This chapter examined what happens when firms experience financial distress.
Financial distress is a situation where a firm's operating cash flow is not sufficient to cover contractual obligations. Financially distressed firms are often forced to take corrective action and undergo financial restructuring. Financial restructuring involves exchanging new financial claims for old ones.
Financial restructuring can be accomplished with a private workout or formal bankruptcy. Financial restructuring can involve liquidation or reorganization. However, liquidation is not common.
Corporate bankruptcy involves Chapter 7 liquidation or Chapter 11 reorganization. An essential feature of the U.S. bankruptcy code is the absolute priority rule. The absolute priority rule states that senior creditors are paid in full before junior creditors receive anything. However, in practice the absolute priority rule is often violated.
A new form of financial restructuring is prepackaged bankruptcy. It is a hybrid of a private workout and formal bankruptcy.
