13. What is the Chapter 11 bankruptcy process?
Chapter 11 bankruptcy (Chapter 11) seeks to reorganize or restructure the debts of the debtor without liquidating all of the debtor’s assets (as under Chapter 7). The objective is to allow the business to continue operations in an attempt to maximize the value of the business to all stakeholders. Chapter 11 follows a similar process to that of Chapter 7, with the following notable differences:
• Bankruptcy Estate – Filing for bankruptcy protection creates the bankruptcy estate. At this point, the court does not appoint a bankruptcy trustee to collect and manage the assets of the estate. Rather, the debtor remains in control of the business operations and all business assets. The DIP is vested with the same authority as a trustee in a Chapter 7 bankruptcy. This includes authority to use or even sell assets for the benefit of the estate, accept or reject contacts, and seek post-petition financing for the business. All of this authority is limited, however, by the objective of the DIP to control the estate for the benefit of all creditors.
⁃ Note: The debtor in possession’s duty to creditors is a change from the board’s duty to manage the corporation for the benefit of creditors.
• Proof of Claims – A creditor of the bankruptcy estate is generally not required to submit a proof of claim. Rather, the DIP is required to account for and identify all debts of the estate. The DIP must give all creditors notice of the bankruptcy filing. Secured creditors may be concerned by the DIP’s use of the collateral securing their claim in the continued operations of the business. If so, they can challenge DIP actions in the bankruptcy court. Unsecured creditors may organize and request the bankruptcy court recognize the group as a creditors committee. The purpose of the creditors committee is to represent the interests of all creditors in negotiations with the DIP.
• Plan of Reorganization – The DIP must put forward a plan of reorganization. This plan must pay off all secured creditors within the term of the plan. Further, the plan must be voted upon and accepted by at least one class of “impaired” unsecured creditors under the plan that is not paid in full. Lastly, the bankruptcy court must approve the plan. If the plan is not reasonable or the DIP cannot possibly achieve these objectives, the plan may fail and the bankruptcy case could be dismissed.
⁃ Note: In many cases, the company will achieve creditor approval of a plan by forcing the plan on certain groups of creditors. This is known as a “cramdown”.
Filing for bankruptcy protection under Chapter 11 can be a useful tool for business. As such, businesses have developed special purpose bankruptcies to achieve a specific business objective. For example, a business may use chapter 11 to escape certain types of tort liability. Further, if a company has a single prevailing asset, a company may liquidate the large asset, but otherwise go through the chapter 11 process. This is common when the debtor has a large single real estate asset.
• Discussion: Why do you think the Chapter 11 bankruptcy process allows the debtor to remain in control of business assets? Why do you think this is of primary concern to secured creditors? Do you think it protects creditor rights to require that a bankruptcy plan be approved by certain classes of unsecured creditor? Why or why not?
• Practice Question: ABC Corp is in dire straits. It is considering filing for bankruptcy to reorganize the company’s business operations. Can you explain to ABC the process of liquidating under Chapter 11?