Two sources familiar with the troubled energy giant's plans say

Enron

(ENE)

is preparing to seek protection under Chapter 11 of the U.S. Bankruptcy Code. The company's petition could be filed as early as tonight to a federal bankruptcy judge.

A third source who also is privy to Enron's legal strategy says the company was preparing a bankruptcy filing even before Wednesday's credit downgrade and the cancellation of its pending merger with

Dynegy

(DYN)

. That source said Wednesday's news accelerated Enron's bankruptcy plans.

Enron officials did not return repeated calls for comment.

While the Enron situation is very fluid, sources say the company may eventually seek to liquidate assets by later converting the filing to Chapter 7, the section of the bankruptcy code governing liquidations.

Companies may choose to file Chapter 11 even though the goal is liquidation, because Chapter 11 allows more control of the initial process. When a Chapter 7 is filed at the outset, the bankruptcy court appoints a trustee who assumes control of the company. Under Chapter 11, management remains in place under the supervision of the court.

In Enron's case, if liquidation is the strategy, the company could file a Chapter 11 petition to organize the liquidation process and then convert to Chapter 7, seeking liquidation and a court-appointed trustee.

One concern over such a strategy is potential preferential treatment for creditors that have close ties to Enron. A primary reason for Enron's downfall is the

cozy relationships between several partnerships established by Enron executives and the corporate parent. Any judge is likely to scrutinize the creditor-debtor relations between the partnerships and Enron.

Both

Standard & Poor's and Moody's downgraded Enron's debt to below investment grade early Wednesday after it became clear the

proposed merger with Dynegy would not occur. The downgrade triggered a covenant in Enron's borrowing agreements that requires the company to

immediately pay back $3.3 billion in debt. Including the debt of its affiliated partnerships, Enron is saddled with more than $20 billion in debt.

Enron has few choices. Without Dynegy as a partner and an investment-grade credit rating, Enron's former clients are no longer trading with Enron and are abrogating contracts under a material adverse change provision that includes language related to creditworthiness. Ironically, that is language Enron demanded in every contract.

And, frankly, it isn't clear that anyone will trade with Enron once it can operate in bankruptcy court. Bottom line: Reorganization isn't like to succeed here. Liquidation appears the only path that is currently lighted for Enron.

Christopher S. Edmonds is president of Resource Dynamics, a private financial consulting firm based in Atlanta. At time of publication, neither Edmonds nor his firm held positions in any securities mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. While Edmonds cannot provide investment advice or recommendations, he welcomes your feedback and invites you to send it to

Chris Edmonds.