Chapter 11 Bankruptcy

A Chapter 11 bankruptcy case, commonly referred to as “Reorganization Bankruptcy,” is filed when a business is unable to pay its debts or creditors and needs to reorganize or effect an orderly liquidation. The business continues to operate and in most circumstances, the debtor in a Chapter 11 case (often called a “Debtor in Possession”) remains in control of the business operations and its assets. A Chapter 11 reorganization case may be filed by an individual, corporation, LLC, partnership, or other business entity. A Chapter 11 case allows the debtor to restructure the business and propose a plan of reorganization by which its creditors may be paid. As with other chapters in bankruptcy, immediately upon filing the case, almost all creditors are forbidden to continue any collection activity against the debtor or its assets. The general idea is that the debtor needs time to breathe from its creditors during which it may reorganize its operations.

The legal fees for Chapter 11 cases are typically more expensive than Chapter 7 or Chapter 13 cases. The filing fee for a Chapter 11 case is currently $1,717. In addition, there are quarterly fees payable to the United States Trustee. However, the recently enacted Subchapter V may reduce some of the cost and time involved. The difference between a Chapter 11 case and a Chapter 7 case is that under Chapter 7, the business liquidates or closes, but under Chapter 11, the business may continue to operate and re-work its operations.

Under a Chapter 11 case, the debtor-in-possession continues to operate the business while the management of the company may stay in place, however, under certain circumstances, the court may appoint a trustee to step into the shoes of management and oversee the operations of the company.

As with other Chapters in bankruptcy, creditors are grouped in different categories:

• Post-Petition costs and expenses, (e.g. lawyers and accountants for the debtor and the creditors’ committee if one is formed) and expenses of operating any business or conducting a debtor’s affairs which are referred to as Administration Claimants and have a first priority in the assets of the debtor (other than secured assets).
• Secured Creditors are those with a mortgage or security interest in assets of the debtor and they have a first right in the assets and usually any proceeds of the assets.
• Priority Creditors are creditors whose claims arose before the filing of the case and who are given a priority under the bankruptcy code – these include: certain wages and employee benefits; consumer deposits; and taxes.
• Unsecured Creditors are all of the remaining creditors.

Unsecured Creditors have a right to form a creditors’ committee, and if they do, the debtor will also be responsible to pay the expenses of the creditors’ committee and its attorneys. However, in many smaller Chapter 11 cases, creditors do not form a creditors’ committee.

Although the debtor may obtain a short reprieve as to payments of rent or payments to secured creditors, to continue as a debtor, the debtor must be able to pay current rent to the landlord and “adequate protection” to secured creditors. While the reorganization case is pending, the debtor has the ability to pay employees for wages accruing after the filing of the petition and in the ordinary course of continuing to operate the business. An issue arises when there are back wages that were owed before the filing of the Chapter 11 petition. These outstanding wages may not be paid without first obtaining permission from the Bankruptcy Court. To avoid impacting the debtor, the bankruptcy code allows the debtor to file a motion to be heard almost immediately on the first day the bankruptcy is filed. These are called “first day motions.”

A Chapter 11 bankruptcy may allow a business (or individual) to:

• Reject (get out of) unfavorable contracts and leases.
• Keep contracts or leases that it wants to retain if it can afford to satisfy arrears over a reasonable period.
• Keep property or equipment that is subject to a mortgage or security interest and reduce the payments to secured creditors to be based on the value of the property (there are stricter and different rules for individuals dealing with the value of their homes).
• Surrender or give up secured property that is no longer wanted, needed, or that they cannot afford to keep.
• Pay unsecured creditors a fraction of the amounts due (with the payments based on the value of the assets and/or future income streams).
• Pay past due taxes over five years.

The end result of a successful Chapter 11 is a plan of reorganization (Plan) which is effectively a contract between the debtor and creditors. In order to reorganize, the debtor must file a Disclosure Statement and get court approval before there is a vote on the debtor’s Plan. The Disclosure Statement must provide enough information regarding the debtor to permit creditors to make a judgment as to whether or not they will agree with the Plan. The debtor generally has four months to come up with a Plan, but the court can grant extensions up to 18 months. A Plan must divide Secured and Unsecured Creditors into groups (classes) and describe how each class will be paid under the Plan.

A Plan has to be confirmed (approved) by the Bankruptcy Court. To be confirmed by the Bankruptcy Court, at least one class of creditors must vote in favor of the Plan by a majority in number of the creditors in the class and by two-thirds in dollar amount of the class. In addition, the Bankruptcy Court must find that the treatment of creditors under the Plan is appropriate under the requirements of the Bankruptcy Code.

There are three potential outcomes for a Chapter 11 case; the case may be dismissed, converted to a different chapter, or confirmed. Confirmation of the Plan may discharge a debtor from debts that arose prior to the date of confirmation.

Legal Editors: Lewis Siegel and Gregory Messer (November 2020)