn-out bankruptcy process involving creditors fighting for their claims. A prepackaged bankruptcy does have a major risk, though. If a creditor knows that a bankruptcy filing is imminent, it may take an aggressive stance in collecting from the company before the Chapter 11 filing. This may upset the intended cooperative nature of prepackaged bankruptcy negotiations. Others may follow suit, causing more financial stress on the company.

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