There’s actually a lot of panic and misconceptions that come up when you get into Chapter 11 bankruptcy, particularly around business loans and how they may be affected or how they will be handled in Chapter 11. So what actually happens to your business loans when you file Chapter 11? Chapter 11 bankruptcy is a reorganization. When the process is complete, the debtor company will come out on the other side as an operating business. It’s designed to allow businesses to keep their doors open while they reorganize debt, and what happens to each loan depends on how the case unfolds.
Bankruptcy Proceedings
For any bankruptcy case, the debtor has to fill out a ton of paperwork and hand it in under oath. In Chapter 11 that means the Schedules and the Statement of Financial Affairs. That paper tells the story of the debtor’s income, assets, and debts. Right after the debtor files, there will be a “341 Meeting” or “First Meeting of Creditors.” That’s a name that sounds really scary but is just a meeting that a “United States Trustee” has with the debtor. (The United States Trustee is an independent office in the U.S. Justice Department. They monitor bankruptcy cases to make sure they’re being handled in the right way). The United States Trustee will ask the debtor questions (under oath) about the paperwork, and how the debtor plans to get out of the bankruptcy. The creditors may ask the debtor questions, too. That includes your lenders.
Usually, the people who ran the company are still in charge during bankruptcy proceedings. This is unless an interested party asks for a trustee to be appointed to oversee the company during the bankruptcy. A Chapter 11 Trustee can be appointed for a number of reasons, but most often, the party moving for the appointment of the Trustee claims that the company management really screwed things up before or after they filed bankruptcy (or both). Before the filing, that might mean the people running the company really misused company funds or spent company money on personal expenses. After it, it might mean the people running the company aren’t filing all the required reports, or aren’t following court orders, or they’re ignoring good offers that would allow them to get out of bankruptcy. So, if you want to avoid losing control to a Chapter 11 Trustee, don’t let your company become a poster child for mismanagement. The debtor in possession can also hire a Chief Restructuring Officer (CRO) to oversee the bankruptcy and be a neutral party. CROs are independent consultants who are familiar with how insolvent companies operate. They may have industry-specific experience.
If you are in a Chapter 11 case, you may be given a special kind of short-term loan called a “Debtor-in-Possession Loan” or “DIP Loan“. This short-term loan will often help you keep the doors open while you work out your plan to get out of the case. Keep that loan in mind: it counts as an administrative claim, and those sit at the front of the line when the money is handed out.
Find the Money to Get Out of Bankruptcy
Whoever is running the company, it has to find the money to get out of bankruptcy. It may be that the business is going to sell off all or most of its assets under section 363 of the Bankruptcy Code. The way that works is the going concern is sold off and everyone in line to be paid will be paid from the sale proceeds according to their priority (roughly, first expenses incurred to get the debtor through bankruptcy, then the tax folks, then secured lenders, then unsecured creditors – including trade creditors – and finally the equity folks). The plan on how to pay all these folks will be in a plan of reorganization which gets filed with the Bankruptcy Court and then voted on by the eligible creditors.
Or, the company might secure new long-term financing (“exit financing“) on easier terms than what it had before it went into bankruptcy, and continue to run the business under its current ownership. This is what’s known as a “true restructuring,” where the company’s debts are restructured — the terms of the debt are extended, or the interest rates are reduced — so that the company will have enough money to keep paying the debt as well as run the business. In most of these restructurings, the critical debts like the DIP Loan and the secured debt get paid off with the new financing. Unsecured creditors often get paid a share of their debts from the company’s future profits. How much the unsecured creditors get varies tremendously from case to case; it’s not uncommon for general unsecured creditors to be paid as little as 5% of their claims. Where the money is coming from and how the various creditors are going to be paid is spelled out in a plan of reorganization that is filed with the Bankruptcy Court and voted on by eligible creditors.
What Typically Happens to Each Kind of Business Loan
Now for the part that matters most if you’re lying awake worrying about your lenders. Whether the business was sold or reorganized, every creditor is limited to collecting what the confirmed plan gives it. In other words, if the plan gives the bank 100 cents on the dollar, it gets paid in full. If it gives the bank 50 cents on the dollar, the bank has to take it. So, for example, if a creditor was going to receive only 20% of what it’s owed, it can’t go around trying to collect the other 80%.
So, to put it all together, here is what typically happens to each kind of business loan in Chapter 11. In a true restructuring, the DIP Loan, from above, is paid off with new financing; in a 363 sale it is one of the administrative claims at the front of the line. Asset sales pay the lenders according to the priority of their loans. Your secured lender comes after those costs and the taxes in a sale, and if the business was reorganized, new financing is used to pay off the DIP Loan and the secured loans. The unsecured creditors get a portion of their debts from future profits (if it’s a true restructuring) or from the sales proceeds if anything is left for them. If the debtor is reorganized, the unsecured creditors can get much less than 100% on the dollar (as little as 5%, as noted above). But in any event, unsecured creditors get whatever the plan gives them.
For a business owner weighing Chapter 11, the real takeaway is that Chapter 11 is a process. Lots of paperwork, lots of meetings, and creditors will have a say in whether you get out or not. Just expect that the terms of your debt are going to be negotiated with your creditors, often subject to a vote by those creditors. If you file for Chapter 11 bankruptcy and successfully get out, the idea is that it gives your company a fresh start, and allows it to survive and grow from a healthier position.
