What happens when a financial-services firm declares bankruptcy?

The sunset of Lehman Brothers Holding Inc.'s distinguished Wall Street tenure began with a Chapter 11 bankruptcy filing at 1:45 a.m. EST today. And yet U.S. brokerages, including those owned by Lehman, are expressly forbidden from filing for Chapter 11. How was Lehman able to do this, and how exactly does a financial-services firm declare bankruptcy?

There are two main forms of bankruptcy in the United States. Chapter 7 is the walkaway-a bankruptcy trustee gathers and sells your (or your company's) assets, giving the debtor a chance to start anew, though with a painful legacy. Chapter 11 is the second chance-firms file a reorganization plan with a bankruptcy court and get an "automatic stay" against immediate collection of debts. Companies can emerge from bankruptcy and continue doing business: Indeed, since 2001 companies representing much of the U.S. airline industry have been under bankruptcy protection at some point. Chapter 7s are more common: There were more than 500,000 nonbusiness Chapter 7s in 2007, with 18,751 business Chapter 7s and 5,736 business Chapter 11s.

Why can't brokerage firms file to reorganize? Brokers act as intermediaries for the common investor. The relationship, the whole quality of the business, is based on trust. Any reorganization could threaten that relationship, and that makes governments wary.

Even so, a large brokerage would generally file for Chapter 7 only if malfeasance is involved; its holdings (such as they are) are buyers' cash, which are protected-the brokerages themselves don't generally own the securities they buy on behalf of their agents.

So how did Lehman manage to file for Chapter 11? It has separated out its businesses. Lehman Brothers Inc., the firm's brokerage arm, is expressly not included in the filing, and Monday afternoon's news reports suggest there may still be outside investor interest in the brokerage arm.

Is Lehman Brothers Holding Inc. - the parent company - in the clear because it can reorganize under Chapter 11? Not likely. The company's situation has been deteriorating all summer. Its bankruptcy filing lists a whopping $613 billion in debts, with $639 billion in assets. Such large assets may create the illusion that Lehman can cover its debts, but many Chapter 11 protections aren't relevant to Lehman's situation. For instance, that automatic stay against debt collection? The law says it doesn't apply to derivatives, swaps, and other sophisticated contracts that have flourished in the past two decades. Those contracts can be canceled. Lehman's bankruptcy filing says it owes $188 billion-almost one-third of its overall debt load-in "tri-party repurchase agreements," which are also likely to be excluded from a Chapter 11-mandated stay.