Chapter 11 bankruptcy (2024)

Chapter 11 bankruptcyis the formal process that allows debtors and creditors to resolve the problem of the debtor’s financial shortcomings through areorganization plan; see Tamir v. United States Trustee.Accordingly, thecentral goalof chapter 11 is to create a viable economic entity by reorganizing the debtor’s debt structure. Unlikechapter 7, chapter 11 is not aliquidationof the debtor’s assets. Rather, it is a reorganization of existing assets,principally as debt. Theconfirmedchapter 11 plan becomes acontractbetween the debtor and creditors, governing their rights and obligations; see In re Nylon Net Company.

When a company can no longer pay its debts, it generally creates a relationship between two stakeholders–thedebtorandcreditors. The debtor seeks relief from thedebtthey cannot repay, while the creditors seek to recollect their debts, quickly and efficiently. Through the “chapters” in theBankruptcy Code, Congress created the rules governing the relationship between creditors and the debtor during bankruptcy in order to systematically, effectively, and efficiently satisfy the often countervailing interests of each side.

The premise behind a chapter 11 reorganization is that a debtor is more valuable as an operating entity than in liquidation (i.e., through a chapter 7 bankruptcy). Hence, chapter 11 bankruptcy is generally chosen when the continuation of a debtor’s business generates more value than a closure and piecemeal sale of its assets. This often occurs when the debtor’s financial troubles are a product of temporary issues, such as lowcash flowand diminishing demand. A bankruptcy judge will confirm a chapter 11 planonly whencreditors are satisfied that they will receive at least as much as they would under a liquidation.

As such, chapter 11 is generally intended to provide business debtors, like corporations and limited liability companies, the opportunity to reorganize their debt. Conspicuous examples of chapter 11 bankruptcy includeLehman Brothersin 2008,General Motorsin 2009, andKmartin 2002. However,Section 109 of the Code permitsandcourts agreethatindividual debtorsnot engaged in business may file for relief under chapter 11. This usually occurs when an individual’s debt exceeds thestatutory debt ceiling (see: 11 U.S. Code § 109) forchapter 13of theBankruptcy Code.

Procedure

Generally,a debtor initiatestheir bankruptcy by filing a bankruptcy “petition” with the clerk of the bankruptcy court. Most debtors must also file schedules stating the debtor’sassets and liabilities,current income and expenditures, andbusiness and financial affairs. According to theBankruptcy Court for the Eastern District of New York, these filings “are carefully designed to elicit certain information necessary to the proper administration and adjudication of the case.” In turn, creditors gain information to make possible a fair and efficient distribution of the debtor’s assets.

When a debtor files for bankruptcy, the court creates abankruptcy estate,composed of the debtor’s property owned at the commencement of the case;see Westmoreland Human Opportunities v. Walsh.Section 541(a)(1)defines "property of the estate" to include "all legal or equitable interests of the debtor in property as of the commencement of the case." The Supreme Court noted inUnited States v. Whiting Pools, Inc.(1983),§ 541(a)'s legislative history demonstrates that this provision was intended to be broad and include "all kinds of property, including tangible or intangible property, causes of action . . . and all other forms of property currently specified in” theBankruptcy Act. According toButner v. United States, a Supreme Court case from 1979, bankruptcy courts look to state law to ascertain the existence and scope of the debtor's "legal or equitable interests" for purposes of§ 541(a)(1).

Reorganization Plan

The reorganization plan is the central feature of chapter 11 bankruptcy. As noted inTamir v. U.S. Trustee, “the primary goal of Chapter 11…[is] to formulate a comprehensive reorganization plan that will ultimately rehabilitate financially distressed debtors.” Ideally,chapter 11 should“be...a negotiated process; a system to induce compromise.” See In re AG Consultants Grain Division, Inc.

• Accordingly, therequirementsfor a proposed reorganization plan reflect the pursuit of order and fairness. A proposed plan must:
• Designateclassesof claims among similarly situated debt- and equity- holders.
• Identifyif the plan will “impair” claims of discrete classes. According toIn re Woodbrook Assocs., (7th Cir. 1994), impairment occurs when there is any alteration of a creditor’s rights, “no matter how minor.”
• Explainhow the plan will alter the claims held by the impaired classes.
• Treatevery entity in each class the same as all class members.
• Provide sufficient measures to implement the plan by, for example, selling debtor’s property, satisfying liens, or waiving a default by the debtor,among othermeans.

Creditors that are adversely affected by the plan canvote for or against it. However, asIn re Edgefield Inn, LLC(Bankr. D.S.C. 2014), accurately states, “unimpaired classes...have no vote in the reorganization process.” The statute limits voting power only to impaired classes; indeed, classes not impaired under the plan are “conclusively presumed to have accepted the plan.”

