If you own or manage a business with significant debt, call Sacramento Law Group LLP bankruptcy attorney Jin Kim to explore your Chapter 11 bankruptcy debt relief options. Unlike chapter 7 or chapter 13 bankruptcy, Chapter 11 bankruptcy can help highly-leveraged businesses restructure their debt while remaining in control of the business. To learn more about Chapter 11 bankruptcy call our firm at (916) 596-1018 to schedule a free consultation.
Overview of Chapter 11 Bankruptcy
If your business is confronting operational distress, an inability to service debt, or impending litigation, Chapter 11 bankruptcy can allow your business to reorganize and continue operations. Unlike liquidation proceedings under Chapter 7, Chapter 11 permits a business debtor to remain in possession of assets and in control of operations during the pendency of the bankruptcy case, subject to fiduciary duties and court oversight. It is, in effect, a forum for business rehabilitation.
Small businesses aren’t the only entities that have turned to chapter 11 bankruptcy. Many large businesses and corporations have resorted to chapter 11 bankruptcy for debt relief. McClatchy, a publisher of newspapers including the Sacramento Bee, is a well-known example of a business that filed for chapter 11. The purpose of filing for a chapter 11 bankruptcy is for the business to reorganize its business operations and become profitable again.
Chapter 11 vs. Chapter 7 & 13
Chapter 11 is codified in Title 11 of the United States Code Sections §§ 1101–1174. Eligibility to file under Chapter 11 is broad: it is open to individuals, partnerships, corporations, and limited liability companies (11 U.S.C. § 109(d)). Furthermore, unlike Chapter 13 bankruptcy, there are no debt ceilings, making Chapter 11 viable for high-liability individuals and mid- to large-scale enterprises.
Chapter 11 bankruptcy is known as a reorganization bankruptcy. It is intended to protect the assets and the business while a reorganization plan is being formulated and approved. This primarily distinguishes it from chapter 7 bankruptcy which is known as a “liquidation bankruptcy.” Under chapter 7 bankruptcy the assets of the debtor are liquidated and the proceeds thereof are paid to creditors.
In chapter 13 bankruptcy the individual agrees to pay a certain amount from their income to creditors over a period of years in exchange for debt relief. In chapter 11 bankruptcy the business (or individual) proposes a reorganization plan subject to approval from the court.
Starting a Chapter 11 Bankruptcy
Chapter 11 bankruptcy is initiated with the filing of a petition. The petition is filed in the bankruptcy court which has jurisdiction over either the residence of the debtor or the principal place of business. A filing fee is also required to be paid with the petition. Currently, the Eastern District fees for chapter 11 bankruptcy stand at $1,167 for the filing fee and $571 administrative fee.
Upon the filing of a voluntary petition, the automatic stay under 11 U.S.C. § 362(a) immediately enjoins virtually all collection actions, including litigation, lien enforcement, and foreclosure. The stay is designed to preserve the bankruptcy estate and provide time to formulate a plan of reorganization.
Upon the filing of the petition, the debtor has the exclusive right to propose a reorganization plan for the business. This right exists for 120 days or approximately four months. A debtor can petition the court to extend this time – up to 18 months. In a similar vein, the exclusive period can also be shortened by the court if adequate reason is given.
Debtor In Possession
A primary feature of chapter 11 bankruptcy is that the debtor remains in possession of the business while the business is allowed to operate. This is why the debtor is called the debtor in possession (DIP) in chapter 11 bankruptcy. A DIP assumes most of the duties and powers of a bankruptcy trustee, including the ability to operate the business, manage the estate, and propose a plan.
As the DIP, the debtor is allowed to hire attorneys, accountants, and other necessary personnel to assist with the formulation of the reorganization plan. However, the debtor must seek the bankruptcy court’s approval when it comes to significant transactions including the use of cash collateral (11 U.S.C. § 363(c)(2)), postpetition financing (11 U.S.C. § 364), asset sales outside the ordinary course (11 U.S.C. § 363(b)), and assumption or rejection of executory contracts (11 U.S.C. § 365).
The debtor-in-possession generally remains in control of the business and its assets until the reorganization plan is approved, or the case is otherwise terminated.
The Chapter 11 Plan
The purpose of a Chapter 11 case is to confirm a plan of reorganization. The plan must classify claims and interests (11 U.S.C. § 1122), designate which are impaired, and provide the means for implementation (e.g., debt restructuring, asset sales, equity infusions). The DIP typically has an exclusive period of 120 days to file a plan, and 180 days to solicit acceptances (11 U.S.C. § 1121(b)–(c)).
