Bankruptcy is a federal court procedure conducted under the Code. The goals of bankruptcy are to give individuals and businesses a “fresh start” by eliminating or restructuring debts they cannot fully repay and help creditors receive some payment in an equitable manner. The filing of a voluntary bankruptcy petition operates as an “automatic stay” that generally stops lawsuits, foreclosures, and most other collection activities against the debtor, allowing the debtor time to eliminate or restructure its debts. In bankruptcy, equitable treatment of creditors means that all creditors with substantially similar claims shall be classified similarly and receive the same treatment. For example, a class of secured creditors — those with liens or other secured claims against the debtor’s property— will receive similar treatment. Secured creditors are more likely to get some debt repaid than general unsecured creditors, and creditors generally receive payment of their debts before shareholders receive any return of their equity in the failed company. Business debtors that are eligible for protection under the Code may qualify for liquidation, governed primarily by Chapter 7 of the Code, or reorganization, governed by Chapter 11. Proceedings under both Chapters 7 and 11 can be voluntary (initiated by the debtor) or involuntary (generally initiated by at least three creditors). However, in an involuntary proceeding, the debtor can defend against the proceeding, including presenting objections within 21 days of being served the summons of the proceeding. The judge subsequently decides whether to grant the creditors’ request and permit the bankruptcy to proceed, dismiss the request, or enter any other appropriate order. A reorganization proceeding under Chapter 11 allows debtors, such as commercial enterprises, to continue some or all of their operations as a way to satisfy creditor claims. The debtor typically remains in control of its assets, and is called a debtor-in-possession (DIP). The court also, under certain circumstances, can direct the U.S. Trustee to appoint a Chapter 11 trustee to take over the affairs of the debtor. As shown in figure 1, a firm going through a Chapter 11 bankruptcy generally will pass through several stages. Each stage of the Chapter 11 process has key attributes: First-day motions. The most common first-day motions relate to the continued operation of the debtor’s business and involve matters such as requests to use cash collateral—liquid assets on which secured creditors have a lien or claim—and obtaining financing, if any. They may include a motion to pay the prebankruptcy claims of critical vendors—those deemed vital to the debtor’s continued business operations. Disclosure. The disclosure statement filed after the bankruptcy petition filing must include information on the debtor’s assets, liabilities, and business affairs sufficient to enable creditors to make informed judgments about how to vote on the debtor’s plan of reorganization and must be approved by the bankruptcy court. Plan of Reorganization. A debtor has an exclusive right to file a plan of reorganization within the first 120 days of bankruptcy. The court may not confirm the plan unless a sufficient proportion of allowed creditors has accepted the plan or would not be impaired by the plan. The court’s approval also depends on whether there are dissenting classes of creditors. If a plan has not been filed by the debtor within 120 days or accepted by a sufficient number of creditors after 180 days, any interested party—including creditors—may file a plan. The plan divides creditors into classes, prioritizing payments to creditors. Reorganization. Possible Chapter 11 outcomes, which can be used in combination, include (1) sale of the company (in whole or in part), which is sometimes called a section 363 sale because that section of the Code applies to sales that are free and clear of creditor claims and interests; (2) liquidation of the company’s assets with the approval of the court through means other than a 363 sale; and (3) actual reorganization of the company in which it emerges from bankruptcy with new contractual rights and obligations that replace or supersede those it had before filing for bankruptcy. The debtor, creditors, trustee, or other interested parties, may initiate adversary proceedings—in effect, a lawsuit within the bankruptcy case to preserve or recover money or property to subordinate a claim of another creditor to their own claims, or for similar reasons. Furthermore, the Chapter 11 trustee or others may bring a preference action (a type of avoidance action) challenging certain payments made by a debtor to a creditor generally within 90 days prior to the bankruptcy filing. In addition, fraudulent avoidance actions generally can be taken on transfers made within 2 years prior to a bankruptcy if payments are determined to be fraudulent. As such, an avoidance action can question the payment as a preferential or fraudulent transfer of assets and require payments to be returned to the debtor. Large, complex financial companies that are eligible to file for bankruptcy generally file under Chapter 11 of the Code. Such companies operating in the United States engage in a broad range of financial services including commercial banking, investment banking, securities and commodities trading, derivatives transactions, and