What Is a Reorganization?
A reorganization is a dynamic transformation of a troubled business aimed at restoring it to profitability. This process may involve closing or selling divisions, changing management, cutting budgets, and laying off workers.
A supervised reorganization is central to the Chapter 11 bankruptcy process, where a company submits a plan to recover and repay its obligations, at least in part.
Understanding Reorganization
The role of a bankruptcy court is to allow an insolvent company to submit a reorganization plan. Upon approval, the company can continue operating and defer its most urgent debts.
Key Points
- Chapter 11 bankruptcy focuses on court-supervised reorganization to revive a company and enable it to manage its debts.
- A financially troubled but not bankrupt company may still pursue reorganization to revive its business.
- Reorganization involves significant operational and management changes and strict cost-cutting measures.
To gain approval from a bankruptcy judge, the reorganization plan must include drastic measures to cut costs and boost revenue. If rejected or unsuccessful, the company faces liquidation, with assets sold off to pay creditors.
Reorganization requires a restatement of the company’s assets and liabilities and negotiations with major creditors to restructure repayment schedules.
Drastic Changes in Reorganization
Reorganization may involve changing the company’s structure or ownership through mergers, spinoffs, acquisitions, recapitalization, name changes, or management changes. This aspect is known as restructuring.
While a reorganization to prevent bankruptcy can favor shareholders, one set during bankruptcy usually adversely impacts them.
Not all reorganizations involve bankruptcy court supervision. Sometimes, management of an unprofitable company undertakes drastic budget cuts, layoffs, management exchanges, and product line modifications to avoid bankruptcy. This is known as structural reorganization.
Supervised Reorganization
During bankruptcy proceedings, supervised reorganization aims to restructure the company’s finances and operations. The company is shielded from full repayment demands by creditors temporarily.
With approval from the bankruptcy court, the company restructures its fundamentals and addresses its revised payment schedule to creditors.
Chapter 11 vs. Chapter 7
U.S. bankruptcy law offers public companies the option to reorganize instead of liquidate. Under Chapter 11 bankruptcy, firms can renegotiate debts to secure better terms, continuing business operations to repay debts.
Conversely, firms without hope of reorganization undergo Chapter 7 bankruptcy, resulting in liquidation.
Who Loses During Reorganization?
Both shareholders and creditors typically experience losses during court-supervised reorganization. Shareholders may see their shares wiped out even if the company successfully reorganizes and issues new shares.
In a failed reorganization leading to liquidation, assets are sold off. Shareholders receive payouts only after creditors, senior lenders, bondholders, and preferred stock shareholders, if any residual funds remain.
Structural Reorganization
For companies facing trouble but not yet bankrupt, reorganization often signals positive changes for shareholders. It focuses on enhancing performance rather than merely fending off creditors and often follows the appointment of a new CEO.
In some cases, an initial structural reorganization might precede a Chapter 11 reorganization if initial efforts fail. A company may use strategies like mergers or acquisitions prior to seeking formal bankruptcy court reorganization.
Related Terms: restatement, creditors, recapitalization, Chapter 7 bankruptcy, shareholders, preferred stock.
