The Hidden Virtues of Chapter 11: An Overview of the Law and Economics of Financially Distressed Firms

Abstract

Chapter 11 shares many of its features with legal regimes in other jurisdictions. Nevertheless, Chapter 11 gives managers of a financially distressed firm an unparalleled ability to control the reshaping of the firm’s capital structure.1 The managers of finan-cially distressed firms are the ones who typically begin the Chapter 11 process.2 Once the process is begun, the debt-collective efforts of all creditors—including secured creditors—must cease. Payments to creditors cease as well. The managers continue to run the day-to-day operation of the business. With court approval, they can borrow new funds and give these funds a priority over existing general creditors.3 In most cases, the managers also control the process of reorganization and are the only ones entitled to present a reorgani-