Chapter 11 Bankruptcy FAQs

What is Chapter 11 bankruptcy?

Chapter 11 is the “reorganization chapter” in the Bankruptcy Code. Congress has expressly stated that the public interest is best served by giving financially distressed individuals and companies a chance to reorganize their financial affairs under the supervision of the bankruptcy court. In a Chapter 11, the debtor has the initial right to propose a plan for dealing with its debts for consideration by the creditors and bankruptcy court.

Is there a trustee in a Chapter 11?

Not usually. The norm is that the debtor remains in possession and control of its assets and operations. The debtor who continues to be in charge of his or her financial affairs is known as the “debtor in possession," sometimes referred to by the acronym DIP. In certain cases, such as for fraud or gross incompetency of management, the court can take control of the case away from the DIP and appoint a trustee to run the case and propose the plan of reorganization, though such situation are rare.

Who is eligible to file Chapter 11?

Any individual, and almost all forms of businesses, are eligible to be a Chapter 11 debtor. There are some exclusions; for example, a trust cannot be a Chapter 11 debtor unless the trust is a business trust.

Why do individuals or companies choose to file Chapter 11?

The most common reason why individuals or companies file Chapter 11 is to protect their ongoing operations from disruption or collapse due to threatened or actual debt collection activity, such as foreclosures, garnishments, lawsuits, and repossession of assets. The threat of foreclosure or repossession often can mean the loss of significant equity in property owned by the debtor. Loss of potentially valuable assets is a common reason to file Chapter 11.

How do I know if my company, or I, are good candidates for Chapter 11?

An individual or a company is a good candidate for Chapter 11 if there is a viable core business that can be preserved if given some breathing space from creditor collection activity. Any debtor who has assets with significant equity that will be lost to repossession or foreclosure is also a prime candidate for protection under Chapter 11.

How is Chapter 11 started?

Chapter 11 is initiated by the filing of a Chapter 11 Bankruptcy Petition, which is effective immediately upon filing to create an automatic stay of all collection activity against the debtor. A number of other motions and documents are usually filed on the first day the Chapter 11 petition is filed (first day motions), described below.

What should be done to prepare for filing a Chapter 11?

The first step that should be taken by any person or company considering filing for Chapter 11 is to locate and retain an experienced Chapter 11 attorney. The attorney will want to review the recent financial information about the potential Chapter 11 debtor. Every Chapter 11 debtor should use best efforts to bring its accounting and financial reports up to date.

What pre-filing actions should not be taken before filing Chapter 11?

Generally, it is a good idea not to do anything out of the ordinary course of business prior to filing Chapter 11. No expenditures should be made, except those that are approved by the bankruptcy attorney in advance. These will usually be limited to those expenses that are absolutely essential to keeping the business operating. Payments to creditors on past due debts is typically not a good idea and usually not necessary to keep the business operating.

Can the debtor issue payroll checks on its regular paydays in Chapter 11?

Ordinarily, yes, but before payroll can be issued, it may be necessary to file a motion with the bankruptcy court to obtain approval to use any funds that are subject to a security interest of a lender. Such motions are known as motions to use cash collateral and are described below. If a lender has a blanket security interest in all the assets of the debtor, then the debtor is prohibited from spending any cash collateral upon filing the Chapter 11 petition until the court has entered an order authorizing the use of cash collateral.

What are first day motions in a Chapter 11?

As the name indicates, first day motions are certain motions typically filed on the first day of a Chapter 11 case. These motions are to obtain permission to take certain actions necessary to maintain the debtor’s business operations that cannot be taken unless the court first issues an order authorizing the debtor to take the actions. Examples of typical first day motions include (1) Motion to Use Cash Collateral; (2) Motion to Pay Prepetition Payroll, including Associated Health Benefits; (3) Motion for Order Fixing Utility Deposits; and/or (4) Motion for Order Authorizing Payment of Critical Vendors. Other first day motions may be appropriate or required, depending on the facts of each particular case.

