Frequently known as the reorganization chapter of the bankruptcy code, since it allows a debtor to reorganize financial obligations while retaining assets, Chapter 11 generally involves the sale of certain assets to pay down debt and refinance or restructuring of existing debts. Chapter 11 is available to both individuals and businesses.
Filing a petition under Chapter 11 grants a debtor what is referred to as an “automatic stay” from the enforcement actions of creditors, which means that it precludes creditors from continuing collection efforts, from bringing a lawsuit or filing liens against property, or foreclosing on property owned by the petitioner.
In Chapter 11, a debtor generally remains in control of the assets in their estate or business. A trustee may be appointed for cause (i.e., fraud, dishonesty, incompetence or gross mismanagement); however, this relief is relatively rare.
A Chapter 11 debtor is called a “debtor-in-possession” and generally has the same rights as if a trustee was appointed, thus any reference to rights or authority of a debtor would apply to a trustee, if appointed, as well.
Exclusive Time Periods
A debtor filing Chapter 11 is granted the exclusive right to file a “plan of reorganization” for a period of 120 days and to solicit a plan of reorganization for a period of 180 days. A debtor can seek an extension from the Court of these “exclusive periods” for cause. Otherwise, once an exclusive period lapses, any creditor or party in interest can file a plan of reorganization for the debtor.
Similarly, if a creditor can demonstrate that the debtor is mismanaging the estate, not negotiating in good faith with creditors or using the exclusive period as leverage in negotiation with creditors, they can seek to terminate exclusivity to allow non-debtors to file a competing plan. Competing plans are rare; however, the threat of a competing plan is often sufficient to keep negotiations between a debtor and its creditors active.
The Plan of Reorganization
A Chapter 11 “Plan of Reorganization” explains how a debtor plans to repay its creditors and is an important tool for rearranging financial affairs. For example, a plan may allow a debtor to reject certain contracts or leases with a cap on damages. This is helpful where a debtor has signed an expensive, long-term contract that is no longer beneficial, such as a lease.
A debtor may also refinance existing loans including increasing the time when it must be repaid (i.e., stretching a two-year loan to five years), decreasing the interest rate if interest rates have declined since the loan was entered into, or changing/removing other arduous terms.
A debtor can also sell an asset free and clear of all liens either through a plan of reorganization or through what is a called a “363 sale.” The ability to sell an asset free and clear of liens can garner a greater sale price as purchasers are assured that the property is unencumbered and the purchaser is subject to less liability for pre-existing liens.
Regardless of who files a plan of reorganization, certain creditors are entitled to vote to approve or disapprove a plan. Only those creditors that are determined to be partially impaired (e.g., reduced payments or payments over time) are entitled to vote on a plan.
Creditors that are unimpaired are deemed to accept the plan and creditors that are fully impaired (i.e., will not recover) are deemed to reject the plan. However, even if they are not allowed to vote on a plan, a creditor still has the right to object to its treatment under the plan.
In order for a plan to be accepted, two-thirds of creditors in number and 50 percent of creditors in dollars must vote in favor of the plan.
The Cramdown Maneuver
A secured claim in a Chapter 11 bankruptcy is treated one of two ways: either the debtor proposes to cure an existing default and pay the creditor in accordance with the terms of the loan documents in effect or a debtor can propose to modify the rights and remedies of the creditor.
A creditor whose rights and remedies are changed by the debtor may vote to reject the proposed modification. When a Chapter 11 debtor seeks permission from the Court to have the creditor’s rights and remedies modified over the creditor’s objection, it is referred to as a “cramdown”.
Even if creditors vote to accept a plan, the bankruptcy court will review the plan and ensure that it meets all the statutory requirements before the plan can be confirmed. If a debtor is unable to get a plan of reorganization confirmed, the case may be converted to a Chapter 7 filing or dismissed.
After a plan is confirmed, the debtor’s bankruptcy proceedings in the Court are essentially over. However, the bankruptcy court retains jurisdiction over the case at least until the last plan payment is made.
Chapter 11 for Individuals
Given the complexity and cost, Chapter 11 is most often used by businesses. However, Chapter 11 may be the only option available to an individual debtor with income greater than that allowed by the Chapter 7 means test and secured debt in excess of that allowed by Chapter 13 means test.
(This is often the case where an individual owns large amounts of real property, but does not have sufficient liquidity to pay his or her debts as they come due.)
The major benefit of Chapter 11 for individuals is the ability to continue to own and utilize assets beyond just the statutory exemptions available under Chapter 7 and Chapter 13. Given that Chapter 11 individual cases are relatively infrequent and the language in the Bankruptcy Code for Chapter 11 is better applied to corporations, the law applied to Chapter 11 consumer cases has been largely unsettled.
If you are considering an individual or business Chapter 11, you would be best served to seek the guidance of a bankruptcy attorney. Learn more about Chapter 11 and whether it is the most appropriate course of action by contacting us online or calling (248) 642-5400.