Dan Garrison 2012-12-12 01:16:49
In my last article, we discussed the basics of Chapter 7 and Chapter 13 bankruptcies. This month, we’ll walk through a primer on Chapter 11. Chapter 11 is intended to effect a “reorganization” of the debtor’s affairs. Most people associate Chapter 11 with large companies, but flesh-and-blood people also can be Chapter 11 debtors. In fact, some people (because of the amount and type of their debts) may only file Chapter 11 bankruptcies. Before your head begins to spin with too much velocity, though, let’s cover some basics. Commencing the Chapter 11 Case Like Chapters 7 and 13, a Chapter 11 case is commenced by a petition being filed. The petition is accompanied or shortly followed by schedules of assets and liabilities and a statement of financial affairs. Filing the petition creates an estate comprising all of the assets and liabilities of the debtor as of the petition date. Again using the metaphor of a “snapshot,” the filing of a petition fixes in time most parties’ rights vis a vis the bankruptcy estate. The automatic stay goes into effect, and creditors (and others) are barred from most efforts to exercise control over estate assets, commence or continue litigation, and collect debts. In other words, the basics of commencing a Chapter 11 case do not differ much from the other types of bankruptcy cases we’ve already discussed. The Debtor in Possession Only in a Chapter 11 case do we speak of a “debtor in possession,” or “DIP.” The phrase connotes that a trustee is not appointed and that, instead, the debtor remains in possession and control of its assets and affairs (subject, of course, to a number of restrictions and reporting requirements). The DIP is allowed, generally, to carry on its “ordinary course” business affairs. Significant limitations on this concept include that the DIP may not use estate assets to pay pre-petition debts, and may not generally borrow money, transfer away significant assets, or enter into major contractual relationships or compromises—at least not without notice to creditors and court approval. Early in the Chapter 11 case, the DIP must meet with a financial analyst employed by the United States Trustee to review its affairs, the reason for the bankruptcy filing, and its preliminary strategy for reorganization. This meeting also introduces the DIP to the monthly operating reports that must be prepared and filed during the bankruptcy, and the other operating guidelines for debtors in possession. Among other things, the DIP must open new, monitored bank accounts (not surprisingly, called “debtor-in- possession” or “DIP” accounts), and maintain insurance on its assets and add the U.S. Trustee as a party to receive notices of changes in insurance. In addition to the monthly operating reports, a DIP often has to develop periodic budgets concerning the use of “cash collateral.” When a lender has a lien against income-producing assets of a debtor, the cash generated by those assets also is the lender’s collateral. That cash may be used only with the lender’s permission, or with court approval over the lender’s objection. In order to approve that use of cash, the court must find (among other things) that the lender’s interests are “adequately protected.” Adequate protection may include a rolling-forward lien on inventory or new cash generated, replacement liens on other unencumbered assets, and/or some form of payment from the debtor to the lender. “First-Day” Practice The “bright line” created on the petition date often requires a DIP to seek special dispensation from the court early in the case. For example, it’s virtually impossible for an operating business to file its bankruptcy at a moment when its employees are paid in full, and the black-letter rules prohibit the DIP from paying employees for accrued but unpaid compensation. In order to prevent mass resignations and preserve the going-concern value of the business, DIPs often seek and receive orders from the court early in the case in order to pay employees their pre-petition compensation. Similarly, DIPs regularly engage in what is referred to as “first-day” practice in order to obtain special dispensations for other operation-critical matters that are restricted under the Bankruptcy Code. The Middle of the Case Beyond the initial matters described above and the end-game matters dealt with below (which play out in virtually every case), it’s impossible to chart an “average” Chapter 11 case’s course. Each is as unique as the debtor. Debtors may seek approval to sell some or all of their assets. Debtors often sue and are sued within the bankruptcy case to resolve contractual disputes, challenge liens, and recover improper payments or transfers of assets made before the bankruptcy was filed. Debtors commonly object to creditor claims. Creditors often seek relief from the automatic stay to foreclose on estate assets that are their collateral. Almost anything that can be litigated outside also may be litigated within a Chapter 11 case. The Chapter 11 Plan Although some Chapter 11 cases don’t reach the “finish line,” the ultimate goal is to confirm (i.e., obtain court approval for) a plan of reorganization. Within a Chapter 11 plan, debts can be restructured; assets can be sold or abandoned; leases and other contracts can be assumed and assigned, or rejected; new financing or investment can be approved; and ownership interests can be created, modified or cancelled. The Chapter 11 plan also dictates (within the confines of the absolute priority rule, discussed in a prior article) how value will be distributed to various classes of creditors. Before a plan can be confirmed the debtor is required to solicit creditors, who are allowed to vote within classes on accepting or rejecting the plan. The plan itself divides the creditors into classes based upon a strictly-policed standard of similarity—in other words, creditors whose legal rights are similar are grouped together, both for voting on the proposed plan and, ultimately, for receiving pro rata distributions under the confirmed plan. A plan can be confirmed even if less than all of the creditor classes vote to accept the plan, so long as at least one class of impaired creditors lends its support. This is known as a “cramdown” situation. In order to solicit votes, the debtor must obtain court approval for a “disclosure statement,” or prospectus, that is intended to explain to creditors the structure, operation and effect of the proposed plan. Once voting is concluded, the court considers confirming the proposed Chapter 11 plan. In addition to considering the voting, the court also determines whether the plan is consistent with the Bankruptcy Code’s strictures and, ultimately, whether it has been proposed in good faith, is feasible, and is in the best interest of creditors. One seminal requirement is that the plan must provide creditors a recovery at least as favorable as they would receive in a Chapter 7 liquidation. Once confirmed, the Chapter 11 plan governs the reorganized debtor and its relationship with its creditors. The Chapter 11 case is closed once the plan is “substantially consummated,” which may happen quickly or take years, depending on the plan’s structure. Special Cases: Individual Chapter 11s and Single-Asset Real Estate Cases There are special rules that overlay the common structures and processes described above for flesh-and-blood debtors in Chapter 11, and for debtors whose assets consist solely of real estate. We’ll cover those in a later article.
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