CHAPTER 11 BANKRUPTCY: REORGANIZATION

How to continue to run your business — work out a plan for future profitability — continue trading your company’s securities–acquire financing and loans on favorable terms–and protect your company from lawsuits. …

How Chapter 11 Works

A case filed under chapter 11 of the United States Bankruptcy Code is often referred to as a “reorganization”.  A chapter 11 case begins when a petition is filed with the bankruptcy court where the debtor does business or lives.  The petition may be filed by the debtor — or by creditors that meet certain requirements.

In addition, the debtor must file with the court…

(1) schedules of assets and liabilities;
(2) credit counseling from an approved credit counseling agency completed within 180 days of filing;
(3) a schedule of current income and expenditures;
(4) a schedule of executory contracts and unexpired leases;  and
(5) a statement of financial affairs.

The Automatic Stay

After the petition is filed, the bankruptcy court issues an “automatic stay,” which, with a few exceptions, gives the company time in which creditors cannot pursue judgments, collection activities, foreclosures, and repossessions of property.  This applies to any debt or claim that arose before filing the bankruptcy petition.  The stay gives the company a breather, during which it can negotiate to try to resolve the difficulties in the debtor’s financial situation.

Under certain circumstances, the secured creditor can obtain an order from the court granting relief from the automatic stay.  The court can grant relief, for example, when the debtor has no equity in the property and the property is not necessary for an effective reorganization.

If, during the 180-day period before filing, the bankruptcy petition was dismissed because the debtor failed to comply with orders of the court — or was voluntarily dismissed after creditors sought relief from the automatic stay — the debtor has to wait the 180-day period before filing again.

Fiduciary Role

Upon filing the petition with the court, the debtor become a “debtor in possession”.  This is a fiduciary role, with the rights and powers of a chapter 11 trustee.  It requires the debtor to perform all the duties of a trustee except the investigative functions.  These duties include accounting for property, examining and objecting to claims, and filing informational reports.

While under Chapter 11, a company can only conduct standard business operations.  Unless it has court approval, it cannot sell off divisions of the company or a major piece of equipment.  Nor can it make any major expansions.

Who Can File a Plan

The debtor (unless a “small business debtor”) has a 120-day period during which it has an exclusive right to file a plan. This exclusivity period may be extended or reduced by the court.  But, in no event may the exclusivity period, including all extensions, be longer than 18 months.  After the exclusivity period has expired, a creditor or the case trustee may file a competing plan. The U.S. trustee may not file a plan.

A chapter 11 case may continue for many years unless the court, the U.S. trustee, the committee, or another party in interest acts to ensure the case’s timely resolution. The creditors’ right to file a competing plan gives the debtor an incentive to file a plan within the exclusivity period and acts as a check on excessive delays in the case.

 Cash Collateral, Adequate Protection and Operating Capital

Although the preparation, confirmation, and implementation of a reorganization plan is at the heart of a chapter 11 case, other issues may arise that the debtor in possession must address.  The debtor in possession may use, sell, or lease property of the estate in the ordinary course of its business, without prior approval, unless the court orders otherwise.  If the intended sale or use is outside the ordinary course of its business, the debtor must obtain court permission.

A debtor in possession may use “cash collateral” only with the consent of secured parties or authorization by the court, which must first examine whether the secured party’s interest is adequately protected.  Cash collateral is cash, negotiable instruments, documents of title, securities, deposit accounts, or other cash equivalents in which the estate and an entity other than the estate have an interest.  It includes the proceeds, products, offspring, rents, and profits of property — and the fees, charges, accounts and payments for the use of rooms and other public facilities in hotels, motels, and other lodging properties subject to a creditor’s security interest.

When “cash collateral” is used (spent), the secured creditors are entitled to receive additional protection under section 363 of the Bankruptcy Code. The debtor in possession must file a motion requesting an order from the court authorizing the use of the cash collateral.  Pending the secured creditor’s consent or court authorization, the debtor in possession must segregate and account for all cash collateral in its possession.

A party with an interest in property being used by the debtor may ask that the court prohibit or condition this use as much as necessary to provide “adequate protection” to the creditor.  This is especially important when the property has gone down in value.  In this case, the debtor may make periodic or lump sum cash payments, or provide an additional or replacement lien that will result in the creditor’s property interest being adequately protected.

When a chapter 11 debtor needs operating capital, it may be able to obtain it from a lender by giving the lender a court-approved “superpriority” over other unsecured creditors or a lien on property of the estate.  The court may also permit the debtor in possession to reject and cancel contracts.

If the business’s debts exceed its assets, the bankruptcy restructuring results in the company’s owners being left with nothing — and the company’s creditors own the newly reorganized company.

Creditors’ Committees

Creditors’ committees can play a major role in chapter 11 cases. The committee is appointed by the U.S. trustee and usually consists of unsecured creditors who hold the seven largest unsecured claims against the debtor.

 The Disclosure Statement

Generally, the debtor (or any plan proponent) must file and get court approval of a written disclosure statement before there can be a vote on the reorganization plan. The disclosure statement must provide “adequate information” concerning the debtor’s affairs so the holder of a claim or interest can make an informed judgment about the plan.

After the debtor files the disclosure statement, the court has a hearing to decide if the disclosure statement should be approved.  Only then can there be acceptance or rejection of a plan.

The Discharge

When the plan is confirmed, the confirmation discharges the debtor from any debt that arose before the date of confirmation.  After confirmation, the debtor must make plan payments. The confirmed plan creates new contractual rights, replacing or superseding pre-bankruptcy contracts.

In Summary…

Businesses choose Chapter 11 because its long-term revenues will exceed the liquidation value of its assets.  This way, creditors get more money back if they allow the debtor business to reorganize and work out a payment plan.  Chapter 11 is the most flexible of all the chapters in bankruptcy.