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Chapter 11 Bankruptcy: A Primer

By Christopher R. Kaup, J. Daryl Dorsey

The commercial bankruptcy practice concentrates in assisting a distressed business in reorganizing its debts to emerge as a going concern. The Chapter 11 proceeding under the U.S. Bankruptcy Code is utilized to accomplish restructuring and liquidation of businesses. Individuals may also file for Chapter 11 relief depending on the circumstances to restructure debts or liquidate assets and property.

The Chapter 11 Case
A Chapter 11 case begins with the filing of a petition with the bankruptcy court where the debtor has its principal place of business or assets. 11 U.S.C. § 301, 28 U.S.C. § 1408.

Upon filing a petition for relief under Chapter 11, the debtor assumes an additional identity as the "debtor in possession." 11 U.S.C. § 1101. The term refers to a debtor that keeps possession and control of its assets while undergoing a reorganization under Chapter 11. Generally, as "debtor in possession" the debtor operates the business and performs many of the functions that a trustee performs in cases under other chapters, including the right, with the court's approval, to employ attorneys, accountants, appraisers, auctioneers, or other professional persons to assist the debtor during its bankruptcy case. 11 U.S.C. § 1107(a). Other responsibilities include filing tax returns and reports that are either necessary or ordered by the court after confirmation, such as a final accounting.

Section 1107 of the Bankruptcy Code places the debtor in possession in the position of a fiduciary, with the rights and powers of a Chapter 11 trustee, and it requires the debtor to perform all but the investigative functions and duties of a trustee. These duties, set forth in the Bankruptcy Code and Federal Rules of Bankruptcy Procedure, include accounting for property, examining and objecting to claims, and filing informational reports as required by the court and the U.S. trustee, such as monthly operating reports. 11 U.S.C. §§ 1106, 1107; Fed. R. Bankr. P. 2015(a).

Other responsibilities of the debtor in possession include filing tax returns and reports that are either necessary or ordered by the court after confirmation, such as a final accounting. The U.S. trustee is responsible for monitoring the compliance of the debtor in possession with the reporting requirements.

The voluntary petition will include standard information concerning the debtor's name(s), Social Security number or tax identification number, residence, location of principal assets (if a business), the debtor's plan or intention to file a plan, and a request for relief under Chapter 11 of the Bankruptcy Code.

The cost for filing a Chapter 11 case is $1,039 for the case filing fee.

The Automatic Stay
The automatic stay provides a period of time in which all judgments, collection activities, foreclosures, and repossessions of property are suspended and may not be pursued by the creditors on any debt or claim that arose before the filing of the bankruptcy petition. The stay automatically goes into effect when the bankruptcy petition is filed and provides a breathing spell for the debtor, during which negotiations can take place to try to resolve the difficulties in the debtor's finances. 11 U.S.C. § 362(a).

The filing of a petition, however, does not operate as a stay for certain types of actions listed under 11 U.S.C. § 362(b). For example, the stay does not apply to the commencement or continuation of a criminal action or proceeding against the debtor or the commencement or continuation of a civil action or proceeding

for the establishment of paternity;
for the establishment or modification of an order for domestic support obligations;
concerning child custody or visitation; or
for the dissolution of a marriage, except to the extent that such proceeding seeks to determine the division of property that is property of the estate.

Under specific circumstances, the secured creditor can obtain relief from the automatic stay. For example, when the debtor has no equity in the property and the property is not necessary for an effective reorganization, the secured creditor can seek an order of the court lifting the stay to permit the creditor to foreclose on the property, sell it, and apply the proceeds to the debt. 11 U.S.C. § 362(d). Unsecured creditors can also seek relief from the automatic stay, for example, to continue state court litigation that was pending before the Chapter 11 case was filed.

Common Participants in a Chapter 11 Case
The debtor/debtor in possession. The debtor is the subject of the bankruptcy case. The debtor-in-possession, commonly known as the DIP, performs the duties of a trustee (e.g., collects the assets of the estate, liquidates assets as necessary, and objects to improper claims of creditors) and owes a fiduciary duty to the bankruptcy estate, which includes its creditors.

The U.S. bankruptcy judge. The judicial officer presides over a bankruptcy case.

The U.S. trustee. The U.S. trustee carries out the administrative functions of the case and ensures the DIP complies with the requirements of the Bankruptcy Code.

Creditors. A creditor is any entity that has a claim against the debtor arising at the time of or before the order for relief concerning the debtor. See 11 U.S.C. § 101(10). Sometimes an "official committee of unsecured creditors" is appointed by the U.S. trustee to represent unsecured creditors and negotiate directly with the debtor over terms of a plan of reorganization on behalf of the class of creditors represented. The committee also may investigate the debtor's business and financial affairs.

The Disclosure Statement
Within 60 days of the filing of the Chapter 11 case, a written disclosure statement must be filed with the court. 11 U.S.C. § 1125. The disclosure statement is a document that contains "adequate information" concerning the assets, liabilities, and business affairs of the debtor sufficient to enable a creditor to make an informed judgment about the debtor's plan of reorganization. In a typical Chapter 11 case, information that is provided in the disclosure statement includes, but is not limited to, the categories below.

