What is Chapter 11 – Bankruptcy Reorganization?

Chapter 11 of United States Bankruptcy Code is commonly referred to as “reorganization.”

The Chapter 11 bankruptcy petition can be filed either by a business entity or an individual. Typically, individuals only file Chapter 11 if they do not qualify to file Chapter 13.

Debtors frequently opt for Chapter 11 in lieu of liquidation because the objective in reorganization is to preserve the assets and the going concern and/or business. In exchange, the Court confirms a plan that provides for treatment of the creditor claims.

Chapter 11 statutes are very complex and the summary provided herein is a simple overview.

A Chapter 11 reorganization proceeding commences with the filing of a petition. Upon filing, the debtor is commonly referred to as “debtor-in-possession.” The debtor is responsible for preserving and managing all assets as a fiduciary and is subject to strict guidelines as set forth in the Bankruptcy Code in order to continue to operate the business. The debtor, absent a Court order to the contrary, has an exclusive right, within the first 120 days of filing the petition, to propose a plan of reorganization. Thereafter, any party in interest may file a plan. Contents of plans of reorganization vary significantly depending on the facts of each case.

Typically, a plan in a retail case would provide that the debtor would “reject” leases for stores that are not profitable, and thereafter would propose a plan that is based on the profits derived from the profitable locations.

Typically, a plan in a real estate case would provide that the mortgages would be rewritten within the confines set forth by the Bankruptcy Code, such that the debtor may service the debt under different terms and retain ownership of the property.

Typically, a plan in a manufacturing or operating company would provide that the debtor would have a period of time to restructure its operation and then, as a result of the restructuring, use future profits to pay past debts.

Again, what the plan will say is driven by the unique facts of each case. In some cases, the “reorganization” is really a controlled liquidation of some or all the debtor’s assets. In these instances, often the prevailing view is that a controlled liquidation will result in a greater pay off for creditors than a foreclosure sale or forced liquidation.

It is quite common that a case will include liquidation of some assets and restructuring of debts based on profits derived from the remaining assets.

The Court has the power to appoint a Trustee to oversee the business, if cause is shown as required under the Bankruptcy Code.  If a Trustee is appointed, it will be the Trustee’s responsibility to manage the assets and to make a determination whether to file a plan of reorganization or to liquidate assets.

Before a plan can be confirmed by the Court, the debtor must file both a plan and disclosure statement describing the plan and the debtor’s financial status. If and only if the Court approves the disclosure statement, then the plan will be submitted to creditors for vote. The Bankruptcy Code has mandatory provisions for each plan of reorganization. For example, a plan must designate distinct classes of claims and interest for treatment under the plan of reorganization. Each claim within a class must be similar to the other claims in that class. For example, a first lienholder’s claim would be in a separate class from a junior lienholders’ claim. Further, general unsecured claims would be classified separately from secured claims.

In order to confirm a plan, a class of claimants has to accept the plan. A class is deemed to accept if the plan is accepted by creditors that hold at least two-thirds in amount and more than half in number of allowed claims in the class.

If there are impaired classes of claims, the Court cannot confirm a plan unless it has been accepted by at least one impaired class. If there is a consenting impaired class that accepts the plan but other impaired classes who do not, the Court can force acceptance upon those classes not consenting. This is commonly referred to as “cram down.” It is very difficult to obtain confirmation through “cram down” as the standards can, depending on the case, be very difficult to meet.

There are substantial issues and pitfalls relating to Chapter 11 cases. Before hiring an attorney, a prospective client should make sure that proposed counsel has substantial experience in confirming Chapter 11 plans. The client should ask the potential counsel for a copy of orders confirming plans in previous cases that they have handled.

As stated, Chapter 11 is very complex. One of the best summaries of Chapter 11 appears on the United States Courts website at www.uscourts.gov/service-forms/bankruptcy-basics/chapter-11-bankruptcy-basics.