Chapter 11 Bankruptcy

Chapter 11 bankruptcy is filed primarily to reorganize an operating business.  A typical Chapter 11 business debtor is one that is generating money but is in financial distress because of bad management decisions including decisions to incur debt payments above net operating revenues.  Chapter 11 is designed to give a business the chance to restructure some of its secured debt and to discount unsecured debt to a level where the business can grow out of financial distress.  An individual debtor can also file Chapter 11 to reorganize their personal financial situation when their debt levels exceed those allowed for a Chapter 13 reorganization.

Chapter 11 Filing Procedure

Chapter 11 bankruptcy, like bankruptcy under other chapters, starts with the general filing of a bankruptcy petition, supporting schedules, and statement of financial affairs. These are the same forms required by consumer bankruptcy cases except that some of the questions are answered differently because the debtor is an operating business.

Chapter 11 bankruptcy is distinguished from consumer bankruptcy by the immediate supplemental filings of what are termed “first day motions.” Upon filing a Chapter 11, an operating business requires court approval to continue business operations. For example, immediate approval is needed to pay current employees and to authorize payment of wages that accrued prior to the filing.  Wage payments are needed so that the employees of the bankrupt business do not resign or find other employment. Similarly, first day motions and orders are issued so that the operating business can pay suppliers, vendors, and other people and entities the business uses on an ongoing basis.

The US Trustee’s office has a standard package they send to Chapter 11 debtors regarding standard operating guidelines.  If a creditor has a lien on the debtor’s cash in the banks, the court would typically authorize the debtor to use the cash for operations.

Prior to filing, the bankruptcy attorney will usually draft a series of “first day motions” so that they may be filed immediately after or with the bankruptcy petition.  First day motions are not actually heard the first day after the filing but they are heard on an emergency basis, usually within the first week (as notice has to be provided to creditors).  Some first day motions will be heard before some creditors have notice.  At or after the hearing, the court will issue appropriate orders so that the business may continue and setting forth standards that the Court expects for the debtor’s operation.

First day orders also include an application by the attorney to be retained by the debtor, an authorization for the debtor to pay the attorney up to 70 percent of the billing up to date with the provision that the billings may be scrutinized by the court at a later date.

Chapter 11 From the Creditor’s Perspective

As with all other chapters, Chapter 11 cases have a meeting of creditors where a creditor (or its representative) may examine the debtor or debtor’s representative regarding the contents of the bankruptcy petition and schedules.  The US Trustee will typically review the schedules prior to the creditors meeting.  A Chapter 11 creditors meeting will last approximately an hour as opposed to the much shorter meetings in Chapter 7 and Chapter 13.  Chapter 11 creditors do not have to file claims so long as they are listed on the schedules and don’t object to the way they are being treated.  Creditors are still eligible to receive a distribution if they are listed on the debtor’s schedules even if they don’t file a claim.  If a creditor is omitted from the schedules or if they disagree with how they are being classified and treated on the schedules, the creditor must file a claim.

Chapter 11 Operations from the Business Owner’s Perspective

The main difference in a Chapter 11 for the owner of the debtor business is that the owner typically stays in charge of the business and the business remains in operation.  However, if the owner has been implicated in fraud or gross mismanagement, the owner will most likely not remain in charge.  Chapter 11 permits a bankrupt business to pay the owner a reasonable salary subject to court approval.  The court will look at how much the debtor was paying the owners prior to filing.  If the owner has not been taking a salary prior to filing, the Court will probably not allow a salary to be paid after the bankruptcy filing.  If the business does not generate enough money to pay its bills, the court will probably not allow the owner to take payments or to accrue wages.  After the bankruptcy filing, if the business does not generate enough money to pay all of its post‑filing debt with some left over, the owner’s wages will be forfeited and not paid in future months even if money is available.

In a Chapter 13 reorganization for individuals, there is a general rule that all payments have to be paid to the Chapter 13 trustee through the plan.  Once a Chapter 11 plan is approved, the debtor takes the role of supervising the business and is responsible for paying the creditors directly in accordance with a plan.  In Chapter 13, payments are made to creditors beginning in the month after filing. In Chapter 11, there may be certain payments made for adequate protection of secured creditors (for example, rent or mortgage payments).  Otherwise, payments to other creditors typically don’t begin until after plan confirmation and the plan will dictate when and how the payments are to be made.   It could be five to ten months or even a year after filing before plan payments start flowing to the creditors in a Chapter 11 case.

Chapter 11 proceedings increase the monthly administrative expenses the business debtor has to incur. The Chapter 11 debtor is required to provide monthly financial statements to the court and many on‑going disclosures and informational filings. The bankruptcy administrative costs are a significant burden that the reorganizing business does not incur outside of bankruptcy. Therefore, in addition to all of the hard work the owner is going through to resurrect his business, there are many demands made by the bankruptcy court including preparation of monthly reports, reviewing the reports with the debtor’s attorney, and meetings with the debtor to talk about how creditors are being treated in the reorganization plan. The Chapter 11 process is very time consuming, demanding, and expensive for the business owner.

Although the business owner usually continues to control the operation of the business in Chapter 11, he must get court approval for anything outside the ordinary course of business including incurring new debt.

