Chapter Eleven Bankruptcy: An Overview

Chapter 11 Bankruptcy

            Chapter 11 is the “reorganization” model for bankruptcy.[1] Well-known American retailers such as Toys “R” Us and Kmart, as well as a Major League Baseball franchise, the Texas Rangers, have filed for it.[2] As a CEO, President Donald Trump decided that three of his Atlantic City hotel-casinos should file for it.[3]

            Introduced in 1978, a Chapter 11 proceeding under the U.S. Bankruptcy Code allows a company or individual to declare bankruptcy, reduce debt and reorganize without having to shut down and liquidate to satisfy debts. Chapter 11 provides a debtor with breathing room. High profile examples of Chapter 11 filers include large companies, including corporate giants Macy’s, General Motors, United Airlines and Kodak, but Chapter 11 is not only for entities like these.[4] In fact, nearly a third of Chapter 11 filers are individuals.[5]

            What advantages may Chapter 11 provide over other types of bankruptcy? First, let’s compare Chapter 11 to Chapter 13. Chapter 11 isn’t as rigid as Chapter 13. There are no debt limits under Chapter 11 like there are for Chapter 13, which currently restricts a person to under $400,000 in unsecured debt and under $1,200,000 in secured debt. This allows people with higher income and debt levels to declare bankruptcy. Additionally, Chapter 13 is more rigid with its time requirements: for example, the debtor must propose a plan for repaying creditors within fourteen days of filing for bankruptcy and the entire Chapter 13 bankruptcy proceeding cannot extend past five years. Chapter 11 has no such time limits, so it provides a debtor with more time to plan for, and pay back, debts.

            Now let’s compare Chapter 7 to Chapter 11. Chapter 7, the most common form of bankruptcy in the United States, is a liquidation. The bankruptcy court appoints a trustee to sell a debtor’s assets and distribute the proceeds to creditors. Chapter 11 is a reorganization and a debtor filing for Chapter 11 can protect assets and business operations from disruption due to collection activities such as foreclosures, garnishments, lawsuits, and repossession while still operating business as usual.  

Initiation of a Chapter 11 Proceeding

            The first step for a debtor is to file a petition for relief under Chapter 11 with the bankruptcy court where the debtor’s principal place of business or residence is located. After filing for Chapter 11 and paying the fee, the debtor is called a debtor-in-possession. Unlike a Chapter 7 proceeding, the debtor remains in control of his assets as the court will not appoint a trustee to oversee the Chapter 11 process unless it decides that the debtor is doing something wrong or that a trustee is necessary to serve the best interests of the creditors.[6]

            As the debtor in possession, the debtor continues operating its business and can hire attorneys, accountants, appraisers, auctioneers, or other professionals to assist in its bankruptcy case and file tax returns and monthly operating reports.

            Filing for Chapter 11 immediately suspends all collection activities, foreclosures, and judgments against the debtor.[7] This is mandated by the automatic stay provisions of Section 362 of the Bankruptcy Code. Though it gives a debtor some space, the  automatic stay doesn’t stop every type of action that may be taken against a debtor. It won’t, for example stop:

·         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, domestic support obligations, child custody or visitation, or marriage dissolution.

After the Filing

      After the filing, for 120 days after filing for Chapter 11, the debtor has the exclusive right to create and file a reorganization plan. The plan must do the following:[8]

·         Identify debts;

·         Identify whether the creditor claims are priority, secured or general unsecured and the number of claims classified as each;  

·         Provide a determination of which debts will be paid in full, and which debts will be repaid in a percentage amount;

·         Provide methods on how the debts will be paid; and

·         Present guidelines as to how the company will operate while implementing the plan

            Along with the plan, the debtor must file a disclosure statement that includes the following information[9]:

·         The debtor’s future;

·         The circumstances that gave rise to the bankruptcy petition;

·         Financial information, data, valuations or projections relevant to the creditors’ decision to accept or reject the Chapter 11 plan

             The plan sets up classes of creditors. For example, classes of creditors may include unsecured debts to vendors, back wages owed to employees, banks to which the debtor owes repayment of loans, etc. The plan treats all members of each class equally to the members of its own class. For example, the plan might stipulate that all unsecured vendors are to be paid 75% of what is owed to them, with payments spread out over the next year. The reorganization plan is a fundamentally proposal for how the debtor plans to pay his creditors.[10]

Creditors’ Reactions

After the plan has been filed, the creditors can respond to the disclosure statement and the reorganization plan at a disclosure hearing. The plan can be negotiated and modified as agreed to by the debtor. The plan is then submitted to a vote of each class and creditors that are “impaired” by the plan, meaning those whose contractual rights are to be modified or who will be paid less than the full value of their claims under the plan. [11]

Most classes of creditors will be impaired at least to some extent in most Chapter 11 plans, as people and companies would hardly resort to the drastic step of filing for bankruptcy if they could pay off most of their debts as they came due. Still, any class of creditors whose claims will be paid in full under the plan are presumed to be in favor of the plan.

            A class has voted to approve the plan if the plan is accepted by the holders of two thirds of the total debt within that class. So, for example, if one creditor holds 70% of the debt in a given class, that creditor can unilaterally accept the plan for the class, regardless of how many other creditors there are in the class. [12]  A party who votes against the plan can ask that the approval be set aside on grounds of bad faith or other wrongful dealing.       

Approval

If all classes approved the plan in the prescribed manner, the plan is approved and moves forward. Even if not all classes have approved the plan, the court can accept it as long as one class of creditors has approved it and “the plan does not discriminate unfairly, and is fair and equitable, with respect to each class of claims or interests that is impaired under, and has not accepted, the plan.”[13] This is sometimes known as a “cram down.”

            If the plan is confirmed by the court, the debtor is required to make all the payments to creditors as outlined in the reorganization plan.

When announcing that Toys “R” Us would be filing for Chapter 11, company CEO Dave Brandon said, “We are confident that these are the right steps to ensure that the iconic Toys “R” Us and Babies “R” Us brands live on for many generations.” That statement sums up why Chapter 11 stands apart from Chapter 7 proceedings. Chapter 11 proceedings are designed to give financially-distressed debtors time to reorganize and revamp and continue, hopefully coming out the other side as strong as ever. The many examples of major American corporations filing for Chapter 11 and emerging to success for many more decades is a testament to the power of this device.