Description of the business, including
- Date of formation/incorporation
- Description of members/principals (with percentage of ownership)
- Description of business pre-petition
- Description of market/clients
- Description of business just prior to filing
- Description of business post-petition
Reason(s) for the bankruptcy filing
Financial information
Description of assets, their value, bases for the valuation
Historical financial statements going back three years pre-petition
- Financial statements for the period post-petition through date of disclosure statement
- Projected financial statements for a minimum of five years and maximum for the life of the plan, including all assumptions, seasonal swings, and other relevant factors upon which the projections are based
- The accounting process used in preparing these statements and the source of information
A liquidation analysis
Description of the Chapter 11 plan
- Method of execution, including the dollar amounts to be paid each class and the dates on which each payment will be made
- Source of funds
Description of post-confirmation management, including salaries
Disclosure of professional fees paid/to be paid
Statement regarding insider transactions/claims (if none, a negative Statement is required)
Description of pending or contemplated litigation (if none, a negative statement is required)
Tax consequences (e.g., capital gains, if property is sold)

The Chapter 11 Plan
The debtor has an exclusive right to file a "plan of reorganization" within 120 days from the date the petition is filed. 11 U.S.C. § 1121(b). This time period may be extended for an additional 60 days upon an order of the court. 11 U.S.C. § 1121(d).

In order for the plan of reorganization to be confirmed, the plan must contain certain information, set forth in Section 1123 of the Code. Section 1123(a) of the Bankruptcy Code lists the mandatory provisions of a Chapter 11 plan, and section 1123(b) lists the discretionary provisions. For example, Section 1123(a)(1) provides that a Chapter 11 plan must designate classes of claims and interests for treatment under the reorganization. Generally, a plan will classify claim holders as secured creditors, unsecured creditors entitled to priority, general unsecured creditors, and equity security holders.

Creditors whose claims are "impaired" (i.e., those whose contractual rights are to be modified or who will be paid less than the full value of their claims under the plan) vote on the plan by ballot. 11 U.S.C. § 1126.

The debtor must provide in the disclosure statement a liquidation analysis as part of the information provided to creditors that will vote on the plan of reorganization. The liquidation analysis is particularly useful to ensure compliance with Section 1129(a)(7) of the Bankruptcy Code.

Section 1129(a)(7) of the Bankruptcy Code requires that each holder of an impaired allowed claim or interest either (1) accept the plan of reorganization or (2) receive or retain under the plan property of a value, as of the effective date, that is not less than the value such holder would receive or retain under the plan or reorganization if the applicable debtor were liquidated under Chapter 7 of the Bankruptcy Code on the effective date. This is referred to as the "best interests" test. To make these findings, a bankruptcy court must (1) estimate the cash liquidation proceeds that a Chapter 7 trustee would generate if each of the debtor's Chapter 11 cases were converted to a Chapter 7 case and the assets of such debtor's estate were liquidated; (2) determine the liquidation distribution that each non-accepting holder of a claim or an interest would receive from such liquidation proceeds under the priority scheme dictated in Chapter 7; and (3) compare the holder's liquidation distribution to the distribution under the plan that the holder would receive if the plan were confirmed and consummated.

After the disclosure statement is approved by the court and the ballots are collected and tallied, the court will conduct a confirmation hearing to determine whether to confirm the plan. 11 U.S.C. § 1128.

Post-Confirmation Issues
Notwithstanding the entry of the confirmation order, the court has the authority to issue any other order necessary to administer the estate. This authority includes the continuation of post-confirmation determination of objections to claims or adversary proceedings, which must be resolved before a plan can be fully consummated. The debtor is required to report on the progress made in implementing a plan after confirmation.

A Chapter 11 debtor in possession has a number of responsibilities to perform after confirmation, including consummating the plan, reporting on the status of consummation, and applying for a final decree. Eventually, the debtor will apply to the court for a final decree closing the case.

Additional Common Bankruptcy Matters
Adversary proceedings. Adversary proceedings, otherwise known as lawsuits in the bankruptcy case, may take many forms, including complaints seeking to avoid liens, actions to avoid preferential transfers, actions to avoid fraudulent transfers, or actions to avoid post-petition transfers. These proceedings are governed by the Rules of Bankruptcy Procedure. Many of the bankruptcy rules mirror the language of the Federal Civil Rules of Procedure.

There are limitations set forth under the Bankruptcy Code for filing such actions. For example, the code sets a 60-day deadline from the date of the initial meeting of creditors (the "341 meeting") to file complaints objecting to the debtor's discharge. Bankruptcy Rule 4007. The business debtor entity cannot receive a discharge, so this limitation does not apply. But the limitation does apply to an individual debtor.

Objection to claims. Filing a proof of claim is the most fundamental method by which a creditor protects its rights in a bankruptcy case. Completing the proof of claim form and filing it with the bankruptcy court is a relatively simple process. However, once the claim is timely filed, a creditor needs to remain aware of the potential that the debtor, the official committee of unsecured creditors, the trustee, or other parties in interest may file an objection to the claim or otherwise seek to limit the creditor's rights with respect to the claim.

Objections to claims are filed in writing and provide claimants with an opportunity to respond prior to a hearing that is scheduled at least 30 days after the filing of the objection. In Chapter 11 cases, the debtor's plan of reorganization often sets deadlines for the filing of objections to claims.

If an objection is filed to a particular claim, the creditor is generally required to prove the existence of the claim's validity. Whether or not a claim is allowable typically turns on the application of state law. Claims that would not be enforceable outside of bankruptcy are not enforceable in the context of the bankruptcy case.

In the Chapter 11 case, debtors can lump together in a single pleading objections to claims that are based on similar objections. This process is called the "omnibus objection." The debtor sets forth a general legal basis for a reduction or elimination of particular claims and then attaches as an exhibit a list of claims to which the objection applies. For example, claims that were filed late after the claims filing deadline are typically included in omnibus objections.

Christopher R. Kaup, Esq., is a shareholder with Tiffany & Bosco, P.A, in Phoenix, Arizona; his practice focuses on the representation of creditors and debtors in complex commercial bankruptcy matters, creditors' rights, and commercial litigation.

J. Daryl Dorsey, Esq., is an associate with Tiffany & Bosco, P.A.; he practices in the area of commercial bankruptcy and creditors rights.

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Chapter 11 Bankruptcy: A Primer

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