What Is 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. The aim of a prepackaged bankruptcy—which must be voted on by shareholders before the company files its petition for bankruptcy—is to save expenses and shorten the turnaround time to emerge from bankruptcy.

Key Takeaways

  • A prepackaged bankruptcy is a strategy to emerge from bankruptcy by negotiating with creditors in advance of Chapter 11 proceedings.
  • The goal of such a plan—which must be approved by shareholders and a court—is to speed up the overall time a company is under bankruptcy protection.
  • Some creditors, however, may take advantage of being forewarned of an imminent bankruptcy and become uncooperative, undermining the goal of being prepackaged.

How Prepackaged Bankruptcy Works

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 wish to negotiate terms of bankruptcy before it files for protection in court.

These creditors—lenders, inventory suppliers, service providers—naturally do not like the distressed situation of the company, but will work with it to minimize time and expenses associated with bankruptcy reorganizations. Creditors are more likely 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.

The Coronavirus Aid, Relief, and Economic Security (CARES) Act, signed into law March 27, 2020, raised the Chapter 11 subchapter V debt limit, which was designed to make bankruptcy easier for small businesses. The limit was raised to $7.5 million from $2.7 million, applies to bankruptcies filed after the CARES Act was enacted, and sunsets one year later.

Advantages and Disadvantages of Prepackaged Bankruptcy

As mentioned above, the advantages include saving expenses and time. The process of entering and exiting Chapter 11 is smoother, with creditors on board 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, however. 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.

Two-thirds

The number of shareholders needed to approve a prepackaged bankruptcy plan before it can be implemented.

Real World Examples of Prepackaged Bankruptcies

Retailers Neiman Marcus and J. Crew filed for Chapter 11 bankruptcy protection with prepackaged plans in May 2020, following the coronavirus pandemic lockdown.  Both were already saddled with major debt from leveraged buyouts before the pandemic hit and exacerbated the situation. Each continues to operate while prepackaged plans are implemented to reduce their debt burden.