Chapter 11 Overview
Chapter 11 bankruptcy allows businesses, and sometimes individuals, to restructure their debts while continuing to operate. Unlike liquidation under Chapter 7, Chapter 11 gives a company the opportunity to reorganize its financial affairs under the supervision of the court and the United States Trustee. The debtor typically proposes a plan to keep the business alive and pay creditors a reasonable amount over time, which might include renegotiating terms or even right-sizing operations by selling certain unproductive assets to become more financially viable. Creditors vote on the plan, and once approved by the court, it becomes binding. Chapter 11 is commonly used by corporations and limited liability companies facing financial difficulties but aiming to avoid outright closure.
Chapter 11 cases are very complex legal proceedings, every case is different, and it’s difficult to capture all of the complex scenarios in a short overview. Below is a general timeline that Chapter 11s typically follow:
Chapter 11 Petition is Filed: Step one takes planning and a clear decision. The decision is hard, but like almost everything in business, once it is made and you are committed you are able to focus and move toward success, restructuring and rebuilding! Now that the case is filed, all creditors have to stop bothering you about your debt. They also cannot start or continue lawsuits, foreclosures, or any attempts to take your assets.
First Day Motions are Filed: These typically ensure that the day-to-day operations of the business can continue. These will differ for each case, but we often see Cash Collateral motions, motions to pay pre-filing payroll, etc. This is necessary because you will have to operate under court supervision, which involves trade-offs in exchange for the protection of the Court and the Bankruptcy Code. Cash collateral is just cash from highly liquid assets (like accounts receivable or rent that is owed to you) and the sales of inventory upon which your creditors have liens. Since the assets are subject to liens of creditors, you will need court approval to use them to pay for operations and expenses.
Debtor Obtains Financing: In Bankruptcy, businesses are able to obtain financing for operations or to take out other secured creditors. This type of financing is called Debtor In Possession, or “DIP” financing.
U.S. Trustee Forms Committee of Unsecured Creditors: The U.S. Trustee oversees your bankruptcy proceeding. As part of that process, if certain groups of creditors believe it is in their best interest to work together, they may request that a committee be formed. The U.S. Trustee is in charge of working with the creditors to determine whether the unsecured creditors would like to have their own legal and financial team. Whether the unsecured creditors form a committee or not, they’ll be one of the constituencies that eventually vote on your Plan of Reorganization.
Work on Business Plan: Your attorney and their team will work to put together a plan of reorganization and a general payment plan for your unsecured creditors, and whatever other debts you expect to be paid during this process. This part will involve a lot of collaboration between you and your legal team. They’ll draft the plan, then talk to you, then revise the plan, and repeat that process until you feel comfortable with the amounts and the general plan going forward. Remember, this plan has to be approved by the creditors, or at least certain groups of creditors, so you and your legal team will talk about how to address creditor concerns. Your legal team will negotiate with the unsecured and secured creditors to reach a final plan. The Plan may include assumption or rejection of executory contracts, retention, surrender, or sale of property. So, your attorneys will continue to revise the plan until they reach the final terms of the Plan of Reorganization that will gain the votes needed to be confirmed.
Confirmation of the Plan requires either the vote of all classes of impaired creditors, or the approval of at least one class of creditors and meeting a number of legal obligations. Your attorneys will help you address these issues.
Subchapter V
If you file a subchapter V case, the timeline of the case is sped up significantly, and the case is streamlined to make reorganization an affordable option for smaller businesses. Subchapter V is available for companies and individuals who have less than $3,024,725.00 of debt, which is adjusted for inflation. In a subchapter V case, the United States Trustee still plays its role in overseeing the case and compliance with the requirements of the bankruptcy code, but there are no committees. This reduces the debtor’s potential exposure to additional costs and fees. It also assists by simplifying the plan preparation and filing process.
A subchapter V trustee is appointed to assist with the consensual confirmation of the plan. The trustee’s job is to understand the business and its future prospects, provide input on the plan to increase the likelihood of confirmation, and to help provide clarity and oversight that the creditors can count on when considering whether to vote in favor of the plan.
Additional benefits of subchapter V include the fact that the owners of a small company are able to retain their ownership even if the creditors are not paid in full, and are not required to provide evidence of sufficient new value to retain their ownership stakes in their businesses. The same benefit is provided to individuals who wish to retain their property. The absolute priority rule does not apply. Further, at plan confirmation, even if the debtor does not obtain the necessary votes, the debtor can confirm its plan provided that the debtor makes appropriate proofs to the Court.
Regardless of what type of chapter 11 case a debtor files, competent attorneys are essential to success, and it helps to know your attorney is known and trusted by other bankruptcy attorneys in the district. Look for an attorney based upon referrals from other individuals or business owners, or obtain a referral from another attorney, certified public accountant, or someone in a similar related profession.