Chapter 11 is primarily for business reorganization. The business continues to operate, but the automatic stay gives the debtor time to restructure its finances. Persons with too much debt to qualify for chapter 13 may also file chapter 11. However, since the provisions are so complex and the costs so expensive, Chapter 11 is normally filed by corporations and other business entities.
A business may reorganize by: 1) drastically lowering expenses; 2) obtaining additional operating capital; or 3) liquidating all or a portion of the business. The presumption is the ongoing value of business is greater than the sale of its assets. However, a liquidating plan is also permissible and allows the debtor to sell the business at a better price or under more advantageous circumstances than a chapter 7.
Cooperation among the various interests in a case is often crucial to a successful reorganization.
How Chapter 11 Works
A debtor commences a chapter 11 by filing a petition and immediately becomes a "debtor in possession." The debtor typically retains management and control of assets during the reorganization without the appointment of a case trustee as in a chapter 7.
A written disclosure statement and plan of reorganization are filed with the court. The disclosure statement must contain sufficient information about the debtor's assets, liabilities, and financial affairs to enable a creditor to make an informed judgment whether to vote to accept or reject the plan.
Once the disclosure statement is approved by the court, a copy is sent to creditors with the plan and a ballot. Creditors whose claims are "impaired," meaning their rights are modified by the plan or they will be paid less than the full claim under the plan, may vote to accept or reject the plan. A confirmation hearing is held. If there are sufficient votes in favor of the plan, it is confirmed as a consensual plan. If not, the court determines whether to "cram down" the plan over creditor objections.
A debtor in possession owes fiduciary duties and has the powers of a bankruptcy trustee. Such duties include accounting for property, examining and objecting to claims, and filing tax returns and reports as required by the court and the United States Trustee. A debtor in possession has the power to employ attorneys, accountants, brokers, or other professionals, subject to court approval, to help with the case.
If a debtor in possession fails to comply with the U.S. Trustee requirements, fails to comply with court orders, or fails to take appropriate steps to submit a plan for confirmation, the U.S. Trustee or a creditor may file a motion to appoint a case trustee, convert the case to chapter 7, or dismiss the case.
The United States Trustee
The United States Trustee monitors the progress of a chapter 11. The U.S. Trustee reviews the debtor's monthly operating reports, applications to employ professionals, motions for fees, and any plan or disclosure statement filed in the case. The U.S. Trustee conducts the creditors' meeting at the beginning of the case where their representative and creditors may question the debtor concerning the debtor's conduct, assets, and the plans for reorganization.
The U.S. Trustee imposes certain requirements on the debtor such as reporting monthly income and operating expenses, opening new bank accounts, and ensuring payment of current employee withholding and other taxes. While the case is pending the debtor pays a quarterly fee to the U.S. Trustee. The amount of the fee is based upon the disbursements made in the prior quarter and adds a significant expense to the case.
The unsecured creditors' committee may play a major role in the case. The U.S. Trustee appoints the committee, consisting of several creditors who hold the largest unsecured claims. The committee may consult with the debtor on the administration of the case, investigate the debtor's conduct or business operations, and participate in the formulation of a plan. The committee may hire its own lawyer, and the legal fees are usually paid from the debtor's bankruptcy estate. This can make a chapter 11 case very expensive.
The Automatic Stay
The automatic stay stops all collection activities, foreclosures, and repossessions on any claim that arose before the filing of the bankruptcy petition. The stay automatically goes into effect when the petition is filed. The stay provides a breathing spell so negotiations can occur to resolve the debtor's financial difficulties.
In certain circumstances, a creditor may move to lift or modify the stay. For example, if there is no equity in a particular property, and the property is not necessary for reorganization, the creditor can request an order granting relief from the automatic stay to foreclose on the property.
Who Can File A Plan
There is no specific time for filing a plan; however, the debtor initially has an exclusive period to file a plan and disclosure statement. This period may be extended or reduced by court order. After the exclusive period expires, a creditor or the case trustee, if one is appointed, may file a plan. The time limit on the debtor's exclusive right to file a plan is intended as an incentive for the debtor to file a plan promptly.
Confirmation of a plan discharges the debtor from any debt arising before the date of confirmation. After confirmation, the reorganized debtor and the creditors are bound by the terms of the plan. The confirmed plan creates new contractual rights, replacing or superseding prepetition contracts.
There are exceptions to the general rule that an order confirming a plan operates as a discharge. Confirmation of a plan does not discharge an individual debtor from any debt made nondischargeable by section 523 of the Bankruptcy Code. Confirmation does not discharge the corporate or partnership debtor if the plan is a liquidation plan, as opposed to one of reorganization. When the debtor is an individual, confirmation of a liquidation plan will effect a discharge unless grounds would exist for denying the debtor a discharge if the case were proceeding under chapter 7 instead of chapter 11.