A Chapter 11 bankruptcy provides individual debtors with an opportunity to reorganize their debts and retain property that would otherwise be sold by the trustee in a Chapter 7 liquidation proceeding. For individuals, Chapter 11 bankruptcy is similar to a Chapter 13 which allows debtors to obtain a discharge of their debts without liquidation of their property. In some cases, individuals will file a Chapter 11 because they cannot qualify for a Chapter 13 but would like to achieve a similar result.
Property of the Bankruptcy Estate
One of the necessary steps to successfully completing the Chapter 11 process is to obtain confirmation of a Chapter 11 Plan. Like Chapter 13, property and earnings acquired by the debtor after the filing of the case are included in the bankruptcy estate and can be distributed to creditors. This allows a debtor to fund the Chapter 11 Plan using future earnings as opposed to liquidation of the debtor’s property. One thing that creditors will want to look for in a Chapter 11 case is whether you are contributing all of your disposable income into the Plan. As a result, Chapter 11 debtors are required to file with the court monthly operating reports so creditors can analyze their post-petition assets, income and expenses.
The Plan Process
The debtor can obtain court approval of a Chapter 11 plan by proposing a plan that is accepted by all classes of creditors in the case. In the alternative, a debtor can “cram-down” the plan over creditor rejections in certain circumstances by adhering to all of the provisions contained in 11 U.S.C. § 1129(b) and if the plan is “fair and equitable”. In most cases, a debtor will be required to pay all of his or her disposable income over five years into the Plan to pay creditors.
Creditors can object to the proposed plan for a variety of reasons, including the following:
- The debtor does not meet Chapter 11 requirements;
- The income contributed by the debtor to fund the Plan is insufficient;
- The payment to creditors under the Plan is less than would be distributed to creditors in a liquidation;
- The valuation of a secured creditor’s collateral is too low and payment of their claim is inadequate;
- The plan is not feasible; and
- The plan was not filed in good faith.
In Chapter 11, creditors play a much greater role in the Plan process because they have the ability to vote to accept or reject the plan. Unlike in Chapter 13, where creditors must have cause to object to the Plan, creditors in Chapter 11 can reject the Plan for any reason. However, Chapter 11 does have benefits for debtors, particularly the period of time that you have to file your plan. In a Chapter 13, a plan normally is filed at the time you file your bankruptcy case. In a Chapter 11, the period of time to file a plan is much more flexible and will depend upon the specific circumstances of your case.
One situation in which individuals can take advantage of Chapter 11 is if they have a home or investment property which they would like to avoid having sold to pay creditor claims. A Chapter 11 can provide a debtor with time to catch up on past due payments while remaining current on post-petition obligations going forward.
In the alternative Chapter 11 can also provide a debtor with time to sell their home or investment property on better terms than in a forced sale at liquidation value. The bankruptcy process will allow a debtor to properly market the property and pay any expenses necessary to make the property presentable for potential buyers. The proceeds retained by the debtor from the sale of a property in a foreclosure sale or Chapter 7 liquidation can be much less than from a sale that is openly marketed by a real estate agent for a significant period of time.
This is just one example of the how the additional time and flexibility provided by a Chapter 11 can be utilized by an individual debtor, and these benefits also extend to businesses in need of reorganization.
Chapter 11 is a good option for business debtors that want to remain in operation after bankruptcy. The Chapter 11 process gives debtors time to restructure their debt and obtain court approval of a feasible bankruptcy plan that will allow them to stay in business while also providing for payment of creditors.
Businesses that file under Chapter 11 will have to get creditors to agree on a repayment plan that pays all or some portion of the debt, or obtain "cram-down" of a Plan. Over the next few years, the business can remain open during bankruptcy while the business owner makes monthly payments on their debt. Once the repayment period is over and the debtor has completed all plan payments, the debt is discharged and the debtor can continue in operation.
Debtor in Possession
In both individual and business Chapter 11 cases, the debtor will operate as the “debtor in possession” during the pendency of the bankruptcy case. This is generally more important in a business case because there are more likely to be significant operational duties that must be performed during the pendency of the case. The debtor in possession operates in the ordinary course of business and will not need to immediately place property under a trustee’s control as in Chapter 7 and Chapter 13. Although the debtor must obtain court approval to perform certain actions, such as sell a substantial portion of its business or take out a loan, Chapter 11 provides a debtor with the freedom to make necessary day to day decisions. The debtor has the flexibility to pay expenses such as utilities, insurance, rent, salaries and maintenance costs without seeking permission from the Court.
