Debt Financing and Bankruptcy

Bankruptcy

Debt financing and bankruptcy

Bankruptcy: Chapter 11 versus other forms of bankruptcy

Thanks in part to concerns about childhood obesity, the low-carb diet craze, and changing consumer tastes, Interstate Bakeries Corp filed for Chapter 11 Bankruptcy in 2004. When the company did so, it was said that although the company was undergoing "reorganization and installed new management...it intended to survive. The company will continue operating its bakeries, outlet stores and distribution centers, and analysts said that its famous brands are unlikely to disappear from store shelves" (Twinkie and Wonder Bread maker files for bankruptcy, 2004, Katu). Hostess was one of Interstate's signature brands. The company showcases a wide range of products, although all fall into the same, relatively undiversified category of baked, sugary goods.

Upon reading that its products would still be offered in stores, consumers might be somewhat confused. How can a company go bankrupt, yet leave supplies of their beloved Twinkies and Wonder Bread and other signature high-sugar, highly processed products untouched? However, Chapter 11 bankruptcy does not mean that the company is defunct. It is more of a form of reorganization rather than dissolution. Chapter 11 refers to the "chapter of the Bankruptcy Code providing (generally) for reorganization, usually involving a corporation or partnership" (Chapter 11, 2012, U.S. Courts). However, individuals as well as corporations can file for Chapter 11.

Other common types of bankruptcy include Chapter 7, which is most commonly used by individuals. "This type of bankruptcy is the most severe. Under Chapter 7, a court-appointed trustee collects the individual's assets. The trustee sells the assets for cash and pays the proceeds to the individual's creditors. Assets that are exempt under federal or state law do not have to be liquidated. Once the Chapter 7 process is final, the filing cannot be repeated for six years" (Types of bankruptcy, 2012, Bankruptcy law). In contrast, Chapter 13 is for an individual or small business "with a steady source of income" (Types of bankruptcy, 2012, Bankruptcy law). Chapter 13 is an "individual reorganization," in which "the debtor must settle his debts over a three to five-year period" (Types of bankruptcy, 2012, Bankruptcy law). The debtor is allowed to retain his or her property, and there are no restrictions regarding when Chapter 13 can be filled. Chapter 11 is thus similar to Chapter 13, but is more commonly used by large businesses and the proceedings put more requirements on the debtor.

The company's options were relatively limited. Ideally, Interstate Bakeries would have preferred to reach an out-of-court settlement with its debtors, but this was not feasible. Liquidation through Chapter 7 would have meant shutting the company down -- and emptying the shelves of the Hostess treats consumers were so worried about losing when they heard the news. Almost always, "when an out-of-court solution is not practical but the company has value as an operating business, it will usually opt for Chapter 11 bankruptcy, in which management remains in control to reorganize the company" (What every CEO should know about filing Chapter 11, 2012, Schreiber Law).

Chapter 11 bankruptcy proceedings place certain limitations on specific company actions, such as "any transaction out of the ordinary course of business, any financing other than accepting ordinary trade credit, employee incentive plans tailored to the Chapter 11 case, and any retention or payment of lawyers or other professionals" (What every CEO should know about filing Chapter 11, 2012, Schreiber Law). However, the company can continue to employ and pay its employees and produce its products and services. This ensures that demand can be sustained for the company, even during the proceedings. Completely shutting down the company would only exacerbate the problem of falling-off demand for Hostess products, given that consumers would likely shift their buying patterns elsewhere.

Chapter 11 bankruptcy petitions can be voluntary or involuntary. A voluntary case is filed by the company; an involuntary petition is filed by creditors. In the case of Interstate, the company "listed assets of $1.6 billion and liabilities of $1.3 billion in its court filings" (Twinkie and Wonder Bread maker files for bankruptcy, 2012, Katu). Its current CEO resigned during the filing and prior to the filing, in an effort to avoid bankruptcy, the company had already laid off 800 employees and closed several bakeries. Reorganization was needed given that the company had to "renegotiate union contracts," close more underperforming bankruptcies, and fundamentally create a new mission for a company that had been sluggish in its response to changing consumer preferences, most notably "a market that is less tolerant of sugar and carbohydrates" (Twinkie and Wonder Bread maker files for bankruptcy, 2012, Katu).

As a corporation, the only assets under consideration in Interstate's Chapter 11 proceedings were that of its shareholders. "A corporation exists separate and apart from its owners, the stockholders. The Chapter 11 bankruptcy case of a corporation (corporation as debtor) does not put the personal assets of the stockholders at risk other than the value of their investment in the company's stock" (Twinkie and Wonder Bread maker files for bankruptcy, 2012, Katu). However, once a company enters bankruptcy, it now has a legal obligation to its creditors not simply its stockholders: "if the company's real value is less than the amount of its debts, then creditors have replaced stockholders as the residual risk-bearers of the company" (What every CEO should know about filing Chapter 11, 2012, Schreiber Law

Interstate ultimately emerged from bankruptcy in 2009, but even this was not enough to solve the company's persistent problems. In 2012, Hostess, one of its subsidiaries and its most famous brand, "said that its previous efforts to produce incremental change, including the prior bankruptcy case, were insufficient" (Twinkie manufacturer goes bankrupt as U.S. becomes more health-conscious, 2012, Daily Mail). It once again entered Chapter 11 bankruptcy, and yet again stated "it does not expect disruptions in the manufacturing and delivery of its products during the bankruptcy process" (Twinkie manufacturer goes bankrupt as U.S. becomes more health-conscious, 2012, Daily Mail).