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Bankruptcy Resource Center - Reisz Law Office

What is chapter 11?

BANKRUPTCY BASICS

Chapter 11 is a reorganization proceeding.  It is used by large business (e.g. if General Motors files a bankruptcy it will be a Chapter 11) but is sometimes used by consumers and by small businesses. 

In consumer cases and personal business cases, it is used extremely rarely – where the debtor’s debt exceeds the limits of what is allowed in a Chapter 13 (unsecured debts of less than $336,900 and secured debts of less than $1,010,650).  Chapter 11 is the exclusive reorganization remedy for reorganization for corporations and other entities.  The following examples help illustrate this point:

Example 1:  The debtor is a sole proprietor desiring to reorganize his business.  His unsecured debts are less than $336,900 and secured debts are less than $1,010,650.  In this case, the debtor could use either Chapter 13 or Chapter 11, but would probably use Chapter 13 because of the economic efficiencies associated with the Chapter 13 proceedings.

Example 2:  The debtor is a corporation desiring to reorganize its business.  It must use Chapter 11 regardless of the size of its debt.  Chapter 13 is available only to persons.

Example 3: The debtor is a consumer debtor desiring to reorganize his financial affairs.  His unsecured debts are less than $336,900 and secured debts are less than $1,010,650.  In this case, the debtor could use either Chapter 13 or Chapter 11, but would probably use Chapter 13 because of the economic efficiencies associated with the Chapter 13 proceedings.  If however the debtor’s unsecured debts are more than $336,900 or his secured debts are more than $1,010,650, he must use Chapter 11.

DEBTOR IN POSSESSION

In most Chapter 11 proceedings a trustee is not appointed.  The debtor serves as a Debtor in Possession (“DIP”) who has most of the rights and responsibilities of a trustee – including his fiduciary duties to the estate.  The bankruptcy can appoint a trustee “for cause” which would include fraud and/or mismanagement. 

BUSINESS OPERATIONS DURING THE CHAPTER 11

After the Chapter 11 is filed, the DIP is authorized to operate the business in the ordinary course of business.  However in order for the debtor to use “cash collateral”, it must obtain approval of the creditor having a security interest in it or of the bankruptcy Court. 

For most businesses, cash collateral is the cash or proceeds of other assets, such as receivables or inventory, which is subject to the security interest of a creditor.  This would typically apply where a creditor bank has a security interest in the inventory and accounts and their proceeds of the debtor.  In such case, the DIP cannot use the cash collateral unless 1) the secured creditor approves of its use, or 2) the secured creditor approves of its use.  In many cases the DIP and secured creditor will attempt to reach some agreement as to how this collateral will be protected in the bankruptcy and this tentative agreement may including giving the secured creditor a replacement lien on inventory and accounts and their proceeds acquired by the debtor subsequent to the filing of the bankruptcy.  The DIP and secured creditor will request that the bankruptcy court approve of this tentative agreement. 

AUTOMATIC STAY

According to the Bankruptcy Code, the filing of the bankruptcy creates an automatic stay preventing (among other things) any action by a creditor to enforce a debt.  The Automatic Stay prohibits all creditor from any acts to collect a debt including calls to the debtor, dunning letters, repossession of collateral (such as an automobile), continuing with a mortgage foreclosure proceeding or otherwise attempting to collect a debt.  The bankruptcy court can for certain reasons terminate the automatic stay to allow a secured creditor to enforce its claim against the collateral. 

CREDITORS’ COMMITTEE

The U.S. Trustee may appoint a unsecured creditors’ committee. If the appointment is made, the creditors’ committee is normally comprised of the seven largest unsecured creditors, excluding insiders and tax creditors. The creditors’ committee may, with court approval, employ its own counsel and other professionals. In small cases, the US Trustee sometimes declines to appoint a creditors committee.

DISCLOSURE STATEMENT AND PLAN

In order for it to have its debts reduced, the Plan proponent (normally the debtor) must have its Plan approved by the bankruptcy court.  Before the Plan can be submitted to creditors, the bankruptcy court must approve the adequacy of the Disclosure Statement submitted by the Plan proponent.  The Disclosure Statement is a document which provides the creditors with sufficient information about the debtor’s business to have an informed opinion of the Plan.

In the proposed Plan, the creditors will be classified by similar types.  Typically, unsecured creditors will be put into a class, tax creditors into a class, etc.  Secured creditors may be put into a class or may be put into separate classes.

Once the adequacy of the Disclosure Statement is approved by the court, the Disclosure Statement and Plan will be submitted to the creditors for voting.  In order for the Plan to be approved, more than one-half in number and two-thirds in dollar amount of each class (counting only those actually voting) must approve the Plan or the court must cramdown the Plan in order for it to be confirmed.  Cramdown is a procedure whereby, if certain conditions exist, the court can confirm a Plan even if it does not receive the requisite amount of votes. 

DISCHARGE

An individual receives a discharge in a Chapter 11 when he completes his Plan.  A corporation does not get a discharge in a Chapter 11 if it is simply liquidating its assets.  Otherwise, a corporation gets a discharge effective upon confirmation of the Plan. 

CHAPTER 11 USED FOR LIQUIDATION

Sometimes a Chapter 11 is used to liquidate the assets of a business.  An example would be where a debtor wants to liquidate its business for its going concern value, which exceeds its liquidation value.  In such an instance where the sale proceeds will not satisfy the unsecured debt of debtor, the buyer may require that the transaction receive the approval of the bankruptcy court – and Chapter 11 is used for that purpose.   
 
 

CONTACT REISZ LAW

Ste 2450, 500 W. Jefferson St.
Louisville, Ky, 40202
502-442-0675
ReiszLaw@Gmail.com

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