A bitter pill to swallow, but Chapter 11 is strong medicine for an ailing company.

• Author: GARDNER, TERRI L.

Recent headlines report employees being laid off and businesses failing. The economic downturn has affected all industries, especially manufacturing, telecommunications, dot-coins and health care. Real estate and retail businesses feel the strain, too. Will ailing individuals and businesses begin seeking a dose of bitter but often-valuable medicine: The protection of Chapter 11? The fact is Chapter 11 filings are already on the increase.

Chapter 11 of the Federal Bankruptcy Code offers corporations, partnerships and individuals an opportunity to reorganize in reaction to severe financial problems. Under court protection, the debtor must develop a feasible plan of reorganization for paying its creditors.

When a debtor files Chapter 11, almost all creditor action is stayed. This does not mean that lenders with liens on assets do not have any leverage. They do. But the Bankruptcy Code levels the playing field while the court examines in a systematic way the rights of all creditors -- not just the interests of secured lenders.

Preparing for a bankruptcy filing

It is very important for Chapter 11 debtors to have good accounting assistance to prepare financial projections. Management must develop a break-even or positive cash-flow environment quickly. The bankruptcy court will not permit sustained losses to the detriment of creditors who extend credit after the bankruptcy case is filed.

Often companies or partnerships are in need of new money to assist in post-bankruptcy operations. Many lenders are experienced in making "debtor-in-possession" loans to Chapter 11 companies. Ironically, because the bankruptcy court can provide protection to lenders that they cannot obtain in a nonbankruptcy environment, lenders often will not make the loan until the debtor files Chapter 11.

During the Chapter 11 case, all payments to prebankruptcy unsecured creditors must cease and interest will not accrue on unsecured debt. Payments to fully secured creditors and lessors must generally continue unless the collateral or leased property is abandoned to the creditor.

Under the protection of Chapter 11, a debtor is able to reject contracts that are not economically feasible and get a break on the damages it must pay for breach of contract. For example, burdensome equipment leases and employment agreements can be rejected, and the damages are treated as pre-petition unsecured debt. Another section of the Bankruptcy Code is particularly attractive to retail businesses...