Back in August 1989, Howard Klemmer took over the presidency of Kroy Inc., a troubled $40-million manufacturer of labeling systems based in Scottsdale, Ariz. Among other problems, Kroy couldn't meet the $6 million in annual interest charges that resulted from a leveraged buyout that had taken it private in 1986. Klemmer, a turnaround specialist, tried to work out an informal payment stretch-out but ran into a roadblock: the Department of Labor named Kroy in a $35-million lawsuit because of objections to the pricing of stock in the LBO. "When our secured lender foreclosed on our note, our only choice was to reorganize under the protection of bankruptcy court," Klemmer recalls.

Kroy's general counsel, Craig Hansen of Streich & Lang, suggested the company opt for a "prepackaged bankruptcy." Companies using this strategy resolve as much of their negotiations and paperwork as possible before filing for Chapter 11 -- and get through courtroom proceedings in a small fraction of the typical 9 to 12 months.

"I wanted the company to be able to restructure itself so quickly that we wouldn't alienate anyone -- particularly our network of 500 distributors -- who'd be of vital importance to our economic well-being in the future," says Klemmer.

Such bankruptcy plans can take two forms:

1. A completely presolicited plan, in which the company receives approval for its proposed workout plan from every class of creditors before it even files for Chapter 11 bankruptcy protection.

2. A plan in which many or all of the requisite documents and pleadings have been prepared in advance, so that all that's left for the bankruptcy judge to do is to schedule meetings and plan the final financial settlement.

Of the two types of packaged bankruptcies, the first is the most effective, since there's nothing left to battle over by the time the bankruptcy plea is filed. But this type of settlement is possible only when the reorganization plan is simple and there aren't multiple layers of debt -- and all major creditors are eager for an early resolution. Klemmer and Hansen didn't believe they stood a chance of negotiating with the Labor Department and the former shareholders, who were suing the company over the LBO's pricing.

So the men opted for plan two. Klemmer figured correctly that among his creditors his likeliest potential ally -- one that was owed large sums, had a secured position, and stood to benefit the most from swift, even if partial, payments -- was First Bank System, a Minneapolis bank that held nearly $27 million worth of Kroy's senior debt.

The planning stage lasted about one month, while Klemmer divided his time between conferences with his lawyers and communications with distributors, creditors, and employees. To monitor credibility among internal and external constituencies, he created a team of five key employees that communicated to all concerned what would happen during the bankruptcy proceedings, what bankruptcy would mean to each of them, and what Kroy's overall long-term goals were.

For Kroy, the packaged bankruptcy worked like clockwork. On May 15, 1990, the day of the filing, Kroy's lawyers were able to wheel into the local courthouse two pushcarts full of prepared legal documents, photocopies attached. The judge responded by quickly setting up a calendar for the entire bankruptcy process. On August 10 the plan of reorganization was confirmed, and three months later, on November 16, the company emerged from Chapter 11.

"Not one distributor abandoned us," Klemmer says. And since then, results look good: Kroy's operating margins are on target, at about 10% of the company's $36-million revenues. n

-- Jill Andresky Fraser