What is cash collateral?

Cash collateral is a liquid asset that is subject to a lien or security interest of a creditor. Cash collateral may include cash on deposit or on hand, accounts receivable, rent payments from tenants, insurance policy proceeds, inventory held for sale, and/or the proceeds arising from the sale of any asset, including real estate, if subject to the lien of a creditor.

Can the debtor use cash collateral without court approval?

Under law, the debtor is not allowed to use any cash collateral in a Ch. 11 filing without getting prior consent from the creditor who has the lien on that cash collateral. Although a court order is not necessary if the creditor consents, as a practical matter, creditors virtually never consent to the use of cash collateral without the entry of a court order. The order authorizing the use of cash collateral will typically contain certain provisions protecting the creditor’s position in connection with the use of cash collateral.

What is a plan of reorganization in a Chapter 11?

The plan of reorganization in Chapter 11 is a complex written document prepared by the Chapter 11 lawyer with the assistance of the Chapter 11 debtor for the restructuring of the financial affairs of the debtor. Chapter 11 plans divide the creditors into groups referred to as classes of creditors. Each class of creditors can be dealt with differently, depending on how the class will be repaid. Similarly situated creditors have to be put into the same class and the debtor may not discriminate unfairly in its treatment of the different classes of creditors. The plan may change interest rates paid on loans, shorten or lengthen the maturity dates of loans, and, in some cases, pay less than the amount owed on debts and discharge the unpaid balance. Because the rules for obtaining approval of a plan by the court are complex, it is recommended that prospective debtors seek the advice of Chapter 11 counsel as early in the process as possible to get an idea of what might be possible in a plan to deal with their own debts.

How long does a Chapter 11 debtor have to prepare and file a plan of reorganization?

Unless changed by the court for cause, the debtor has the exclusive right to propose a plan for the first 120 days following the commencement of the Chapter 11 case. In most cases, except for “pre-packaged” plans, the debtor usually takes most of the 120 days to prepare and file the plan. The debtor may file the plan at an earlier time, or may, in some instances, file a motion for permission to extend the 120-day period for filing the plan.

What is a disclosure statement in a Chapter 11?

A disclosure statement is a detailed written document that must be filed at the same time the debtor files his or her plan. A disclosure statement is similar to a stock prospectus. The function of the disclosure statement is to provide the creditors with adequate information to enable the creditors to make an informed decision on whether to vote for or against the plan. The disclosure statement will explain how the plan will be accomplished and why the plan will be successful. It will disclose the risks associated with the plan. It will also contain a detailed liquidation analysis of the debtor’s assets to show creditors what, if anything, would be paid to creditors if the debtor were liquidated in a case under Chapter 7 of the Bankruptcy Code.

What is a creditors’ committee and what is its role in a Chapter 11 case?

The US Trustee’s office will attempt, in every case, to form a “watchdog group," known as the Official Unsecured Creditors’ Committee, to monitor the debtor’s progress during the Chapter 11 case and to protect the interests of the general unsecured creditors in the case. The Committee has standing to file motions, negotiate plan terms with the debtor, file objections to the plan, and to otherwise participate in every aspect of the case. The committee has the authority to hire professionals to assist the committee, such as lawyers, appraisers, or accountants. The committee’s expenses are paid for by the debtor, and are subject to review and approval by the Bankruptcy Court for reasonableness.

What are classes of creditors in a Chapter 11?

Classes of creditors are groups of creditors selected by the debtor for purposes of treatment as a group and voting as a group in the plan. The debtor cannot put similarly situated creditors in different classes nor can the debtor gerrymander the classes for the sole purposes of procuring a favorable vote in support of the plan from the class.

How are the votes counted in Chapter 11?

A class accepts the plan when more than one-half of the numerical votes cast vote in favor of the plan and more than two-thirds of the dollar value of the claims within the class have accepted the plan.

