Quick Answer
Chapter 11 has three flavors: prepackaged ("pre-pack") negotiates the plan and votes before filing (fastest); prearranged negotiates terms pre-filing via a restructuring support agreement (RSA), with votes post-filing; traditional ("free fall") negotiates entirely post-petition (slowest). A going-concern asset sale sells property free and clear of liens with court approval, via stalking-horse auction. Chapter 7 liquidates under a trustee replacing management.
This unit groups four related M&A-in-bankruptcy concepts: the three flavors of Chapter 11, the free-and-clear going-concern sale that is the fastest M&A path inside bankruptcy, and the Chapter 7 liquidation alternative.
What Are the Three Flavors of Chapter 11?
| Flavor | Plan Negotiation | Voting Timing | Typical Duration | Use Case |
|---|---|---|---|---|
| Prepackaged ("pre-pack") | Plan negotiated AND votes solicited before filing | Pre-petition | Fastest (weeks to a couple of months) | Capital-structure-only fix; high creditor consensus; minimize operational disruption |
| Prearranged (prenegotiated) | Plan terms negotiated pre-filing with key creditors via a restructuring support agreement (RSA); votes solicited post-filing | Post-petition | Moderate (a few months) | Material consensus but some classes need to be solicited under court oversight |
| Traditional ("free fall") | Plan negotiated entirely post-filing | Post-petition | Slowest (a year or more) | Operational restructuring needed; complex stakeholder dynamics; no pre-filing agreement |
The fundamental tradeoff is speed versus optionality. A pre-pack moves fast but locks in terms before filing. A traditional case takes longer but lets the debtor renegotiate operational contracts, reject leases, and reshape the business under court supervision.
Exam Tip: Gotchas
- A prepackaged Chapter 11 is far faster than a traditional Chapter 11. The speed differential is the whole point of a pre-pack; the company is in and out of bankruptcy with minimal operational disruption.
- Pre-packs work for capital-structure-only fixes. When the operating business is healthy but the debt stack is unsustainable, the holders just need a new capital structure and a pre-pack is the cleanest path. When the business itself needs work (lease rejections, operational reset), a traditional case provides the tools.
What Does a Restructuring Support Agreement (RSA) / Lock-Up Do?
The RSA is the contract that binds key creditors to support a defined plan:
- A contract between the debtor and key creditors committing those creditors to support a defined plan
- Often used in prepackaged and prearranged cases
- Typically includes milestones (filing date, disclosure statement, confirmation hearing), termination events, and a fee paid to RSA-signing creditors
- The RSA binds the signing creditors to vote in favor of the plan and to refrain from supporting any competing plan during the term of the agreement
Exam Tip: Gotchas
- An RSA can be terminated for cause. Termination events typically include missed milestones, material modifications to the plan, or other defined breaches; once terminated, the signing creditors are free to vote however they choose.
- RSA fees are a sweetener. Signing creditors typically receive a fee for committing early; this incentive is part of why an RSA can build pre-filing consensus.
How Does a Going-Concern Asset Sale (M&A in Bankruptcy) Work?
The Bankruptcy Code permits the debtor (or trustee) to sell estate property outside the ordinary course of business with bankruptcy court approval. The defining feature is the ability to sell "free and clear of liens, claims, interests, and encumbrances" if one of five statutory conditions is met:
- Applicable non-bankruptcy law permits a free-and-clear sale
- The lien-holder consents
- The sale price exceeds the aggregate value of liens against the property
- The interest is in bona fide dispute
- The lien-holder could be compelled to accept money satisfaction
Most distressed M&A sales run through a stalking-horse auction:
- Stalking horse: an initial bidder signs an asset purchase agreement with a break-up fee and expense reimbursement
- Bid procedures: court approves bidding procedures and minimum overbid increments
- Auction: held on a defined date; highest qualifying bid wins
- Sale order: approves the transaction free-and-clear
A going-concern sale is faster than plan confirmation because it skips disclosure statement approval, voting, and the confirmation hearing. The sale transfers assets to the buyer free and clear; the proceeds remain in the bankruptcy estate and are distributed later, either through a confirmed plan or a Chapter 7 conversion.
Exam Tip: Gotchas
- A going-concern asset sale is faster than a plan of reorganization. It skips disclosure statement approval, voting, and confirmation. It transfers assets to the buyer "free and clear" while leaving creditor claims with the bankruptcy estate (typically resolved later through a plan or distribution).
- The stalking horse gets a break-up fee. If a competing bidder ultimately wins the auction, the stalking horse is paid a customary break-up fee plus reimbursement of out-of-pocket expenses. The fee compensates for setting the floor price and bearing the risk of the going-concern sale process.
- "Free and clear" does NOT mean creditor claims vanish. The liens come off the assets being sold, but the underlying claims attach to the proceeds and are dealt with in the bankruptcy estate.
How Does Chapter 7 Liquidation Work?
Chapter 7 is the liquidation chapter. The defining structural differences from Chapter 11:
| Element | Chapter 7 | Chapter 11 |
|---|---|---|
| Outcome | Liquidation of assets; business ceases | Reorganization; business typically continues |
| Debtor in control? | NO: Chapter 7 trustee replaces management | YES (DIP): management continues, exceptions rare |
| Trustee role | Mandatory: liquidates estate, distributes proceeds | Rare: only on cause |
| Creditor recovery | Pro rata from liquidation proceeds in priority order | Per confirmed plan (often a mix of new debt plus equity) |
| Use case | Failed reorganization; no operational value to preserve | Going-concern value preserved; capital structure broken |
| Conversion | Can be converted to or from Chapter 11 | Same |
A Chapter 7 trustee is appointed in every Chapter 7 case (this is mandatory, unlike Chapter 11). The trustee replaces management, collects and sells assets, and distributes proceeds to creditors in priority order. The business does not continue as a going concern; the Chapter 7 case is fundamentally a wind-down.
A Chapter 11 case can be converted to Chapter 7 if reorganization fails (for example, no feasible plan can be confirmed, or losses to the estate continue). A Chapter 7 case can be converted to Chapter 11 if a going-concern reorganization becomes possible.
Exam Tip: Gotchas
- Chapter 7 trustee REPLACES management; Chapter 11 trustee REPLACES management only in rare cases. This is the structural difference between the two chapters. A Chapter 7 case has a trustee by definition; a Chapter 11 case has a trustee only when cause is shown.
- Conversion runs both directions. A Chapter 11 case can convert to Chapter 7 if reorganization fails; a Chapter 7 case can convert to Chapter 11 if going-concern value can be preserved.
What Should You Check on Exam Day?
- Can you distinguish the three flavors of Chapter 11 by when the plan is negotiated and votes are solicited (pre-pack: both before filing; prearranged: terms pre-filing via RSA, votes post-filing; traditional: everything post-filing)?
- Do you know the five statutory conditions for a free-and-clear sale, and can you name at least two (lien-holder consent, sale price exceeds aggregate liens)?
- Can you explain why a going-concern asset sale is faster than plan confirmation (it skips disclosure-statement approval, voting, and the confirmation hearing)?
- Do you know a Chapter 7 trustee always replaces management (mandatory) while a Chapter 11 trustee is appointed only for cause, and that conversion runs both directions?