We often hear about giant corporations going into Chapter 11 and then continuing to operate their businesses. A Chapter 11 business reorganization is designed to do that for large companies including partnerships and sole proprietorships though it is generally used by corporate entities facing massive debt and an inability to pay its creditors. In some cases, individuals can use Chapter 11 as well if their debt does not qualify them for a Chapter 13. The process allows the company to restructure its obligations as well as its business operations so that it can continue to operate while paying its creditors less than what is owed them under an approved repayment plan that will get the company back to profitability.
Under the protection of the bankruptcy court, the company can seek new income or funding sources, shed poorly performing departments and employees and renegotiate contracts and leases. It can be a long and costly process but ultimately a life-saver for many companies if their restructuring is well-crafted, costs are trimmed and sound business decisions are made.
The Initial Filing
Like any other bankruptcy, once the debtor files the petition, an automatic stay goes into immediate effect under US Code Section 362, Title 11. The stay prohibits any further collection activities by creditors including court proceedings or seizure of property.
The debtor company also becomes the debtor-in-possession and has the power of the trustee to oversee the process of continuing to operate the company but with the approval of the bankruptcy court in most instances. The debtor-in-possession has the right to engage in litigation, negotiate contracts and seek and accept loans. Creditors, though, can object to the company’s role and ask the court to appoint someone else to act in this capacity if it is in the best interests of the creditors and bankruptcy estate.
The corporate or business debtor is required to file a Disclosure Statement within 120 days after filing and has the exclusive right to have it approved or rejected within 180 days after filing. The statement gives the creditors information about the company’s affairs so it can make an intelligent and informed decision about the reorganization plan. The statement includes all relevant information about the company and the proposed reorganization including:
- Company history
- Circumstances that led it to file for Chapter 11
- Ongoing or pending litigation affecting the company
- Identification and valuation of its assets including accounting and valuation methods
- Source of information regarding the assets and any other relevant information
- List of liabilities and what creditors can expect to receive
- Comparison to what creditors would receive under Chapter 7
- How feasible the planned reorganization will be
- List of accounts receivables
- Tax consequences
- Summary of the plan
The bankruptcy court must approve the statement before a reorganization plan can be approved. If it does approve the statement, then the court serves or submits to all creditors copies of the statement, plan or summary of the plan and notices of when acceptance or objections must be filed. A confirmation hearing regarding the plan is scheduled and all creditors are advised.
A committee consisting of unsecured creditors is formed to represent their interests. In some cases, there may be multiple committees. When the plan is formulated and distributed for acceptance, the creditors vote on it. The reorganization plan categorizes the creditors into four classes with secured creditors having priority with each class voting on acceptance or rejection.
In some cases, those creditors who will receive less than what is offered may have the plan forced on them in a “cram down.”
Confirmation and Implementation
It is not unusual for there to be several competing plans filed after the 120 day period of exclusivity has expired and no plan has been submitted or after an additional 60 days if it has been but is rejected. These competing plans are examined by the court and all must meet all the requirements including filing a Disclosure Statement and being voted upon. Once a plan is accepted, the debtor is obligated to follow it. The plan may provide for the sale of assets, renegotiation of leases and labor contracts, but these and any other major business decisions must be court approved. The US Trustee monitors the business operations and submission of operating reports. Normally, the business must make a monthly payment for the benefit of the creditors.
Small Businesses Under Chapter 11
Small businesses are treated slightly different than large corporate entities or partnership in a Chapter 11 business reorganization. Ordinarily, a small business would file under Chapter 13, which is a much simpler and less costly process. Where a small business has filed, the court has the discretion to order that no creditors’ committee be appointed and that the Disclosure Statement requirement be waived. The exclusivity period for filing a reorganization plan is also extended from 120 to 180 days. There is more oversight in small business Chapter 11 matters but the process is more expeditious and far less costly than compared to the typical corporate reorganization.
A Chapter 11 is a complicated process, requiring intimate knowledge of the business’ operations and being able to draft a workable reorganization plan that will meet the approval of the court and creditors. Retain an experienced bankruptcy attorney to discuss your legal options if your company is facing overwhelming debt.