Do creditors get to vote on the approval of a Chapter 11 plan?

Yes. Each creditor gets to vote for or against the plan. The votes are counted both by the number of creditors casting votes and the amount of dollars represented by creditors casting ballots.

Can the court force a secured creditor to reduce its interest rates or change the loan payments or due dates in a Chapter 11 plan?

Yes. The court can, under certain circumstances, reduce the interest rates on loans to market rates of interest in the plan. The court can also approve a plan that extends the maturity dates of loans, or changes the monthly payments or amortization schedules. The court can make these changes over the affected creditor’s objections, under certain circumstances.

Can the court force a secured creditor to reduce its interest rates or change the loan payments or due dates in a Chapter 11 plan?

Yes, the plan can be approved even if all of the classes of creditors do not vote in favor, provided at least one impaired class of claims accepts the plan. A class is impaired if the plan makes a change in the terms of the contract between the debtor and the creditor(s) within the class.

What is the “best interest of creditors number” and why is it important in Chapter 11?

The “best interest of creditors number” is the hypothetical amount that the unsecured creditor class would receive if the debtor’s case were converted to Chapter 7 and the unsecured creditors were paid the amount available if the debtor’s assets were liquidated by a Chapter 7 Trustee. In order to confirm a Chapter 11 plan, the court must find that the unsecured creditors will be paid at least as much as the best interests of creditor’s number under the terms of the plan. If not, the court will deny confirmation of the plan.

Are the rules different in a single asset real estate case than in a standard Chapter 11?

The primary difference between a single asset real estate case and a standard Chapter 11 case is that the rules are designed to speed up the process of presenting and approving the debtor’s plan in a single asset real estate case versus a standard Chapter 11 case. A debtor in a single asset real estate case must, within 90 days of the petition date, either file a plan of reorganization that is reasonably confirmed on its face, or commence making adequate protection payments to the secured lender in monthly amounts equal to interest only calculated at the non-default contract rate, or the secured creditor is entitled to relief from the automatic stay to commence or conclude foreclosure of the real estate.

How does the court determine the interest rate for real estate loans in a single asset real estate case?

If the debtor and the lender cannot agree on an interest rate, the bankruptcy court has the power to fix the rate, which could be higher or lower than the contract rate. The standard the court is to apply when determining the new rate is the market rate that would apply to a loan to a debtor under the same or similar circumstances, taking into account various risk factors. This determination usually will require the presentation of expert testimony as to the prevailing market rates of interest for loans made to similar buyers and under similar circumstances as the debtor.

What does the term "cram down" mean in a Chapter 11?

"Cram down" is a well-known term in the Chapter 11 process although the term does not appear anywhere in the Bankruptcy Code or Rules. "Cram down" simply means the process by which the bankruptcy court can, as part of confirmation of a Chapter 11 Plan, force a treatment upon an unwilling creditor or class of creditors against their will, provided the plan otherwise meets all of the other confirmation criteria under Section 1129 of the Bankruptcy Code.

How are disputed claims resolved in Chapter 11?

The debtor or the Creditors’ Committee have the right to file written objections to creditor’s claims in Chapter 11. If the objection is not resolved by agreement between the objecting party and the creditor, the court will conduct a hearing and the court will fix the amount of the claim for purposes of the Chapter 11 case. Once a claim is not subject to dispute, it is referred to as an allowed claim.

Can the Court force my lender to make new loan advances to me so my company can pay its bills?

No. A bankruptcy court cannot force anyone to loan new money to a debtor under any chapter of the Bankruptcy Code. However, the court can force a creditor to allow a debtor to use existing bank collateral to pay the debtor’s operating expenses. For example, the court could allow a debtor to use the proceeds from the sale of a house that was subject to a lender’s mortgage rather than to pay off the mortgage. No debtor should assume he or she will have the automatic right to use cash collateral. The debtor has the burden of proving that the secured lender’s position will not be hurt by the debtor’s use of cash collateral. The right to use cash collateral should be discussed early on with competent Chapter 11 counsel.

