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Background
Chapter 11 is for business reorganizations. It allows a debtor to remain in business while
giving the debtor a chance to restructure its finances so it may continue in business.
Individuals may file chapter 11, but the provisions are so complex and the costs so
expensive, the proceeding is normally used to reorganize corporations or partnerships.
Generally there are three means to reorganize: 1) drastically lower operating costs; 2)
obtain additional operating capital; or 3) liquidate all or a portion of the business. A
reorganization presumes the ongoing value of business is greater than the sale of its
assets. However, a liquidating plan is 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 assumes the role of
"debtor in possession." The debtor typically retains possession 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 accept the plan.
After court approval of the disclosure statement, a copy is sent to creditors with the
plan and a ballot. Creditors whose claims are "impaired," meaning their
contractual rights are modified or they will be paid less than the full claim under the
plan, may vote on 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.
The Debtor-In-Possession
A debtor in possession is held to the level of a fiduciary and has the duties and 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.
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, their
motions for fees, and any plans or disclosure statements filed in the case. The U.S.
Trustee conducts the creditors' meeting at the beginning of the case where the U.S.
Trustee 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, establishing new bank accounts, and ensuring payment of
current employee withholding and other taxes. While the case is pending the debtor must
pay a quarterly fee to the U.S. Trustee. The fees currently range from $250 up to $10,000,
depending upon the total disbursements made during the prior quarter. This can add
significant expense to a chapter 11.
If a debtor in possession fails to comply with the U.S. Trustee's requirements, fails to
comply with court orders, or fails to take appropriate steps to bring the case to
confirmation, the U.S. Trustee may file a motion to convert to a chapter 7 or have the
case dismissed.
Creditors' Committee
The unsecured creditors' committee often plays a major role in a chapter 11. 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 for a debtor.
The Automatic Stay
The automatic stay stops all collection activities, foreclosures, and repossessions on any
debt or 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 take place to try 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 limit for filing a plan; however, the debtor has a 120-day
exclusive period to file a plan. This period may be extended or reduced by the court.
After the exclusive period expires, a creditor or the case trustee, if one is appointed,
may file a competing plan. The U.S. Trustee may not file a plan.
The right to file a competing plan is an incentive for debtor to file a plan within the
exclusive period. Also, a creditor or the U.S. trustee may move to dismiss, to convert to
a chapter 7, or to appoint a trustee to take control of the debtor's business if the case
does not move forward.
Motions
The continued operation of the debtor's business may lead to a number of motions. The most
common are motions to lift the automatic stay and motions for authorization to use cash
collateral. Delays in filing or confirming a plan may lead a secured creditor to move for
relief from stay or to seek conversion to chapter 7 or to dismiss the case altogether.
Cash Collateral and Adequate Protection
The debtor in possession may use, sell, or lease assets in the ordinary course of its
business without prior court approval, unless the court orders otherwise. If the use, sale
or lease is outside the ordinary course of business, court permission is required. A
debtor in possession may not use "cash collateral," meaning accounts subject to
security interests or proceeds from the sale of pledged inventory or equipment, without
the consent of the secured creditor. The court may permit the use of cash collateral
without the secured creditor's consent if the judge determines the secured creditor is
adequately protected. The court may require the debtor to make periodic or lump sum
payments or give an additional or replacement lien to protect the creditor's interest.
Appointment of a Case Trustee
Appointing a case trustee is rare, but a party in interest or the U.S. Trustee can move
for a trustee before plan confirmation. The court orders the appointment of a trustee for
cause, such as fraud, dishonesty, incompetence, or gross mismanagement, or if it is in the
best interests of creditors, equity security holders, or other interested parties. The
U.S. Trustee appoints the case trustee.
The U.S. Trustee is responsible for monitoring chapter 11 cases and has standing to appear
and be heard on any issue in the case. The case trustee, on the other hand, is responsible
for management of the assets, operation of the debtor's business, and if appropriate,
filing a plan of reorganization. The Bankruptcy Code requires the trustee to file a plan
"as soon as practicable" or to file a report explaining why a plan will not be
filed and then recommend either the case be converted to another chapter or dismissed.
Conversion or Dismissal by Debtor
A debtor in possession has a one-time absolute right to convert to a chapter 7 unless: (1)
the debtor is no longer a debtor in possession, (2) the case was commenced as an
involuntary case, or (3) the case was converted to chapter 11 other than at the debtor's
request. A Chapter 11 debtor does not have an absolute right to have the case dismissed.
The Disclosure Statement
Anyone proposing a plan must also file a disclosure statement. The disclosure statement
must provide "adequate information" concerning the debtor's affairs to enable a
creditor to make an informed decision whether to accept the plan. After the disclosure
statement is filed, the court holds a hearing to determine whether the disclosure
statement should be approved. Acceptance or rejection of a plan cannot be solicited
without court approval of the disclosure statement. Once the disclosure statement has been
approved, the plan proponent can begin to solicit acceptances of the plan, and creditors
may also solicit rejections of the plan.
The Plan of Reorganization
During the first 120 days after the voluntary petition, only the debtor in possession may
file a plan. If the plan is filed within 120 days, the debtor in possession has 180 days
from the petition date to obtain acceptance of the plan. The court may extend or reduce
this exclusive period for cause. The exclusive right to file a plan is also lost if a
trustee is appointed in the case.
The court is required to hold a plan confirmation hearing. Any party in interest may file
an objection to confirmation. Even if no objection is filed, in order to confirm the plan
the court must find: (1) the plan is feasible, (2) it is proposed in good faith, and (3)
the plan and the proponent of the plan are in compliance with the bankruptcy code. The
court must also find confirmation is not likely to be followed by liquidation or a need
for further reorganization.
The court is required to hold a plan confirmation hearing. Any party in interest may file
an objection to confirmation. Even if no objection has been filed, the court must
determine if the plan has been proposed in good faith and according to law. In order to
confirm the plan, the court must find: (1) the plan is feasible, (2) it is proposed in
good faith, and (3) the plan and the proponent of the plan are in compliance with the
Code. The court must also find confirmation is not likely to be followed by liquidation or
a need for further reorganization.
The Discharge
The confirmation of a plan discharges the debtor from any debt arising before the date of
confirmation. After confirmation, the reorganized debtor is 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 of reorganization will discharge any type of debtor ---
corporation, partnership, or individual --- from most types of prepetition debts. However,
confirmation does not discharge an individual debtor from any debt made non-dischargeable
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.
Postconfirmation Modification of the Plan
At any time after confirmation and before "substantial consummation" of a plan,
the proponent of a plan may modify a plan if the modified plan would meet Bankruptcy Code
requirements. Unlike preconfirmation modification, a postconfirmation modification does
not automatically become part of the confirmed plan. A postconfirmation modification only
becomes part of the plan "if circumstances warrant such modification" and the
court, after notice and hearing, confirms the plan as modified pursuant to chapter 11.
Revocation of the Confirmation Order
Revocation of the confirmation order is an undoing or cancellation of the plan
confirmation. A request for revocation, if made at all, must be made by a party in
interest within 180 days of confirmation. The court, after notice and hearing, may revoke
a confirmation order if and only if the confirmation order was procured by fraud.
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