Reorganization of a Corporation or Partnership
Chapter 11 is typically used for a reorganization of a corporation or partnership. Under Chapter 11, the debtor generally proposes a plan to continue its business and make payments to creditors over a period of time. Most of the time the debtor will continue to operate the business. Affected creditors will have the opportunity to vote on the plan, and the court may approve it if it receives the requisite number of votes and satisfies other legal requirements.
Nine Things That Happen Once the Petition Goes In
That summary makes it sound simple. It isn’t. The owners we talk to at Delancey Street, many of them behind on merchant cash advances or loans, often hear Chapter 11 mentioned as a way out without being told what the day after filing looks like. Here are nine things that happen once the petition goes in.
The first is the automatic stay. As soon as the debtor files a Chapter 11, the automatic stay goes into effect. Any judgments, collections, foreclosures or repossessions of property related to pre-petition obligations are frozen. Some activities are not subject to the stay. The automatic stay provides a respite for negotiations. It is not unlimited, though. A secured creditor may request relief from the stay on grounds such as the debtor having no equity in the property and that the property is not necessary to an effective reorganization.
Second, the company becomes a debtor in possession. The business will remain under your control as a debtor in possession (DIP). You will continue to run the business, and you will have most of the powers and duties of a trustee (as a fiduciary to the estate), including accounting for property, examining and objecting to claims, filing monthly operating reports, etc. Only in a small number of cases will a trustee be appointed, for cause, for things like fraud, dishonesty, incompetence or gross mismanagement. Ordinary expenses will continue to be paid.
Third, the paperwork piles up. Along with the petition, the debtor also needs to file schedules of assets and liabilities, a schedule of current income and expenditures, a schedule of executory contracts and unexpired leases, and a statement of financial affairs, unless the court orders otherwise. In addition, small business and subchapter V debtors will be required to submit, as an attachment to their petition, the most recent balance sheet, statement of operation, cash-flow statement, and federal income tax return, and to continue to make periodic filings regarding profitability and projected cash receipts and disbursements. Those two streamlined versions of Chapter 11 are open to businesses with combined debts of $3,424,000 or less, at least half of it from business activity. For all small business cases and subchapter V cases, the deadlines are shorter, and the case usually moves along faster than a standard chapter 11 case.
Fourth, the U.S. trustee starts watching. The United States Trustee’s office keeps an eye on the business and its reports, calls the first meeting of the case (section 341 meeting) and the debtor is questioned under oath at the meeting by the U.S. Trustee and creditors, expects new bank accounts, monthly income and expense reports, and current payment of withholding taxes, and a quarterly fee based on payments. If the debtor does not follow the rules, the U.S. Trustee can file a motion to convert to a different chapter of the Code or dismiss the case.
Fifth, a creditors’ committee may be formed. The U.S. Trustee appoints the committee, which normally is comprised of the unsecured creditors with the seven largest unsecured claims. The committee consults with the debtor in possession on running the case, investigates the debtor’s conduct and business operations, and participates in formulating a plan. The committee can hire lawyers or other professionals with court approval. In small business and subchapter V cases, there is no automatic appointment of a committee and one will only be appointed upon a showing of cause.
Sixth, you lose some control over your cash. A debtor in possession can use, sell or lease property in the ordinary course of business without court approval (unless the court says otherwise). Sale or lease outside the ordinary course requires court approval. A debtor in possession cannot use “cash collateral” (cash, deposit accounts and other cash equivalents in which a creditor also has an interest) without the secured creditor’s consent or court authorization. Until one of those comes through, the debtor must segregate and account for it. The secured creditor may be entitled to adequate protection (e.g., periodic cash payments, or a replacement lien). A debtor that needs operating capital may be able to borrow by giving the lender court-approved superpriority or a lien on estate property.
Seventh, payments made before the filing can be pulled back. The Bankruptcy Code gives the debtor in possession powers to avoid certain transfers of money or property made during a specified period of time before the filing of a bankruptcy petition, so that any payment or property can be returned, and put together for the benefit of all of the creditors. Basically, and depending on the various defenses, a payment can be recovered from a creditor if you paid him or her within 90 days of filing. If the creditor was an insider like a relative, a general partner, director or an officer, the money or property could be returned if you paid him or her up to one year before filing. The point is to stop one creditor from being paid ahead of everyone else right before the case starts.
Eighth, the clock starts on a plan. The first 120 days - only you can file a plan. The court can give you more or less time, but not over a total of 18 months. If the time runs out, creditors (or a case trustee) can file a competing plan, giving you an incentive to act quickly. Small business and subchapter V cases run on their own clocks. Before creditors are asked to vote, the court will generally have to approve a disclosure statement so that creditors have sufficient information to evaluate the plan. Creditors with impaired claims vote, and a class of creditors accepts a plan when creditors holding at least two-thirds in amount and more than half in number of allowed claims in the class accept.
Ninth, the case ends with a confirmed plan or it doesn’t. So at the confirmation hearing the judge has to decide if the plan is feasible, proposed in good faith, and follows the Code, among other things. A plan is considered “feasible” if it is not likely that confirmation will be followed by the debtor’s liquidation, or the need for further financial reorganization. Confirmation of a plan discharges the debtor from debts incurred prior to confirmation, subject to certain exceptions. The debtor then makes payments under the plan and is bound by the terms of the plan, which replaces the old contracts with new ones. A liquidating plan is also permissible and may allow the business to wind up its affairs under better conditions than chapter 7. The other outcome is less friendly. A party in interest can file a motion to dismiss or convert the case to a chapter 7 for “cause”, including persistent losses and no chance of reorganization, gross mismanagement, unauthorized use of cash collateral, failure to file reports, failure to pay post-petition taxes, or failure to file and confirm a plan on time. It’s not unusual for a creditor to file a motion to dismiss or convert for cause when a debtor takes a long time to get a plan confirmed. Chapter 11 cases can drag on for years unless someone is pushed into taking action to ensure its timely resolution.
Weighing Chapter 11 Against Settling with Your Creditors
Chapter 11 can keep a business alive, but it comes with a great deal of oversight. If you are weighing Chapter 11 against settling with your creditors, talk it through before you file. Delancey Street isn’t a law firm - we’re a business debt settlement company. If your business can do debt settlement, we’ll negotiate with your merchant cash advance funder and lender(s) for less than what you owe. If it’s not a good fit, like when Subchapter V bankruptcy makes more sense, we’ll be upfront on the first call and refer you to a trusted independent bankruptcy attorney. Book a free, confidential first consultation.
