Bankruptcy 101
Chapter 7 Bankruptcy

Chapter 11 Bankruptcy

In Chapter 11 bankruptcies, the debtor-in-possession is the bankrupt entity, and it maintains partial control over its estate during the bankruptcy proceeding. In addition, it proposes a plan regarding how it should be reorganized. A US Trustee monitors the debtor’s compliance with statutory requirements. The Bankruptcy Court determines whether the plan should be confirmed, resolves disputes, and issues orders. Creditors submit claim(s) for a right to payment from the debtor. A trustee may, but is usually not, appointed in a Chapter 11 case.

The petition will reveal the entity that has filed as the debtor in the case and any other names the debtor has used in the last 8 years. Related entities such as affiliates and subsidiaries may also file separate cases. The related entities will file their own schedules, but commonly the Court will jointly administer the proceedings so that documents, including Adversary Proceeding complaints, can be commonly filed.

For a note on venue, click here.
Proper Venue: Any federal jurisdiction where the principal place of business or location of principal assets have been located for 180 days. Because corporations can satisfy the venue requirement in multiple places, they may choose where they file. Three big bankruptcy venues are New York, Delaware, and Texas.

Normally, a debtor will submit a ‘skeletal filing’ to get a bankruptcy started. This skeletal filing will include the bankruptcy petition, a filing fee, and a disclosure of the top twenty largest creditors. More detailed schedules of the debtor’s assets and liabilities, and a statement of financial affairs, will be filed within 14 days after the case is filed (though that period is often extended).

The Adversary Proceeding (AP) Process

Upon filing for bankruptcy, an automatic stay is in effect. A consumer’s attorney must be aware that as soon as a debtor has filed a bankruptcy petition, the consumer and the consumer’s attorney are subject to the automatic stay. Some government enforcement is not subject to the stay. Unless private litigation is well underway, it will be challenging to obtain relief from the stay. For more information on navigating the stay, click here.

In a Chapter 11 bankruptcy, unlike a Chapter 7 bankruptcy, the debtor may still operate its business(es) while the bankruptcy is ongoing. In First Day Motions, the debtor will ask the court to enter orders authorizing it to obtain financing and to use cash collateral (generally the cash, deposit accounts, and accounts receivable it owns) so that it can continue operations while the company is reorganized. See Fed. Rule Bankr. P. 4001.

For more information on what a debtor may do when operating their business during the bankruptcy, click here. The debtor may generally lease, sell, or use property within the bankruptcy estate as it would in the usual course of business, unless the court orders otherwise. However, the debtor cannot use “cash collateral” without permission of the Court or secured parties. 11 U.S.C. § 363. Additionally, while the debtor may seek to continue to pay executives, partners, and proprietors substantial salaries after filing bankruptcy (thereby eating assets that could otherwise be distributed to creditors), creditors may object to these payments. See Chapter 18.7.5 in the Consumer Bankruptcy Law and Practice Manual.

In the initial days after filing, the debtor will seek court authorization to assume favorable contracts and leases and reject those that are unfavorable. The Bankruptcy Code allows the debtor to “reject” or exit unfavorable contracts, such as a lease on property that the debtor no longer intends to occupy, and to “assume” or continue the debtor’s prior position within profitable, or favorable contracts. See 11 U.S.C. § 365(a). The debtor will use the initial filings to attempt to reduce its liabilities.

For more information on rejected contracts, click here.
Advocates can look to rejected contracts to get a sense for what operations the debtor intends to continue after the bankruptcy and what it intends to abandon. If the Court allows the debtor to reject a contract, the rejection places the debtor in breach of the contract, and the other party is entitled to liquidated damages in the form of an unsecured claim. Because unsecured claims are low-priority (for a prioritization of claims in bankruptcy, see 11 U.S.C. § 507), it is unlikely that the contract parties will be able to fully recoup their losses.

A US Trustee will monitor the case and will hold an initial debtor interview to learn more about the case. The US Trustee will review the debtor’s first day motions and any applications by the debtor for employment and payment of professionals, and will begin the process of appointing a creditors’ committee.

A trustee typically is not appointed in a Chapter 11 case, and the debtor performs many of the tasks that would be handled by a trustee. However, a trustee can be appointed if the court finds that “cause” exists (such as fraud, dishonesty, incompetence, or gross mismanagement) or if it would be in the interest of creditors. 11 U.S.C. § 1104(a).

