Bankruptcy Code
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Netting resources
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The US Bankruptcy Code, as feared as it is venerated, is the progenitor of the Chapter 11 process, and also the legendary “safe harbor” for derivatives.
Safe harbor
The so-called “safe harbor” provisions excuse derivatives from much of the normal operation of the bankruptcy code which would usually afford an insolvent debtor some time to decide which contracts it wants to keep and which it no longer needs. If “contract” in this context, were construed as an “individual Transaction under an ISDA Master Agreement”, you can see how this might challenge close-out netting: not only would it scramble the intent of the flawed asset provision (the famed Section 2(a)(iii)), but the broken counterparty would want to keep those contracts with a value to it, and would insist its counterparty could line up as a creditor to enforce those it did not. This rather buggers up the idea of netting positive and negative values from different trasactions down to a single termination sum.
The Safe Harbor Provisions provide nondebtor counterparties to qualifying agreements with a bundle of rights, including the right to exercise contractual rights of termination and the netting of transaction termination values, as well as the ability to apply collateral to the amounts owed without regard to the automatic stay under section 362 of the Bankruptcy Code.
The safe harbor stipulates that for derivatives, the choice moves to the Non-Defaulting Party, who can choose whether to allow the debtor to keep the contract or close out.
Chapter 11
Chapter 11 of the Bankruptcy Code allows businesses to reorganise their debts while continuing to operate. A struggling business can file for “Chapter 11 bankruptcy”. Once filed, an “automatic stay” stops creditors from do anything to collect their debts, from angry phone calls to lawsuits.
The debtor typically remains in control of its operations and assets as a “debtor-in-possession” and creates a plan to restructure its debts and operations with the goal of making the business financially viable again. Creditors, and the bankruptcy court, review the debtor’s plan (the debtor may amend it in response) and eventually can vote to accept or reject it.
Acceptance
If the creditors and the court approve the plan, it becomes binding. The business then follows this plan to pay off its debts and reorganise its operations. During this time, the business continues to operate and work towards financial stability. Once the plan is completed and the business meets its obligations, it emerges from Chapter 11 bankruptcy. Ideally, the business is now on firmer financial footing.
Rejection
If creditors reject the plan but the court approves it, the court can confirm the plan through a process known as a "cramdown." This allows the plan to be approved over the objections of some creditors, provided it meets certain legal requirements.
If it becomes neither the court nor the creditors approve the plan or otherwise it becomes clear the reorganisation is not feasible, the case may be converted to a traditional bankruptcy under Chapter 7 whereupon the business's assets are liquidated, and the proceeds are used to pay creditors. Usually in the case the business is eventually dissolved.