Chapter 11 Bankruptcy

Chapter 11 Bankruptcy

Introduction

Chapter 11 is typically used by businesses wishing to reorganize. Nonetheless, chapter 11 is not limited business reorganization. A business looking to liquidate its assets may wish to do so under chapter 11. Similarly an individual that does not otherwise qualify for chapter 13 may wish to file for relief under chapter 11.

Businesses considering reorganization under chapter 11 presume the that the going concern value of the business is greater than its liquidation value (the sale of its fixed assets). On the other hand, businesses considering liquidation under chapter 11 presume the converse, and choose chapter 11 over chapter 7 so as to retain as much control over the liquidation process as possible.

The Chapter 11 Process

A chapter 11 bankruptcy case begins with the filing of a petition for relief pursuant to the United States Bankruptcy Code (the “bankruptcy petition”). 11 U.S.C. § 301(a). The bankruptcy petition is filed with the Bankruptcy Court in the district where the business debtor has its principal place of business or its principal assets. The debtor, in addition to the bankruptcy petition, must also file schedules listing all assets and all liabilities and a statement of financial affairs. Federal Rules of Bankruptcy Procedure 1007(b). Immediately upon the filing of the bankruptcy petition the debtor assumes the role of “debtor in possession.” 11 U.S.C. § 1101. The debtor typically retains possession and control of assets during the reorganization without the appointment of a trustee or an examiner.

to file plan of reorganization accompanied by a disclosure statement. The disclosure statement must contain sufficient information about the debtor in possession’s assets, liabilities, and financial affairs to enable a creditor to make an informed judgment respecting acceptance or rejection of the plan of reorganization. The debtor in possession is the only entity that can file a plan of reorganization for 120 days after the filing of the bankruptcy petition. 11 U.S.C. § 1121(b). After the exclusivity period expires, any holder of a claim (equity or creditor) or committee may file a plan of reorganization. 11 U.S.C. § 1121(c).

Before creditors are given the option of voting on the plan of reorganization, the bankruptcy court must approve the disclosure statement. 11 U.S.C. § 1125(b). After court approval of the disclosure statement, a copy is sent to creditors with the plan and a ballot. Creditors whose claims are “impaired,” meaning their contractual rights are modified or they will be paid less than the full claim under the plan, may vote on the plan. After the voting is complete and the ballots tabulated, the bankruptcy court will conduct a confirmation hearing. If there are sufficient votes in favor of the plan and it satisfies the requirements of section 1129(a), the plan is confirmed as a consensual plan. If not, the bankruptcy court determines whether to “cram down” the plan over creditor objections. 11 U.S.C. 1129(b).

The Debtor in Possession

A debtor in possession is held to the level of a fiduciary and has the duties and powers of a bankruptcy trustee. 11 U.S.C. § 1107. Such duties include accounting for property, examining and objecting to claims, and filing tax returns and reports as required by the bankruptcy court and the Office of the United States Trustee. A debtor in possession has the power to employ attorneys, accountants, brokers, or other professionals, subject to court approval. 11 U.S.C. § 327.

The debtor is required to file a chapter 13 plan 15 days after the filing of the bankruptcy petition. Federal Rules of Bankruptcy Procedure 3015(b). The debtor must commit to pay into the plan all projected “disposable income” for the duration of the plan. 11 U.S.C. § 1322(a). Disposable income is defined as income not reasonably necessary for the maintenance or support of the debtor or dependents. If the debtor operates a business, disposable income is defined as excluding those amounts which are necessary for the payment of ordinary operating expenses. 11 U.S.C. § 1325(b)(2).

The Office of the United States Trustee

The Office of the United States Trustee monitors the progress of all chapter 11 bankruptcy cases. Generally speaking, the U.S. Trustee reviews the debtor in possession’s monthly operating reports, applications to employ professionals, fee applications, and any plans or disclosure statements filed in the case. The U.S. Trustee also conducts the creditors’ meeting at the beginning of the case where the U.S. Trustee and creditors may question the debtor concerning the debtor’s conduct, assets, and any prospective plan of reorganization. 11 U.S.C. § 341(a).

The Office of the United States Trustee monitors the progress of all chapter 11 bankruptcy cases. Generally speaking, the U.S. Trustee reviews the debtor in possession’s monthly operating reports, applications to employ professionals, fee applications, and any plans or disclosure statements filed in the case. The U.S. Trustee also conducts the creditors’ meeting at the beginning of the case where the U.S. Trustee and creditors may question the debtor concerning the debtor’s conduct, assets, and any prospective plan of reorganization. 11 U.S.C. § 341(a).

The Creditors’ Committee

Chapter 11 provides for the creation of an unsecured creditors’ committee. 11 U.S.C. § 1102. The unsecured creditors’ committee often plays a major role in a chapter 11. The U.S. Trustee appoints the committee, consisting of several creditors who typically hold some of the largest unsecured claims against the debtor in possession. The committee may consult with the debtor on the administration of the case, investigate the debtor’s conduct or business operations, and participate in the formulation of a plan. 11 U.S.C. § 1103. The committee may hire its own lawyer, and the legal fees are usually paid from the debtor’s bankruptcy estate. 11 U.S.C. § 327. This can make a chapter 11 case very expensive for a debtor.

