Overview of Chapter 11 cases


In Brief

Chapter 11 bankruptcy cases are governed by the United States Bankruptcy Code and are administered in the United States Bankruptcy Court for the Federal District in which the Debtor resides/has its principal place of business.

Companies and individuals usually file for Chapter 11 bankruptcy protection to restructure their debts, assets, and/or business operations.

Many Chapter 11 cases are commenced by individuals or businesses faced with situations that threaten the survival of the business operation and for which there is no immediate, agreed-upon solution.

A Chapter 11 case can provide management with the opportunity to maintain business operations under the legal protections and restriction of Chapter 11 while working solutions to the problems that caused the filing.

The goal of most Chapter 11 cases is a confirmed plan of reorganization by the Bankruptcy Court that incorporates a feasible business plan for the business after bankruptcy.

A Chapter 11 plan may provide for the continued operation of the business or the liquidation of the assets and operations of the business and a distribution of the proceeds.

If the plan is accepted by the requisite classes of creditors and is confirmed by the court, it is binding on all creditors and shareholders whether or not they have accepted the plan of reorganization.

Effects of Filing a Petition

Upon the filing of a Chapter 11 petition, the operations, assets, and liabilities of the debtor entity are subject to the control of the Bankruptcy Court. These provisions are intended to preserve the status quo, to permit the continued operation of the business in the ordinary course, to protect the interests of creditors, and, where feasible, promote a rehabilitation of the business.

The filing of the Chapter 11 petition operates as an automatic stay of almost all actions against the business and its property (aside from certain criminal and regulatory actions), including lawsuits, the recording or enforcement of liens/mortgages, repossessions, and other creditor actions. The automatic stay is intended to protect the debtor and its property from all collection efforts, creditor harassment, foreclosure actions, and seizures of property and to preserve the status quo pending formulation and confirmation of the plan of reorganization.

The automatic stay remains in effect for the duration of the reorganization process unless modified or terminated by order of the Bankruptcy Court. A secured creditor may request the Court to require adequate protection which may include cash payments, the giving of substitute collateral or other actions by the business as a condition to maintaining the automatic stay.

Prohibition on Paying of Pre-petition Debts

The Bankruptcy Code also prohibits the debtor-business from paying obligations and debts incurred for goods received or services rendered before the filing of the Chapter 11 case. Such obligations are payable only in accord with the terms of a confirmed plan of reorganization.

The only exceptions to this general prohibition are payments that are authorized by an express prior order of the Bankruptcy Court, payments made in connection with assumed executory contracts, such as leases, and the payment of certain obligations secured by liens/mortgages on assets of the debtor-business.

Preservation of Certain Legal Rights and Actions

The Bankruptcy Code preserves certain legal rights and causes of action for the Debtor filing for bankruptcy protection.

The automatic stay may bar the termination of an existing contract even where it has been a pre-petition breach by the debtor.

Statutes of limitation that are enforceable as of the filing date are generally extended for a period of time.

Contract provisions for automatic or optional termination of a contract in the event of a bankruptcy filing are not generally enforceable.

The Bankruptcy Code also contains provisions which permit the Debtor to avoid certain pre-petition transfers or obligations made to creditors or related parties.

Continuation of Business in the Ordinary Course

Generally, the debtor-business is authorized to continue operating in the ordinary course of business. This authorization permits the payment or satisfaction of many obligations or debts for goods received or services rendered after the commencement of a Chapter 11 case.

Payments due under contracts entered into prior to the petition may be made only to the extent that post-petition goods and services have been received under those contracts. Any pre-petition obligations under such contracts are treated as any other unsecured obligation and may not be paid without express court authorization.

The authorization of the debtor-business to conduct operations is subject to restrictions which protect the interests of creditors and their rights to payment by requiring prior Bankruptcy Court approval of certain transactions. Failure to comply with these restrictions may subject the debtor to sanctions such as the dismissal of the Chapter 11 case, conversion of the case to a case under Chapter 7 of the Bankruptcy Code, or the appointment of a Chapter 11 trustee or examiner.

Debtor’s Duties

1. File a list of creditors and other required financial information;

2. Appear and submit to examination under oath at the official meeting of creditors;

 3. Maintain money of the estate in debtor-in-possession or “D.I.P.” accounts;

4. Comply with laws regarding withholding, collection, and payment of taxes;

5. Be accountable for all property received by the estate;

6. Examine proofs of claim and object to allowance of improper claims;

7. Furnish information concerning the case and its administration as requested by a party in interest;

8. File with the Court and appropriate taxing agencies periodic reports of the operation of its business, including a statement of receipts and disbursements;

9. Make a final report and file a final account of the administration of the estate;

10. File tax returns;

11. File, as soon a practicable, a plan, or recommend conversion to Chapter 7 or dismissal of the case; and

12. File reports after confirmation of a plan as necessary or as ordered by the Court.

Additional duties may be imposed on the debtor in possession pursuant to court order.

Plan of Reorganization

The plan is a new contract between the debtor-business and it’s creditors. The plan must be accepted by at least one class of impaired creditors and confirmed by the court. The plan confirmation order is a binding federal court order which determines all issues relating to the plan.

At the hearing on confirmation, the Court will receive evidence to determine if the requirements for confirmation have been met. If the requirements are met, the court will confirm the plan, which is then binding on the debtor, creditors and shareholders.

Cash or other property to be distributed under the plan can be derived from a variety of sources, including the proceeds of a full or partial liquidation of the debtor-business’s assets, the merger or acquisition of the debtor with another entity, income derived from future operations, capital infusions, the restructure or replacement of existing secured obligations, litigation recoveries, or any combination of the above.

An important provision of the Bankruptcy Code enables the plan proponent to confirm the plan even though one or more classes of impaired claims or interests vote to reject the plan or receives no distributions under the plan and, therefore, is deemed to have rejected the plan.

Effect of Confirmation

If the plan is confirmed, its terms and conditions will be binding on all creditors, all security holders and all shareholders unless the plan or confirmation order provides to the contrary.

After confirmation, the debtor or other entity charged with performance of the obligations under the plan will proceed under the terms of the plan. Except for the obligation to carry out the plan and to comply with the court’s confirmation order, the debtor or successor entity will be free of all Bankruptcy Code restrictions on operations and reporting requirements.