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Trends that could spell the end of Chapter 11 bankruptcy

When Congress approved the current Chapter 11 bankruptcy law in the late 1970s, it was imagined that this part of the code would allow distressed businesses to leverage economic and legal interests in their companies so that they may attract buyers that would infuse money into the organization (as well as new ideas) so that the company could emerge stronger and more profitable.

With the trend of companies selling liens to their assets multiple times over, and the increasing practice of credit default swaps, Chapter 11 restructuring plans have become ever more complex. These trends may spell certain doom for companies looking towards Chapter 11 as a way to emerge from financial despair.

One trend that is increasingly popular is the practice of transferring a company’s real estate holdings into real estate investment trusts (REITs). This ostensibly allows a company to have multiple entities and individual investors benefit from the value of the property owned by a distressed company since the law requires the income generated by such property to be passed to shareholders.

From a pure bankruptcy prospective, a financially troubled company may not have many options by passing property into an REIT. But from a creditor’s perspective, this may be the ideal way to ensure that one’s rights and ability to collect remains intact.

Nevertheless, the practice of splitting the rights to a company’s assets may appear welcoming when it comes to obtaining funding and maintaining cash flow. But when it comes to protecting a creditor’s interests, it could be very risky.

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