After the First Day Orders, the debtor will propose a form of notice and the Court will send notice of case filing to all creditors and/or will publish notice in a news publication. The notice will include: 1) the date and location of the meeting of the creditors (generally 21-40 days after the petition was filed); 2) how creditors can file claims and the deadline for filing claims; 3) the deadline and process for objections to discharge or the exemptions from discharge; 4) a summary of the reorganization plan.

For sample model notice documents, click here.

The U.S. Trustee appoints creditors to a creditors’ committee (commonly the largest creditors). The U.S. Trustee can alter the composition of the creditors’ committee to make sure the committee reflects the interests of the creditors. Consumer creditors typically must ask that they be appointed to the creditors’ committee.

Where there are a large number of creditors with similar claims against the debtor, the Court may form a special committee in addition to the creditors’ committee to represent that group’s unique interests. In the past, this procedure has been used to create special consumer committees or victims’ committees.

The creditors’ committee has a significant role in a Chapter 11 bankruptcy. It can request that a litigation trust be created to preserve the interests of consumers engaged in litigation. For sample pleadings creating a consumer trust, click here. 

It can also submit reorganization plans and vote on the debtor-in- possession’s proposed reorganization plan.

In these filings, the debtor-in-possession will seek Court approval to use enough cashflow to allow it to continue operating its business. The Court usually reviews and approves the cash collateral filing on or shortly after Day 1. These filings can provide valuable insight into the cashflow for any business. Bank accounts are listed and flow charts will disclose how funds move in and out of the company etc. These filings are extremely revealing about the inner operations of the debtor and should be reviewed by consumer attorneys.
The debtor’s schedules provide information about the assets and liabilities of the business. The debtor must also list the names of its creditors in these schedules and indicate the amount owed, the type of debt, and whether the debt is contingent, unliquidated or disputed. Potential creditors should review the schedules to determine if the creditor’s claim is listed and whether the information is accurate.

For a listing of what information is listed in each filing, click here.
The forms that consist of the debtor’s schedules are: Schedule A/B: Property, Schedule C: Exemptions (or property unavailable to pay the claims of creditors), Schedule D: Secured Claims, Schedule E/F: Unsecured Claims, Schedule G: Executory Contracts and Unexpired Leases, Schedule H : Codebtors (parties or entities who are also liable for debtor’s debts), Schedule I: Income, Schedule J: Expenses
For information about when schedules are normally filed, click here.
Although the bankruptcy rules state that a debtor must file its schedules within 14 days of the case filing, that deadline is almost always extended. If the debtor fails to properly file the schedules, the court has discretion to order the trustee (if appointed), a petitioning creditor, committee, or other party to prepare and file any of these papers within a time fixed by the court. Fed. Rule Bankr. P. 1007(k).

The debtor will propose when the claim bar date (the deadline for when a creditor’s proof of claim must be filed) should be set and provide a draft of the notice that will be sent to creditors. The Court will allow parties who have not filed a proof of claim or who represent a class of creditors who have not yet filed claims to object to the proposed claim bar date and the Court may extend it accordingly.

To see an example of an application to extend the bar date, click here. A proof of claim that is filed after the bar date will be disallowed.

The Claims Process

In the section 341 meeting, 11 U.S.C. § 341, creditors can question the debtor under oath about its conduct that led to the bankruptcy filing, the operation of its business, and its plan for reorganization. However, more meaningful input and information generally is exchanged with the debtor through the creditors’ committee. The creditors’ committee may consult with the debtor about the administration of the case and participate in formulating the debtor’s reorganization plan.

In practice, the section 341 meeting tends to be too cursory to be useful. If too many questions are asked of the debtor, the US Trustee will instruct parties to seek a separate discovery process via a Fed. Rule Bankr. P. 2004 examination, which a party must request by filing a motion. Under Bankruptcy Rule 2004, any interested party can move the Court to require the debtor to produce documentation or testify on matters related to the bankruptcy. This is commonly called a 2004 examination.

The disclosure statement must provide information about the assets, liabilities, and business affairs such that the creditor can make an informed judgment about the debtor’s plan of reorganization. These documents tend to be very long, but can provide useful information to litigators representing consumers.

The Court will hold a disclosure statement hearing. Parties must file objections to the disclosure statement prior to the hearing. 11 U.S.C. § 1125; Fed. Rule Bankr. P. 3017. The Court must approve the disclosure statement before the debtor can solicit voting on the reorganization plan.