Chapter 11 Liquidations

Chapter 11 plans may provide for the liquidation of business assets rather than for reorganization of an operating business.  A typical liquidation situation is where a business has relatively little value as an ongoing concern but there are sufficient assets that could be sold to pay the creditors. In a liquidation Chapter 11 bankruptcy there is a liquidating “trust” where assets are sold individually and the proceeds are put in the trust for distribution to creditors.  Chapter 11 liquidations are controlled by the business owner.  Unlike a Chapter 7 liquidation where the trustee gathers and sells non‑exempt assets.  The theory is that the business owner is in a better position to get the most value for the sale of business assets.  A Chapter 11 case can convert to a Chapter 7 for liquidation, but there are many reasons why a Chapter 11 debtor prefers the liquidating trust.  The debtor may be able to do a better job liquidating the assets because it knows the market for the assets and believes that it will get more money through a gradual asset sale than could a Chapter 7 trustee who is not familiar with the market for business assets.  If there is any money left after liquidation and payments to creditors, that money goes back to the debtor business or its equity holders.

Individual Chapter 11

Individuals who do not qualify for Chapter 13 because they exceed the debt ceiling limits ($1,149,525 secured, $383,175 unsecured) but who still want to reorganize their finances may need to file Chapter 11 to get protection from their creditors.  Individuals have a very difficult time in Chapter 11, and for that reason most individual Chapter 11 bankruptcies fail.  Chapter 11 for an individual can be successful if the goals are limited.  For example, if an individual is a few payments behind on secured debt and needs a limited amount of time to catch up, Chapter 11 could buy the individual enough time to make up past due payments and emerge rather quickly with a completed and successful Chapter 11 plan.  More complicated individual financial situations are not typically solved in a Chapter 11 because of the complexity of Chapter 11 and its relatively high costs and fees.  Individuals who are seeking protection but do not qualify for Chapter 13 are better off finding solutions outside the bankruptcy court.

Chapter 11 Plan

The central part of a Chapter 11 bankruptcy is the design, approval, and administration of a reorganization plan.  A Chapter 11 plan starts by dividing the creditors into various classifications including priority creditors, administrative creditors, secured creditors, and unsecured creditors.  The plan proposes how much money each of these creditor classes are going to be paid, how the debt is restructured, and the terms of the payments.  Usually a plan lasts about five years, but with court approval the term could be extended for up to ten years.  Chapter 11 plans must provide that the superior class of creditors (such as administrative creditors or priority creditors) are paid in full before payments are made to the junior classes.

Chapter 11 plans may cram down part of a creditor’s claim.  That typically occurs when claims are bifurcated into secured and unsecured portions.  If the current value of property securing a claim is less than the amount of the debt, the court may split the claim into two parts – one being a secured claim to the extent of the property value and the other being an unsecured claim for the balance of the debt.  Chapter 11 plans have requirements similar to Chapter 13 plans in that the debtor must show that all of the business’s disposable income is going into the plan and that all creditors within a class are being treated fairly.

The Chapter 11 debtor files the plan and a financial disclosure statement and serves both to all creditors.  The plan is subject to approval by the creditors, each of whom is entitled to vote for approval or rejection.  The court often approves a Chapter 11 plan over the objection of one or more creditors or creditor classes.

Chapter 11 Bankruptcy Trustee

The role of the trustee is different in each of the bankruptcy chapters.  In Chapter 7 cases, there is a panel of individual trustees each of which are assigned to Chapter 7 cases.  They liquidate the non‑exempt assets, if any, and pay unsecured creditors who have filed a claim.  In Chapter 13 cases, there is a single trustee that evaluates debtors’ plans and administers payments.  Chapter 11 bankruptcy is administered by the Office of the United States Trustee.  Various people in the US Trustee’s office act together to oversee the entire Chapter 11 process.  Immediately after a Chapter 11 is filed, there is an initial interview of the Chapter 11 debtor’s representative during which the debtor produces historical and prospective financial data.  In order to anticipate revenues and expenses for the first six‑month period after the Chapter 11 is filed, the Trustee’s accountants review the debtor’s economic data and pose questions to the debtor’s representatives.

Chapter 11 bankruptcy, like Chapter 13 bankruptcy, involves repayment of debts.  In Chapter 13, the plan is evaluated and approved or rejected by the Chapter 13 trustee.  Chapter 11 is different in that the trustee may offer an opinion as to the debtor’s plan, but the plan is subsequently reviewed by the court after receiving comments from the various creditors.  The US Trustee is less directly involved than is a Chapter 13 trustee in plan approval.  The role of the US Trustee’s office is to oversee the bankruptcy and to offer opinions to the court which the court can either accept or reject.

In Chapter 11, the US Trustee’s office is acting as a watchdog for the creditors and takes a more adversarial role on behalf of the creditors than does the Chapter 13 trustee in an individual reorganization.

Costs and Fees

Chapter 11 bankruptcy is much more expensive than consumer bankruptcies filed under Chapter 7 and 13 as there are more procedures and reports built into the bankruptcy Code and bankruptcy rules (including first day motions, the bankruptcy reorganization plan, monthly reports, and disclosure statements).  The work involved in a Chapter 11 bankruptcy involves numerous court hearings throughout the bankruptcy process and negotiations with the US Trustee’s office and creditors.  The Chapter 11 bankruptcy plan is much more precise than those prepared in consumer cases.  Legal work related to a Chapter 11 not only requires more time, it requires substantial expertise and more experience than the legal work involved in a consumer bankruptcy proceeding.  Chapter 11 bankruptcy procedures are set up to accommodate the largest corporations and businesses in our country.  The same steps, procedures, and requirements apply to a small business.

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