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Attorney Thomas B. Gorrill

Chapter 11

Background on Chapter 11

Chapter 11 is usually for business reorganizations. The business continues to operate, but the automatic stay gives the debtor time to restructure. Persons with debt above the dollar limits for chapter 13 may file chapter 11. However, since the proceeding is complex and expensive, Chapter 11 petitions are normally filed by corporations and other business entities.

A business typically reorganizes by: 1) drastically lowering expenses; 2) obtaining additional operating capital; or 3) liquidating all or a portion of the business. A debtor may also renegotiate loan or contract terms. The presumption in chapter 11 is that the value of the operating business is greater than selling the 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 in chapter 7.

How Chapter 11 Works

A debtor commences a chapter 11 by filing a petition and immediately becomes a “debtor in possession.” The debtor retains management and control of assets during the reorganization without the appointment of a case trustee as in a chapter 7. A trustee may be appointed if the debtor mismanages the business or fails to comply with the duties of a debtor in possession.

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 decision whether to accept or reject the proposed plan.

The court reviews and approves disclosure statement is before it is sent to creditors with the plan and a ballot. Creditors with “impaired” claims, meaning their rights are modified by the plan or they will be paid less than their full claim under the plan, may vote to accept or reject the plan. If there are enough votes accepting the plan, it is confirmed as a consensual plan. If not, the court determines whether the plan can be “crammed down” and confirmed over the creditor objections.

The Debtor-In-Possession

A debtor in possession has the powers of a bankruptcy trustee and owes a fiduciary duty to creditors while operating the business. Such duties include accounting for property, examining and objecting to creditor claims, and filing tax returns and monthly 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. If a case trustee is appointed, then the debtor in possession losses management and control of the business and assets. A case trustee can add significantly to the expense of the Chapter 11 case.

The United States Trustee

The U.S. Trustee monitors the progress of a chapter 11. Their office reviews the debtor’s monthly operating reports, applications to employ professionals, motions for fees, and any plan or disclosure statement filed in the case. An attorney from the U.S. Trustee conducts the creditors’ meeting at the beginning of the case. Creditors may question the debtor concerning the debtor’s conduct, assets, and the plan for reorganization.

The U.S. Trustee imposes certain requirements on the debtor such as filing monthly reports of income and expenses, opening new bank accounts, and ensuring payment of current employee withholding and other taxes. While the case is pending the debtor is obligated to pay a quarterly fee to the U.S. Trustee. The amount of this fee is based upon disbursements made in the prior quarter and adds to the cost of the case.

Creditors’ Committee

An unsecured creditors’ committee sometimes plays a major role in the case. The U.S. Trustee may appoint a committee, consisting of several creditors who are owed 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 adds to the expense of the chapter 11 case.

The Automatic Stay

The automatic stay stops creditor collections, foreclosures, and repossessions. 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 asset and the asset is not necessary for reorganization, the secured creditor can request an order granting relief from the automatic stay to allow the creditor to foreclose on its collateral.

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 debtor’s exclusive right to file a plan is an incentive for the debtor to act promptly and file a plan.

The Discharge

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 of debts. Confirmation of a plan does not discharge an individual debtor from any debt that may be nondischargeable under section 523 of the Bankruptcy Code. [See the Chapter 7 page on this site that describes the debts that may be exceptions to the discharge.] Confirmation of an individual debtor’s 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. On the other hand, plan confirmation does not discharge a corporate or business entity’s debts if the plan is a liquidation plan, as opposed to a plan where the debtor continues business operations.

Conclusion

This is a very brief overview of chapter 11, which is obviously a complex type of bankruptcy. Unlike chapter 7 or 13 cases, where most of the paperwork is done with standardized forms, a chapter 11 requires extensive pleadings, notably the plan and disclosure statement, which must be custom tailored for the case. Each step in the reorganization process may require notice to creditors and/or a court hearing which adds to the cost of the case. Since most chapter 11 cases end in dismissal or conversion to chapter 7, it is important to consult with an experienced attorney to determine if reorganization is a realistic option.

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Law Office of Thomas B. Gorrill

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San Diego, CA 92101‎

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