Toward a New Corporate Reorganization Paradigm

Chapter 11 is becoming an increasingly flexible, market‐driven forum for determining who will become the owners of financially troubled enterprises. With increasing frequency, distressed companies are sold in Chapter 11 as going concerns. At the same time, distressed investors, including hedge funds and private equity investors, are actively trading the debt of such companies in much the same way that equity investors trade the stock of solvent companies. Market forces drive the troubled company's debt obligations into the hands of those investors who value the enterprise most highly and who want to decide whether to reorganize or to sell it. One way or the other, the Chapter 11 process is used to effect an orderly transfer of control of the enterprise into new hands, whether the creditors themselves or a third party. But if the market‐oriented elements of this new reorganization process promise to increase creditor recoveries and preserve the values of corporate assets, other recent developments could present obstacles to achieving these goals. In particular, the increased complexity of corporate capital structures and investment patterns—including the issuance of second‐lien debt and the dispersion of investment risks among numerous parties through the use of derivatives and other instruments—threatens to increase inter‐creditor conflicts and reduce transparency in the restructuring process. These factors, coupled with provisions added to the Bankruptcy Code that selectively permit “opt‐out” behavior by favored constituencies, could interfere with the ability of troubled companies to reorganize as the next cycle of defaults unfolds.