insurance. Many of them are organized under both U.S. and foreign laws. The U.S. legal structure is frequently premised upon the ownership by a parent holding company of various regulated subsidiaries (such as depository institutions, insurance companies, broker-dealers, and commodity brokers) and other nonregulated subsidiaries that engage in a variety of financial activities. Many of these businesses have centralized business lines and operations that may be housed in a holding company or in one or more subsidiaries. Smaller banking institutions also are organized as holding companies, but many of these hold few, if any, assets outside a depository institution and generally engage in a narrower range of activities. Certain financial institutions may not file as debtors under the Code and other entities face special restrictions in using the Code: Insured depository institutions. Under the Federal Deposit Insurance Act, FDIC serves as the conservator or receiver for insured depository institutions placed into conservatorship or receivership under applicable law. Insurance companies. Insurers generally are subject to oversight by state insurance commissioners, who have the authority to place them into conservatorship, rehabilitation, or receivership. Broker-dealers. Broker-dealers can be liquidated under the Securities Investor Protection Act (SIPA) or under a special subchapter of Chapter 7 of the Code. However, broker-dealers may not file for reorganization under Chapter 11. Commodity brokers. Commodity brokers, also known as futures commission merchants, are restricted to using only a special subchapter of Chapter 7 for bankruptcy relief. Regulators often play a role in financial company bankruptcies. With the exception of CFTC and SEC, the Code does not explicitly name federal financial regulators as a party of interest with a right to be heard before the court. In practice, regulators frequently appear before the court in financial company bankruptcies. For example, as receiver of failed insured depository institutions, FDIC’s role in bankruptcies of bank holding companies is typically limited to that of creditor. CFTC has the express right to be heard and raise any issues in a case under Chapter 7. SEC has the same rights in a case under Chapter 11. SEC may become involved in a bankruptcy particularly if there are issues related to disclosure or the issuance of new securities. SEC and CFTC also are involved in Chapter 7 bankruptcies of broker-dealers and commodity brokers. In the event of a broker-dealer liquidation, pursuant to the SIPA, the bankruptcy court retains jurisdiction over the case and a trustee, selected by the Securities Investor Protection Corporation (SIPC), typically administers the case. SEC may join any SIPA proceeding as a party. The Code does not restrict the federal government from providing DIP financing to a firm in bankruptcy, and in certain cases it has provided such funding, as it did in the bankruptcies of General Motors and Chrysler with financing under the Troubled Asset Relief Program (TARP). The authority to make new financial commitments under TARP terminated on October 3, 2010. In July 2010, the Dodd-Frank Act amended section 13(3) of the Federal Reserve Act to prohibit the establishment of an emergency lending program or facility for the purpose of assisting a single and specific company to avoid bankruptcy. Nevertheless, the Federal Reserve may design emergency lending programs or facilities for the purpose of providing liquidity to the financial system. The federal government also has provided financial support to companies who later declared bankruptcy. For example, CIT Group, Inc. received funding from TARP in 2008. CIT subsequently declared bankruptcy under Chapter 11 in 2009 and was reorganized. Although the automatic stay generally preserves assets and prevents creditors from taking company assets in payment of debts before a case is resolved and assets are distributed in a systematic way, it is subject to exceptions, one of which can be particularly important in a financial institution bankruptcy. Commonly referred to as a safe harbor, this exception pertains to certain financial and derivative contracts, often referred to as qualified financial contracts (QFC). The types of contracts eligible for the safe harbors are defined in the Code. They include derivative financial products, such as forward contracts and swap agreements that financial companies (and certain individuals and nonfinancial companies) use to hedge against losses from other transactions or speculate on the likelihood of future economic developments. Repurchase agreements, collateralized instruments that provide short-term financing for financial companies and others, also generally receive safe-harbor treatment. Safe-harbor treatment was first added to the Code in 1982 for forward contracts, commodity contracts, and securities contracts. In a recent change, the Code’s definition of repurchase agreements was expanded (in 2005) to include, among other things, agreements for the transfer of mortgage related securities, mortgage loans, interests in mortgage- related securities or mortgage loans, and government securities issued by countries that are members of the Organisation of Economic and Co- operation and Development, thereby expanding the scope of contracts subject to the safe-harbor treatment.