The Automatic Stay

Automatic StayThe automatic stay stops all collection activities, foreclosures, and repossessions on any debt or claim that arose before the filing of the bankruptcy petition. 11 U.S.C. § 362(a). The stay automatically goes into effect when the bankruptcy petition is filed. The stay provides the debtor in possession with the needed time resolve its financial challenges through negotiations with its creditors.

Under certain circumstances, a creditor may move to lift or modify the automatic stay. For example, if an asset has no equity and is not necessary for an effective reorganization, the creditor might be successful in obtaining a court order lifting or modifying the automatic stay. 11 U.S.C. § 362(d).

Cash Collateral and Adequate Protection

The typical chapter 11 debtor has few assets which are not encumbered by a lien in favor of one or more creditors. This lien more often than not extends to the proceeds from the sale of pledged inventory or equipment which proceeds constitute “cash collateral.” Other than “cash collateral,” the debtor in possession may use, sell, or lease its assets in the ordinary course of its business without prior court approval. 11 U.S.C. § 363(c). If the use, sale or lease is outside the ordinary course of business, court permission is required. 11 U.S.C. § 363. Absent court authority, a debtor in possession may not use “cash collateral,” without the consent of the secured creditor. 11 U.S.C. § 363(c). The court must make a finding that the secured creditor is adequately protected before it can order the secured creditor to allow the debtor in possession to use the cash collateral. 11 U.S.C. § 363(e). Typically, adequate protection will take the form of periodic or lump sum payments to the secured creditor or additional or replacement liens in favor of the secured creditor. 11 U.S.C. §§ 361, 363(e).

The Disclosure Statements

Anyone proposing a plan must also file a disclosure statement. 11 U.S.C. § 1125(b). The disclosure statement must provide “adequate information” concerning the debtor in possession’s affairs so as to enable a creditor to make an informed decision whether to accept the plan. 11 U.S.C. § 1125(b). Once the disclosure statement has been approved, the plan proponent can begin to solicit acceptances of the plan. Federal Rules of Bankruptcy Procedure 3017(d).

The Plan of Reorganization

Chapter 11 PlanA chapter 11 plan must, among other things: (1) designate classes of claims and interests for treatment under the reorganization; (2) specify which class of claims are impaired and which are not impaired; (3) provide the same treatment for each claim within a particular class; and (4) provide for an adequate means of implementation. 11 U.S.C. § 1123(a). A plan may, without limitation: (1) impair or leave unimpaired a class of claims; (2) provide for the assumption or rejection of executory contracts; and (3) provide for the sale of substantially all of the debtor in possession’s assets. 11 U.S.C. § 1123(b). Generally, a plan will classify claim holders as secured creditors, unsecured creditors entitled to priority, general unsecured creditors, and equity security holders.

A class of claims accepts a plan if more than one-half of the allowed claims in the class and two-thirds in amount vote to accept the plan. 11 U.S.C. § 1126(c). Holders of unimpaired claims are deemed to have accepted the plan. 11 U.S.C. § 1126(f).

Once the disclosure statement has been approved and votes solicited and tabulated, the bankruptcy court is required to hold a plan confirmation hearing. Prior to the confirmation hearing, any party in interest may file an objections to the confirmation of the plan. Even if no objection is filed, in order to confirm the plan the court must find: (1) the plan is feasible, (2) it is proposed in good faith, and (3) the plan and the proponent of the plan are in compliance with the bankruptcy code. 11 U.S.C. § 1129(a). The court must also find confirmation is not likely to be followed by liquidation or a need for further reorganization.

The Discharge

The confirmation of a plan discharges the debtor from any debt arising before the date of confirmation. 11 U.S.C. § 1141. After confirmation, the reorganized debtor is bound by the terms of the plan. The confirmed plan creates new contractual rights, which contractual rights replace any prepetition contracts.

There are exceptions to the general rule that an order confirming a plan operates as a discharge. Confirmation of a plan of reorganization will discharge any type of debtor in possession (corporation, partnership, or individual) from most types of prepetition debts. However, confirmation does not discharge an individual debtor from any debt made nondischargeable by section 523 of the Bankruptcy Code. 11 U.S.C. § 1141(d)(2). Confirmation does not discharge the corporate or partnership debtor in possession if the plan is a liquidation plan, as opposed to one of reorganization. 11 U.S.C. 1141(d)(3). When the debtor is an individual, confirmation of a liquidation plan will effect a discharge unless grounds would exist for denying the debtor a discharge if the case were proceeding under chapter 7 instead of chapter 11.

Revocation of the Confirmation Order

Revocation of the confirmation order is an undoing or cancellation of the plan confirmation. A request for revocation, if made at all, must be made by a party in interest within 180 days of confirmation. 11 U.S.C. § 1144. The court, after notice and hearing, may revoke a confirmation order if and only if the confirmation order was procured by fraud. 11 U.S.C. § 1144.

The Final Decree

A final decree closing the case must be entered after the estate has been “fully administered.” Federal Rules of Bankruptcy Procedure 3022. Local bankruptcy court policies may determine when the final decree should be entered and the case closed.