Each class of impaired creditors must vote on the plan. To be accepted, a class must have at least two-thirds in dollar amount and more than one-half in number of claims voting in favor (§ 1126(c)). However, even absent unanimous acceptance, a plan may be confirmed through cramdown under § 1129(b), provided it does not unfairly discriminate and is fair and equitable to dissenting classes.
The fair and equitable test varies by class: secured creditors must receive the present value of their collateral or the collateral itself (§ 1129(b)(2)(A)); unsecured creditors must receive at least as much as in a Chapter 7 liquidation and no junior interest may receive anything unless the dissenting class is paid in full (§ 1129(b)(2)(B))—the so-called “absolute priority rule.”
A plan must also be proposed in good faith (§ 1129(a)(3)), be feasible (§ 1129(a)(11)), and provide for administrative expense and priority tax claim payment in full (§§ 1129(a)(9)(A)–(C)).
Subchapter V: Small Business Streamlining Under the Small Business Reoganization Act of 2019 (SBRA)
The Small Business Reorganization Act of 2019 created Subchapter V of Chapter 11 (11 U.S.C. §§ 1181–1195), a framework for eligible small business debtors to access Chapter 11 relief more efficiently and cost-effectively. As of 2022, the debt cap for eligibility is $7.5 million in combined secured and unsecured noncontingent, liquidated debts.
Key features of Subchapter V include:
- No creditors’ committee unless ordered by the court (§ 1181(b)).
- A Subchapter V trustee is appointed in all cases (§ 1183), but unlike traditional Chapter 11 trustees, their role is limited to facilitating plan negotiation and disbursement.
- Only the debtor may file a plan (§ 1189(a)), which must be filed within 90 days of petition.
- No disclosure statement is required unless ordered (§ 1181(b)).
- The absolute priority rule is inapplicable, allowing equity holders to retain their interests even if unsecured creditors are not paid in full (§ 1181(a); see also § 1191(b)).
- Plans are confirmed under a feasibility and “disposable income” standard over 3 to 5 years (§ 1191(c)).
These reforms reduce both the cost and complexity of reorganization for qualifying business debtors, and have dramatically expanded Chapter 11’s accessibility for sole proprietors and smaller enterprises.
Appointment of Trustee
A trustee is rarely appointed in a chapter 11 bankruptcy case because the debtor usually remains in possession of the business and its assets. There are two instances however when the court may decide to appoint a trustee:
- Fraud, dishonestly, incompetence or gross mismanagement; or
- The appointment of a trustee is for the best interest of the creditor, equity security holders or other interested persons.
The appointment of a trustee divests the debtor of their status as a debtor-in-possession. If a trustee is appointed, he or she will be responsible for managing the business and its estate. The trustee does not work independently, but rather in consonance with the orders of the court.
In some cases, a trustee may be responsible for filing a plan of reorganization. If the trustee elects to not submit a plan of reorganization, the Bankruptcy Code requires the trustee to either file a report on why he or she elected not to submit a plan, or to file a recommendation on the possibility of the case being converted or dismissed.
A trustee can also be divested of their status upon request. If the court grants this, the debtor will be restored to their position as a debtor-in-possession.
At this point, it’s important to distinguish that there are actually two kinds of trustees in a bankruptcy case: the US Trustee and the Case Trustee.
The US trustee is a staple feature of bankruptcy cases, while a case trustee may or may not be appointed depending on the case.
The US trustee is actually an employee of the Department of Justice. They monitor the conduct of the debtor-in-possession during the pendency of the bankruptcy case. The case trustee is appointed only when the instances mentioned above are met. The case trustee actually takes over the functions of the debtor-in-possession, unlike the US trustee.
Creditor’s Committees
The US trustee may appoint a committee composed of the 7 creditors holding the seven largest unsecured claims. This committee is referred to as the ‘creditors committee’. The function of this committee is mainly to safeguard the proper management of the business during bankruptcy proceedings. The tasks of the committee may involve but are not limited to consulting with the debtor-in-possession, participating in the formulation of the plan, and hiring of necessary professionals for the bankruptcy proceedings.
Confirmation of the Plan
The last stage in the approval of the plan is the confirmation by the court.
There may be competing plans submitted by the debtor, creditors or trustee. In order for a plan to be accepted or confirmed by the court, at least one class or unsecured claims must accept the plan. (The debtor can use certain strategies to increase their chances of confirmation). The court will consider whether or not the plan is feasible, was made in good faith and conforms to the requirements of the Bankruptcy Code before confirming it.
Once a plan has been confirmed by the court, the confirmation can only be revoked upon showing that the confirmation was procured through fraud.
Conversion
A case for Chapter 11 Bankruptcy may be converted to a case for Chapter 7 Bankruptcy upon request of the debtor. The right however is not available under the following circumstances:
- The debtor is not a
debtor-in-possession - It was originally commenced
as an involuntary case - The case had been converted
before