Chapter 7 vs Chapter 11, Explained
The question
Compare Chapter 7 and Chapter 11. What is the automatic stay, what is a debtor-in-possession, and why do most large corporate cases file Chapter 11 rather than Chapter 7?
General educational practice only. This is not an actual, confidential, leaked, or firm-provided interview question. Check important technical details against primary learning materials.
The answer
Chapter 7 is a liquidation: a trustee sells the assets and distributes the cash down the priority waterfall, used when the business is worth more dead than alive. Chapter 11 is a reorganization where the company keeps operating as a debtor-in-possession, meaning existing management stays and runs the business, while it negotiates a plan to fix its balance sheet.
The automatic stay freezes everything the instant the company files. All collection actions, lawsuits, and foreclosures stop, giving the company breathing room so creditors cannot grab assets during the case. A debtor-in-possession is exactly that, the company itself continuing to run under its current management through the bankruptcy.
Most large corporate cases file Chapter 11 rather than Chapter 7 because these are viable going concerns that are simply over-levered. Chapter 11 lets them stay alive, preserve going-concern value, and restructure the debt, whereas Chapter 7 would destroy that value by selling the business piecemeal.
Balance sheet
| Cash | 150 |
| Accounts receivable | 120 |
| Inventory | 90 |
| Total current assets | 360 |
| PP&E, net | 400 |
| Goodwill | 150 |
| Other assets | 40 |
| Total assets | 950 |
| Accounts payable | 80 |
| Deferred revenue | 40 |
| Total current liabilities | 120 |
| Long-term debt | 380 |
| Total liabilities | 500 |
| Total equity | 450 |
| Total liabilities & equity | 950 |
Also asked as
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- Recite the priority-of-claims waterfall from top to bottom and state the absolute priority rule. Where do secured claims, DIP financing, administrative claims, unsecured bonds, subordinated debt, and equity each sit?
- Define the fulcrum security. Explain how you locate it given a capital structure and a reorganized enterprise value, and why it matters: specifically, what happens to the fulcrum holders in a reorganization.
- Explain the holdout problem in an out-of-court restructuring, and how Chapter 11's class-voting and cramdown mechanics solve it. What are the voting thresholds for a class to accept a plan, and what is a pre-pack?
- A company has $250M first-lien, $200M senior unsecured, and $150M sub notes. Reorganized enterprise value is estimated at $360M. Identify the fulcrum security, compute its recovery, and state what each tranche and old equity receive.
- What is DIP financing and why does it get superpriority? Why do distressed lenders compete to provide it, and how does a 363 sale with a stalking-horse bidder work, including credit bidding?
- Two bonds sit pari passu in a capital structure yet recover very differently in bankruptcy. Explain how liability management transactions (specifically a drop-down and an uptier) can cause this, using J.Crew and Serta as reference points, and explain how this changes the way you diligence a distressed bond.
- A company reorganizes with EV of $600M. Above the equity: $350M first-lien secured, $200M senior unsecured, $150M sub notes. Two creditor groups hire bankers who dispute the valuation: one argues EV is really $480M, the other $760M. Identify who argues which number and why, compute the fulcrum and recoveries under both valuations, and explain how the outcome (who owns the reorganized company) changes across the two cases.
- A company files with reorg EV of $700M and an $80M superpriority DIP. Pre-petition claims: $400M first-lien term loan secured by collateral appraised at $520M, at an 8% all-in rate; $250M senior unsecured; $120M sub notes. The case runs 18 months and the oversecured first-lien accrues post-petition interest plus an assumed $25M make-whole. Compute the naive fulcrum ignoring the DIP and accruals, then re-run the waterfall accounting for the DIP superpriority and the grown first-lien claim, and identify the true fulcrum and its recovery.
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The rest of this topic
Distress, bankruptcy and recoveries