Bankruptcy in 2004, Interstate Bakeries,

Bankruptcy In 2004, Interstate Bakeries, the maker of well-known food products such as Twinkies and Wonder Bread, filed for Chapter 11 bankruptcy reorganization. The move was necessitated by rapidly growing expenses and market share losses resulting from the company's slow reaction to America's low-carb craze (Twitty). The company still had some strong brands and the ability to make money, but its debt position would make it nearly impossible to fund the types of new products, growth initiatives and reforms needed to put the company on solid footing again (Twitty).

Although Interstate had several options at its disposal to reduce debt and generate cash, ultimately Chapter 11 bankruptcy allowed Interstate to address its debt and cost problems without having to mortgage the company's future through overly deep cuts or sell-offs. Types of bankruptcy The biggest misconception about Chapter 11 bankruptcy is that the filing company is ceasing operations. Rather, Chapter 11 is a bankruptcy process that involves a corporate reorganization that is overseen by a court.

Companies tend to file for Chapter 11 when they have an opportunity to be successful if they are able to reduce their debt and restructure their operations (Corporate bankruptcy). Several major American airlines, for example, have gone through the Chapter 11 process and emerged from bankruptcy as much healthier entities. In a Chapter 11 bankruptcy process, the court and a company's debtors will approve a reorganization plan that, among other things, determines how much various creditors get paid (Corporate bankruptcy). There are two classes of competitors: secured and unsecured.

The secured creditors, such as banks, get paid first; the unsecured creditors, such as vendors, may get only pennies on the dollar. Chapter 11 sometimes allows companies to restructure contracts, such as union deals, which was a big problem for Interstate (Twitty). At any rate, companies emerge from Chapter 11 with a much better debt and cash-flow picture. Municipal organizations, such as cities or school districts, have a form of bankruptcy similar to Chapter 11, which is called Chapter 9 bankruptcy.

Chapter 9 bankruptcy allows a municipal entity to restructure its debt and reorganize its operations, similar to Chapter 11 (Francis). Chapter 9 filings are much more rare, as municipal entities have the power to raise money at will through taxation. Chapters 12 and 13 are bankruptcy reorganizations, similar to Chapters 9 and 11, for farms and individuals, respectively (Francis). Chapter 7 bankruptcy, in contrast to the other types of bankruptcy discussed, is completely liquidation-oriented (Francis). In the case of Chapter 7 bankruptcy, a company's assets will be sold off to pay creditors, and the company will cease to operate.

A trustee will be appointed to oversee the sale. As a private entity, Interstate essentially had a choice between Chapter 11 and Chapter 7 bankruptcy. Because the company was confident it could succeed if it restructured and achieved a level of debt relief, it elected for Chapter 11. Alternatives to Chapter 11: Pros and Cons Interstate, of course, had other options it could consider for improving its cash-flow situation. Whether any of those options would have offered all the benefits of Chapter 11 filing is debatable.

First, Interstate could have restructured its debt with lending institutions and its vendors. By extending the terms of a $10,000-a-month loan and reducing the payment to $6,000, for example, Interstate frees up $4,000 a month in cash flow. Similarly, establishing payment plans with vendors may help reduce monthly costs and free up extra cash. The benefit of such restructuring is that it would allow the company to avoid the highly invasive Chapter 11 process, where there is a loss of control as creditors and a court get to weigh in on company operations.

The downside of debt restructuring is that Interstate would still have to pay its debts in full, and quite likely much more in the long run, as interest accrues. Another option for Interstate would be to find ways to free up or generate extra cash. The company could sell assets, particularly assets that are not critical to core operations, or lay off some of its workforce.

The advantage of this process is that it can improve cash flow without accruing additional debt, and Interstate did pursue these options on a limited basis (Twitty). The downside is that the company is essentially mortgaging its future by disposing of human and capital resources. If the company feels that debt levels are the only real problem, it might not make sense to aggressively shed resources the company could use to grow. Finally, Interstate has the option of selling its business completely.

Perhaps a company with a stronger balance sheet could manage Interstate and pay down its debt. If the purchaser is from the same industry as Interstate, there may be overlap and synergies that would allow staff cuts or the sale of factories or equipment. The downside, of course, is Interstate management would be surrendering control of the company and shareholders would have to approve the deal. In short, Interstate had other options for generating more cash or perhaps reducing monthly debt levels.

However, all of these options provided trade-offs that company management was unwilling to make. Company management felt like it had a solid business if debt levels could be reduced. Chapter 11 provided a way to reduce those debt levels without.