Making Chapter 11 Work

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Last December, a plan calling for the participation of Applied Technology Ventures Inc. in Chapter 11 bankruptcy proceedings regarding Findex Corp. was confirmed by the U.S. Bankruptcy Court of the Central District of California. To gain this participation, ATV entered into a preliminary agreement with Findex management, the "debtor in possession." If the terms of the agreement were not ultimately met, ATV would summarily withdraw its interest -- a tough stance that gives creditors little leeway. Without another offer to keep the business operating, creditors often risk liquidation with no hope of adequate recovery.

But ATV is not the bankruptcy bully this may suggest. Understandably, as a holding company ATV attempts to carve a favorable but fair deal that doles out little immediate cash in exchange for lots of future hope. To appreciate how ATV's chips fall to various creditors, here are some of the salient episodes and arrangements in Findex's Chapter 11 adventure:

* In mid-1981, attempting to create a positive cash flow and thus attract additional equity financing, institutional investors engineered the layoff of about half of Findex's work force. Among those summarily presented with pink slips were a number of upper managers, including the two founders of the business.

* To help steer a steadier course, a new chief executive officer, with a strong background in marketing, was installed by the Findex board. He was the only member of the Findex management team to stay on when ATV took over.

* Investor interest was not forthcoming. In December 1981, when an application for accounts-receivable financing was turned down by the potential lender, when nervous distributors delayed further purchases, and as chronic lack of cash dogged its books, Findex filed for protection under Chapter 11.

* It was determined that forced liquidation of Findex assets would be insufficient to pay even secured creditors. (If a debtor is forced by creditors into Chapter 7 liquidation, the debtor can respond by filing for protection under Chapter 11, which is automatically granted -- a concept of business preservation dating back to the nineteenth century.) Management then pursued reorganization opportunities. Findex discussed possible reorganization modes with several organizations.

* Enter Applied Technology Ventures. ATV would "use its best efforts to secure and provide to and for the benefit of Findex such additional financing and lines of credit as may be required for the financing of the reorganized Findex," the disclosure statement before the court pledged.

* ATV would enable Findex to pay in full claims of Class 1, 2, and 3 creditors (those entitled to priority status, such as the Internal Revenue Service and unpaid employees), plus Class 5 creditors (unsecured claims up to $1,000).

* Class 4 creditors (secured claims) and Class 6 creditors (all other claimants) were to be satisfied out of future revenues. To supply the flow of repayment, ATV pledged to pay in 3% of the actual cash gross revenues of the business, up to a maximum of $2 million for a five-year period. The formula went as follows:

Until Class 4 claimants received half their claims, 80% of the pay-in fund would go to them and only 20% to Class 6; after that, until Class 6 claims received all of theirs, 50% would go to Class 4 claimants; thereafter, all of the pay-in would go to Class 4 claims.

Class 7 claimants (holders of unsecured subordinated notes) would get 2.5% of the common stock of the reorganized company. Class 8 (senior preferred stock owners) would get 7.5%. Class 9 (holders of junior preferred stock) and Class 10 (common stockholders) were deemed "impaired" and would get nothing.

* For its part, ATV received 80% of the common stock of the reorganized company, and it owned another business.