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Businesses (and certain individuals) sometimes find it necessary to reorganize their debt load in order to emerge as a more viable and profitable entity. In the United States, federal bankruptcy law -- Title 11, Chapter 11 governs this restructuring process.
Businesses eligible for reorganization under Chapter 11 include:
- Corporations. Under U.S. law, a corporation exists separate and apart from its owners. As a result, other than the value of their investment in the company’s stock, the personal assets of the owners and/or stockholders are not put at risk.
- Partnerships. In general, personal assets of the partners are not at risk. However, in some cases, personal assets may be used to pay creditors, or the partners themselves may be required to file for bankruptcy protection.
- Sole proprietorships. Sole proprietors do not have an identity separate and distinct from the owner. Therefore, bankruptcy involving a sole proprietorship includes both the business and personal assets of the owner-debtor.
In 2004, more than 9,000 business Chapter 11s were filed in the United States.
Steps in the Chapter 11 Process
The steps outlined below refer to a regular Chapter 11 business filing. It should be noted that companies falling under the definition of “small business debtor” under the bankruptcy code are put on a “fast track” and treated somewhat differently than in a regular Chapter 11.
- Bankruptcy Filing. The process commences when a bankruptcy petition is filed with the bankruptcy court. The petition may be filed by the company (a voluntary petition) or by creditors of the company (an involuntary petition). At the time of filing, certain provisions automatically come into play:
- Appointment of Trustee. In most Chapter 11 cases, whether voluntary or involuntary, the debtor automatically assumes the identity of “debtor in possession” and will continue to operate the business and maintain control of its assets while undergoing the reorganization. In a small number of cases, a separate trustee may be appointed or elected.
- Automatic Stay. A stay of creditor actions against the debtor automatically goes into effect when the bankruptcy petition is filed. This automatic stay is a statutory "order" which protects the debtor and property, and prohibits actions by creditors after the filing of a bankruptcy. In general, it applies to all creditors (both secured and unsecured). (See our article “Automatic Stay”)
- Avoidable Transfers. The debtor in possession or the trustee has “avoiding” powers that can be used to undo a transfer of money or property made during a specific time period prior to the filing of the bankruptcy petition. Generally, this power is effective only against transfers made within 90 days prior to the filing of the petition. Avoiding powers are used, for example, to prevent unfair payments to one creditor at the expense of other creditors. (See our article “Preferences”)
- Disclosure Statement. The debtor files a written disclosure statement with the bankruptcy clerk. The statement must contain
- a list of creditors
- a schedule of assets and liabilities, current income and expenditures
- a statement of the debtor’s financial affairs
The information must be sufficient to enable a creditor to make an informed judgment about the debtor’s plan of reorganization.
- Notice to Creditors. The court clerk sends a notice of filing of the petition to all creditors on the list of creditors (mentioned above).
- Filing Proofs of Claim. The Court will assign a date (the "General Bar Date") by which the Proof of Claim must be filed. This date is usually listed on the Notice to Creditors. Creditors whose claims are listed on the schedules provided by the debtor are not required to file proofs of claim, but can if they wish to do so. Proofs of claim must be filed on claims that are not listed on the debtor’s schedules, or are listed as disputed, contingent or unliquidated. Proofs of claims must be filed with the bankruptcy clerk in the district where the case is pending. It is the responsibility of the creditor to determine whether its claims are accurately listed. As a general rule, a creditor should file a Proof of Claim as soon as (1) the Notice to Creditors is received, or (2) the creditor finds out from the debtor or a third party that the bankruptcy has been filed. (See our article “Proof of Claim”)
- Unsecured Creditors’ Committee. The United States Bankruptcy Trustee, a federal official, appoints a committee of unsecured creditors – usually the seven largest – to represent the interests of all unsecured creditors. This Committee can hire professionals, including lawyers and accountants, to monitor the company’s actions. The debtor is responsible for paying the cost of retaining these professionals. (See our article “Unsecured Creditors’ Committee”)
- Plan of Reorganization. There is a 120-day period, from the time of filing the Chapter 11, during which the debtor has the exclusive right to file a reorganization plan. Once this period has expired, a creditor or the case trustee may file a competing plan. The contents of the reorganization plan must include a classification of claims (debts) and must specify how each class of claim will be treated under the plan. Section 1123(a) of the Bankruptcy Code lists the mandatory and discretionary provisions of a Chapter 11 plan of reorganization. The debtor in a Chapter 11 also has a one-time absolute right to convert the Chapter 11 case to a Chapter 7 liquidation if he/she is the debtor in possession and if the bankruptcy is voluntary.
- Court Approval of Disclosure Statement. Before a plan of reorganization can be voted upon, the court must hold a hearing to determine whether the disclosure statement is approved.
- Vote on Reorganization Plan. Once the court has approved the disclosure statement, the plan of reorganization is considered by the creditors. All creditors and equity security holders will be mailed:
- the plan, or a court approved summary of the plan
- the disclosure statement approved by the court
- notice of the time within which acceptances and rejections of the plan may be filed
- such other information as the court may direct
- notice of the time fixed for filing objections
- notice of the date and time for the hearing on confirmation
- a ballot for accepting or rejecting the plan
The debtor in possession has 180 days after the filing of the petition to obtain acceptances of the plan. All creditors have the right to vote on the plan.
- Confirmation Hearing. The bankruptcy code requires the court to hold a hearing on confirmation of the plan after notice is given to all interested parties. If no objection to confirmation has been timely filed, the court must then determine if:
- the plan is feasible;
- it is proposed in good faith; and
- the plan and the proponent of the plan are in compliance with the Bankruptcy Code.
Confirmation of the plan discharges the debtor from most debts existing on the date the petition was filed. This discharge is the law’s embodiment of what is probably the most important purpose of bankruptcy, giving the debtor a fresh start financially.
- Post-Confirmation Administration and Modification. After the plan is confirmed the debtor is required to make plan payments and is bound by the provisions of the plan of reorganization. Any time after confirmation, the plan can be modified, assuming any modifications are warranted by circumstances, meet certain Code requirements, and are approved by the court.
The order in which payments are made is fixed by Federal statute. The general rule is that those who take the least risk are paid first. (See section 726 of the code, or our article “Introduction to Chapter 7” for further information on payments.)
- Final Decree. A final decree closing the case must be entered after the estate has fully administered the plan of reorganization.
While the steps described here seem relatively straightforward, the U.S. Bankruptcy Code is quite complex and filled with exceptions and special rules under specific circumstances. It is possible for Chapter 11s of large companies with hundreds or thousands of creditors to take years to reach a final decree. If you have questions or concerns regarding a specific Chapter 11 filing, it is prudent to seek advice from a qualified bankruptcy attorney.
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