Under11 U.S.C. Section 1125, a proponent of the plan is generally required to submit a disclosure statement. Such disclosure allows potentially affected parties to make an informed judgment on whether to vote for the plan.§ 1126(c)states that a class of creditors accepts the plan if “creditors … that hold at least two-thirds in amount and more than one-half in number of the allowed claims of such a class” vote to accept the plan.Section 1126(c), (e)authorizes the court to disregard the vote of any creditor whose acceptance or rejection of the plan was not in good faith.

Subsequently, the court will hold a hearing to “confirm” the plan. For the plan to be confirmed,a court must findthat creditor classes either accept the plan or are not impaired and that the plan satisfies additional criteria listed inSection 1129of the Bankruptcy Code. A chapter 11 reorganization plan may not be confirmedunless it satisfiesseveral statutory requirements, principally the following three:

• Best Interests of Creditors.

  • UnderSection 1129(a)(7)(A), a reorganization plan must satisfy the "best interests of creditors" test. According to the Supreme Court inUnited States v. Reorganized CF&I Fabricators of Utah, Inc.(1996), this testrequiresthat each holder of an impaired claim or interest either accept the plan or receive under it at least as much as they would receive in achapter 7 liquidation. Unless a creditor consents to otherwise,this requirement means thata creditor must receive property that has a present value equal to what that participant would have received in a chapter 7 distribution, had the debtor been liquidated on the plan’s effective date.

• Feasibility.

  • The "feasibility requirement" requires the court to find that a plan isworkable, butsuccess need not be guaranteed. A plan is workableunder the statuteif the court finds that the debtor is unlikely to liquidate or need further financial reorganization. Thedebtor bears the burdenof establishing the feasibility of the plan by showing that the plan has a reasonable probability of success. The court inIn re Apex Oil Co.(Bankr. E.D. Mo. 1990) notes that to determine whether the plan has a reasonable probability of success, the court may compare the debtor's future income and expenses to actual performance, considering the capability of management, the adequacy of capital resources, and reasonably anticipated liquidity.

• Cram-down.

  • Under certain circ*mstances, theCodepermits a court to confirm a plan over a creditor's dissent. This non-consensual confirmation is called a "cram-down" and theCoderequires the debtor to show that 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.” According toIn re Hoffinger Indus., Inc.(Bankr. E.D. Ark. 2005), the plan may only treat similar claims differently when the debtor has a reasonable basis for the disparate treatment. There is generally a reasonable basis for treatingsecured claimsdifferently from each other since secured claims are usually secured by differentcollateral, thereforewarranting disparate treatment.

When a plan is confirmed, it becomes abindingcontract on the debtor, the creditors, and other parties. Theeffect of a confirmationvests all the property of the estate in the debtor, “except as otherwise provided in the plan or the order confirming the plan.” In turn, “confirmation generally dischargesthe debtor from its pre-confirmation debt, “substituting the obligations of the plan for the debtor's prior indebtedness. The Bankruptcy Court retains jurisdiction to “interpret, enforce,or aid” the management of the reorganization plan.

Debtor-In-Possession

Under a chapter 11 bankruptcy, the debtor generallyholds possessionof its assets throughout the proceeding and administers themfor the benefit of the creditor class. This feature, termed “debtor-in-possession,” reflects a key distinction between the bankruptcy rules underchapter 7and chapter 11.

Under chapter 7,a trustee administersthe debtor’s assetsto satisfy creditors’ claims. By contrast, chapter 11 reflectsCongress’ viewthat “current management is generally best suited to orchestrate the process of rehabilitation” to benefit creditors and other interests of the estate. In turn, the debtor generally retains its control over its assets and business operations, acting as a “debtor-in-possession.” Such status explainswhy managers of the debtor preferchapter 11 over chapter 7: chapter 7 displaces the managers’ control over the firm vis-a-vis the appointed trustee, while chapter 11 does not require such an appointment.

In practice, chapter 11permitsthe debtor-in-possession touse property and transactin the ordinary course of business,without preapprovalfrom the court. For acts takenoutside the ordinary course of business, notice, hearing and court approval is generallyrequiredin advance. According to theDistrict of Utah Bankruptcy Court, an action “outside the ordinary course of business” encompasses any transaction “that might be considered unusual, controversial, or questionable for the debtor to undertake during its chapter 11 case.” The same court inanother proceedingfound a sale of “substantially all the debtor’s assets” to satisfy that standard. As such,this standard balancesthe efficiency of permitting the debtor-in-possession to perform ordinary business functions without onerous oversight of creditors and the court with the need to protect creditors from unordinary transactions.

[Last updated in July of 2022 by the Wex Definitions Team]