How do I locate a Chapter 11 attorney?

Vanden Bos and Chapman, LLP has been handling Chapter 11 cases for more than 30 years. Chapter 11 is a complex process and should only be undertaken with the assistance of experienced attorneys. The websites of Chapter 11 counsel should be reviewed carefully for the amount of experience as well as the types and the sizes of the cases. Every effort should be made to get a referral from a party you trust, such as your general business attorney or your CPA. Finally, a face-to-face meeting with the lawyer is, of course, necessary to evaluate whether your choice of counsel will be a good fit for you and for your business.

What does Chapter 11 cost?

As of January 1, 2012, the filing fee for Chapter 11 is $1046.00. Individual Chapter 11 debtors must also first complete a consumer credit counseling session to become eligible to file a Chapter 11 case. The actual cost of the Chapter 11 will vary greatly from case to case. The debtor’s costs can include paying for the professionals of the creditors’ committee and secured creditors as well as paying the debtor’s own professional fees. The only way to get a rough idea of how much a Chapter 11 case might cost in your own situation is to meet with experienced counsel, review all of the facts and circumstances, and ask for an estimate of the fees. At Vanden Bos and Chapman, LLP, our lead partner will meet with qualified Chapter 11 candidates at no cost for an initial evaluation of the suitability of Chapter 11 and discuss the costs of the case with you.

Do I have to be operating a business to file Chapter 11?

No, there is no requirement that there be an operating business to file Chapter 11. Filing Chapter 11 to preserve the value of assets, even if there is no business, is a perfectly acceptable reason to file Chapter 11.

What is a motion for relief from the automatic stay?

A motion for relief from stay is a motion to lift (eliminate) the stay of actions against the debtor or the debtor’s property so that the creditor can proceed to enforce the creditor’s rights against the property as if there were no bankruptcy. The most common motion for relief from the automatic stay is for permission to continue with a foreclosure against the debtor’s real property, thereby removing the real property from the bankruptcy estate. In many cases, particularly single asset real estate cases, if the debtor loses a motion for relief from stay, the chances of proposing and confirming a Chapter 11 plan are seriously diminished.

What is meant by the term "equity cushion"?

Equity cushion refers to the value of an asset above the amount of the secured debt on the asset. For example, a parcel of real estate worth $1,000,000 subject to a mortgage of $800,000 would have an equity cushion of $200,000.

What happens at the confirmation hearing?

Prior to the confirmation hearing, the debtor will have filed a tally of the creditor votes on the plan. Even if all creditors vote in favor of the plan, the bankruptcy court will not approve the plan unless the court first finds that the plan meets all of the requirements for confirmation provided for in the Bankruptcy Code. If not all classes of creditors have accepted the plan, or if creditors or creditors’ committee have objected to confirmation of the plan, the court will conduct a trial of the issues to determine if the plan can be confirmed over the objections. If the court finds the plan meets all of the confirmation requirements, it will enter an order confirming the plan. The court may also indicate it will deny confirmation of the plan as written, but allow the debtor a chance to file an amended plan to fix or eliminate the offending plan provisions, then confirm the amended plan, either with or without an additional hearing.

What are 503(b)(9) claims?

Suppliers who have delivered materials to the Chapter 11 debtor within 20 days prior to the filing of debtor’s Chapter 11 bankruptcy petition who have not been paid as of the date of the filing of the bankruptcy are entitled to treatment as administrative claims in the bankruptcy case. Unless otherwise agreed, administrative claims are entitled to payment in full on or before the effective date of the plan (which is generally within 14 days of entry of the confirmation order). Because administrative claims have to be paid in full in order to achieve confirmation of a plan, it is important that special attention be paid to the possible existence and the amount of 503(b)(9) claims when preparing for a Chapter 11 case.

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