The Court will begin the process to approve a reorganization plan after the disclosure statement is approved.

The debtor has the exclusive right to file a plan for 120 days, and the exclusive right to solicit acceptance of the plan for 180 days, after the case is filed. This “exclusivity period” is often extended by the court. After the exclusivity period expires, or if a trustee has been appointed in a case, then “any party in interest” including a trustee (if appointed), a creditors’ committee, an equity holder, or a creditor may file a plan. However, even during the exclusivity period a creditors’ committee can work with the debtor to formulate a plan.

A reorganization plan must state how the debtor plans to treat creditors. 11 U.S.C. § 1123. 11 U.S.C. § 1129 establishes what distribution is fair for each class of claims. The reorganization plan will propose a way to pay off or compromise claims. Priority claims must be paid in full, unless those claimants agree to different treatment. (see 11 U.S.C. § 507 for the prioritization of claims). The Bankruptcy Code allows the plan to be formulated in different ways, with some provisions being mandatory (11 U.S.C. § 1123(a)), and others permissive (11 U.S.C. § 1123(b)).

In addition, the plan will classify creditors as priority, secured, or unsecured and specify the treatment of each class of claim. Creditors can object to how they are classified in the reorganization plan. Alternatively, creditors can agree to less favorable treatment to the treatment provided to others of the same class/interest. In addition, the plan will describe actions that may be taken when the plan is implemented (i.e. curing defaults, voiding liens, selling property, amending the debtor’s charter, etc.). Of note to consumers is that the debtor may propose to sell assets free and clear of claims against the debtor under certain circumstances. However, a 2005 amendment to the Code preserves many consumer defenses from attempts to sell assets free and clear of these claims. 11 U.S.C. § 363(o). For more on preserving consumers’ claims, click here.

The reorganization plan will typically include a proposal for exit financing. The DIP financing used by the debtor to operate during the duration of the Chapter 11 proceeding will likely get paid off with this approved credit.

Parties whose rights are impacted by the reorganization may vote to approve or reject the reorganization plan. Court approval of the plan is referred to as plan confirmation. The requirements for voting are found at 11 U.S.C. § 1126, and for plan confirmation at 11 U.S.C. § 1129.

The Bankruptcy Code generally requires that all impaired classes of creditors approve the plan. However, if at least 1 class approves the plan but other classes of creditors have not, the court may still confirm the plan and force the other classes to be subject to the plan if the Court determines that the fairness tests for treatment of creditors in 11 U.S.C. § 1129 are met. This confirmation of the plan despite creditor objection is commonly referred to as “cram down.”

For more information on how voting works within one class, click here.
Voting on the Plan Within One Class
For a class with many creditors to approve a plan, at least half of the creditors, representing 2/3rds of the aggregate dollar amount owed, must approve. 11 U.S.C. § 1126. A creditor that fails to vote will not be considered when determining aggregate amounts.

The Court may confirm only one plan. If multiple plans satisfy the requirements for confirmation, the court will consider the preferences of the creditors’ committee and equity security holders in deciding which plan to confirm. 11 U.S.C. § 1129(c).

An order confirming the plan may be revoked only if, at the request of a party in interest made within 180 days of confirmation, the Court finds that the order was procured by fraud. 11 U.S.C. § 1144.

After the plan is confirmed, the debtor must begin making the payments and other distributions required by the plan and carry out any other required provisions. Payments made under the plan may be funded by the operation of the debtor’s business or through the liquidation or recovery of assets. The debtor-in-possession, or a trustee if one has been appointed, must provide periodic reports on the status of implementation of the plan. Fed. R. Bankr. P. 2015.

The provisions of the confirmed plan are generally binding on the debtor and all creditors and entities acquiring property under the plan. 11 U.S.C. § 1141(a).

The plan proponent or the reorganized debtor may move to modify the plan after confirmation at any time before “substantial consummation” of the plan. 11 U.S.C. § 1127(b). The Court may confirm the modified plan if it meets the usual requirements for plan confirmation.

Corporations and other Chapter 11 debtors who are not individuals do not receive a discharge in bankruptcy. However, confirmation of the plan can operate like a discharge of the debtor’s debts because the terms of the plan replace any prepetition contracts and creditors are left with only the rights that are provided under the plan. In addition, the order confirming the debtor’s plan may release the debtor and some third-parties from liability on certain claims.