In a business case, a debtor could have several clients or customers with whom it has a contractual relationship that has not yet ended at the time of the bankruptcy filing. Executory contracts could include supply contracts (with both vendors and customers), financing agreements, labor union contracts and real estate leases. Some of these contracts may be beneficial to the debtor or even necessary to its success, while others are no longer profitable.
One of the major benefits of Chapter 11 is that debtors can choose whether or not they want to continue with an executory contract. This is done by electing to“assume” or “reject” the contract. If the debtor assumes the contract, both the debtor and its counterparty must continue to perform the contract in full and meet all contractual obligations. If it is rejected, the contractual relationship is ended and the counterparty is left with a claim against the debtor's bankruptcy estate and is treated like any other creditor. A Chapter 11 thus gives debtors the flexibility to retain profitable contracts and reject those that are dragging the business down.
Debtor in Possession (DIP) Financing
A Chapter 11 filing can give a debtor time to negotiate with its creditors or obtain a loan from a new lender to refinance its major obligations. The bankruptcy court must approve any post-petition financing secured by assets of the estate. DIP financing is used to pay off outstanding debts of the company as well as provide funds for working capital and other general operating purposes. DIP financing can be vital to a reorganization effort because it can lower your annual interest cost, extend the date your debt matures and improve your cash flow.
Small Business Debtors
A business or other commercial entity is defined in the Bankruptcy Code as a "small business debtor" when it has secured and unsecured debts as of the date of its bankruptcy filing of $2,490,925 or less. The Bankruptcy Code places small business debtors under greater scrutiny than other debtors and requires that their cases proceed more quickly. Unlike other debtors, small business debtors must attend an initial interview with the U.S. trustee during which the trustee will evaluate the debtor's business and its ability to obtain a confirmable Chapter 11 Plan. The U.S. trustee will also monitor the activities of the small business debtor during the case.
The most important requirement in a small business case is that a plan must be filed within 300 days of the filing of the bankruptcy. If this is not done, the debtor risks dismissal of its case.
The reason for the additional oversight by the U.S. trustee and tightened restrictions is that, unlike in larger bankruptcy cases, in smaller cases the U.S. trustee may not be able to to find creditors who are willing to serve on a creditors' commitee. The Bankruptcy Code requires small busines debtors to submit to stricter rules to ensure that creditors receive adequate representation in their cases.
Single Asset Real Estate Cases
Like small business debtors, single asset real estate debtors are also subject to stricter provisions under the Bankruptcy Code. The term "single asset real estate" means real property constituting a single property or project, other than residential real property with fewer than four residential units, which generates substantially all of the gross income of a debtor who is not a family farmer and on which no substantial business is being conducted by a debtor other than the business of operating the real property and activities incidental thereto. 11 U.S.C. § 101(51B).
The Bankruptcy Code provides creditors of a single asset real estate debtor with additional grounds for obtaining relief from the automatic stay that are not available to creditors in other cases. The court will grant relief from the automatic stay in a single asset real estate case unless the debtor either files a feasible plan of reorganization or begins making interest payments to the creditor within 90 days from the date of the filing of the case, or within 30 days of the court's determination that the case is a single asset real estate case. The interest payments must be equal to the non-default contract interest rate on the value of the creditor's interest in the real estate. 11 U.S.C. § 362(d)(3).
As a result of these provisions, it is important that single asset real estate debtors be prepared to make paymnets to secured creditor that will adequately protect their interest in the real property.
Filing a Chapter 11 Case
Chapter 11 provides more flexibility to debtors than the other chapters of the Code but also places more responsibility on debtors. In exchange for the ability to operate as debtor in possession and receive additional time to reorganize, a Chapter 11 debtor must meet requirements that are not imposed on other debtors and timely provide information requested by the U.S. trustee and the Court.
The rules governing Chapter 11 cases are more complex and can change depending on the type of debtor. Chapter 11's also tend to impose greater challenges because they often involve debtors with more valuable assets and a larger debt load then debtors in Chapter 7 and Chapter 13. As a result, Chapter 11 cases normally require more work but also worthwhile benefits.
Please consult with our office to determine if a Chapter 11 filing is right for you.