Blockbuster Inc., the world’s largest movie-rental chain, hired legal counsel to explore a possible bankruptcy filing, a person familiar with the situation said. Blockbuster fell as much as 86 percent before trading was halted.

Kirkland & Ellis LLP was asked to evaluate restructuring options for the company, which may include a “pre-packaged” or “pre-arranged bankruptcy,” in which much of the restructuring work is completed out of court, the person said. A pre-packaged filing is more advanced than a pre-arranged bankruptcy as it includes agreements from creditors about the outcome of the company’s reorganization.

“We’ve hired them for refinancing and capital raising initiatives,” said Karen Raskopf, a Blockbuster spokeswoman. “We do not intend to file for bankruptcy.”

Blockbuster is working with Kirkland and Ellis on refinancing, Raskopf said. The company previously announced plans to fund its own operations through the end of 2009 after two of its credit facilities expire this August, she said.

Blockbuster has also hired Rothschild Inc., an investment bank, to advise it on restructuring, a person familiar with the situation said.

Blockbuster, with more than 7,500 stores in North America, Europe, Asia and Australia, has faced increased competition from Netflix Inc., the largest U.S. mail-order movie service. Dallas-based Blockbuster has expanded its digital library of movies and made them available on mobile phones and Web- connected TVs. It plans to offer 90,000 DVD titles by mail, according to the company’s Web site. Netflix, by comparison, has 100,000 DVD titles, according to the company’s Web site.

“Balance sheet issues are easily solved with a prepackaged or prearranged bankruptcy,” said Paul Silverstein, a lawyer with Andrews & Kurth LLP, who has no connection to Blockbuster. Silverstein, speaking in a phone interview, said operational issues and business problems are less easily solved with such filings.

Kate Kortenkamp, a Kirkland spokeswoman, didn’t immediately return a call seeking comment. Kirkland has a specialty in restructuring and bankruptcy, and has represented Tronox Inc., Wellman Inc. and Solutia Inc., all chemicals companies, in bankruptcy filings. Kirkland has also been reported to have retained Charter Communications Inc., Paul Allen’s money-losing cable television carrier, and Visteon Corp., the auto-parts maker spun off by Ford Motor Co. in 2000.

“Blockbuster has been challenged liquidity-wise for a while now,” said Wedbush Morgan Securities analyst Edward Woo. “They acquired a whole bunch of debt when they had the spinoff away from Viacom.”

On Jan. 14, the company announced a partnership with Novato, California-based Sonic Solutions Inc., a digital video publishing company, to combine libraries and give customers immediate access to movies. It also recently released a media player the size of a cable box that downloads movies for viewing on television.

Blockbuster fell as much as 83 cents to 13 cents in New York Stock Exchange composite trading before trading was halted at 2:25 p.m. Netflix surged $2.01, or 5.9 percent, to $36.36 in Nasdaq Stock Market trading today.

Blockbuster’s top shareholders are Prentice Capital, which owns 10 percent of the outstanding stock, Icahn Capital, with 9 percent, and Barclays Global Investors, with 7 percent, according to Bloomberg data.

Blockbuster’s shift to new products hasn’t fully offset a declining video rental industry and a competitive home entertainment market, according to Standard & Poor’s. S&P analyst David Kuntz said in a Feb. 25 report that the company also has a “highly leveraged capital structure” and may face challenges to refinancing a revolving loan that expires Aug. 20.

S&P rates Blockbuster’s $1.1 billion senior secured credit facilities a “2,” indicating lenders would receive 70 to 90 percent recoveries in the event of a default. That debt is secured by Blockbuster’s U.S. assets as well stock in some international subsidiaries, according to S&P.

S&P rates Blockbuster’s $300 million in notes a ‘6,’ indicating they could get a “negligible” recovery of zero to 10 percent, according to the report.

Blockbuster’s $300 million in 9 percent notes due 2012 most recently traded at 52.25 cents on the dollar, down 39 percent from their 52-week high of 85.12 cents achieved June 9, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.

In May, Blockbuster had made a preliminary offer to buy Circuit City Stores Inc., backed by Carl Icahn. Blockbuster backed out a few months later.

The company increased its borrowing capacity last October under a deal with former parent Viacom Inc., according to its quarterly filing Nov. 14 with the Securities and Exchange Commission.

Blockbuster, spun off from Viacom Inc. in 2004, had an agreement from its initial public offering to reserve $150 million under its revolving credit facility to issue letters of credit for Viacom at Viacom’s expense. That agreement was amended last October to reduce the amount to $75 million, and give Blockbuster responsibility for expenses. In exchange, Blockbuster’s borrowing capacity increased by $75 million, according to the SEC filing.