Chapter 11 of the Bankruptcy Code is titled “Reorganization” and contains the legal tools for businesses (and, in some cases, individuals) to remain in possession of their assets and to restructure and continue their operations.1 Chapter 11 cases vary in size and complexity from the ‘mom and pop’ retail store to mega cases like General Motors and United Airlines.
The goal in a Chapter 11 case is to obtain Bankruptcy Court confirmation of a Chapter 11 plan of reorganization. The Chapter 11 plan sets out how and on what terms prepetition debt will be repaid. Subject to reasonable limitations imposed by statute and case law, a Chapter 11 plan for Middletown, White Plains and Newburgh clients can result in discounted payments on unsecured debt, and needed modifications to secured debt obligations for property that the filer needs to retain. Such modifications can include, among other things, reductions in principal, reductions in interest rate, and extension of the period over which secured obligation(s) are paid. Secured property that is no longer needed or affordable can be surrendered in partial or complete satisfaction of the indebtedness, depending on the value of the collateral.
When a Chapter 11 case is filed in Orange County, payments on prepetition debt are suspended.2 As a result of that suspension of past-due payments, the debtor (the party seeking relief) gets immediate relief from the pressures of excessive debt that led to the filing of the case. The debtor’s proposal for payment of prepetition debts is contained in the Chapter 11 plan, and payments on a Bankruptcy Court approved plan begin when the case is nearing its completion. During the case, the debtor must resume making payments on certain secured debts, called adequate protection payments. Interest payment on significantly oversecured debts, i.e., those for which the value of the collateral significantly exceed the amount of the debt, can be deferred until confirmation of a plan. The debtor must also maintain insurance on its assets, and file and pay its taxes and other postpetition obligations as they come due.
In a Chapter 11 case, the debtor has a much greater involvement in terms of time (and, therefore, money) than does a debtor in an individual reorganization case under Chapter 13. The Chapter 11 voluntary petition for relief is accompanied by an affidavit regarding the debtor’s income, expenses, operations, and certain projections. If the debtor is a small business (a defined term) as is often the case in Chapter 11’s filed in the Poughkeepsie Division of the U.S. Bankruptcy Court for the Southern District of New York, any balance sheet, profit and loss statement, or cash flow statement that the debtor ordinarily generates must be filed with the Court. The timely filing of monthly operating reports in the case and the timely filing and payment of post-filing (“postpetition”) taxes are critical in the “small business case” because the failure to file reports and tax returns, and to pay taxes on time is grounds to either convert the case to Chapter 7, or to dismiss the case.
A number of filings need to be made when the case is filed. These filings are known as “first day motions” and “first day orders.” They include applications to employ professionals such as attorneys and accountants, interim applications to use the cash proceeds of property that is subject to a creditor’s lien (“cash collateral”), interim applications to approve any agreement for postpetition financing (new loans or advances on existing loans while the debtor is in bankruptcy), applications to approve payments on prepetition debt to critical vendors (because, absent court order, payments on prepetition debt are prohibited), and applications to pay employees (because payroll will almost always include prepetition debt).
A prompt meeting, known as an IDI, short for Initial Debtor Interview, is scheduled with the U.S. Trustee. At the IDI, a representative of the U.S. Trustee confirms the debtor’s knowledge and understanding of the U.S. Trustee operating guidelines for the case. Those guidelines include meticulously respecting the separate legal identity of the postpetition debtor (known as the “debtor in possession”); the requirement that all pre-filing bank accounts have been closed and that new, debtor-in-possession bank accounts have been opened. It is essential that the debtor’s assets be appropriately insured, and that taxes coming due after the commencement of the case are returned and paid when due.
The U.S. Trustee and the Bankruptcy Court maintain a focus on the central obligation placed on every Chapter 11 debtor in possession: to act as a fiduciary for the benefit of creditors. This requires scrupulous attention to keeping the debtor in possession’s postpetition business and financial affairs and record-keeping in good order and separate from those of its owners. Self-dealing in contravention of this central requirement will result in the case being converted to a Chapter 7 liquidation, or dismissal of the case. Conversion results in the assets of the estate being administered for the benefit of creditors by a Chapter 7 trustee, while dismissal puts the debtor and its creditors in the same position they occupied when the case was filed, i.e., orders entered by the Bankruptcy Court in the Chapter 11 case will no longer be valid or enforceable.
Just as in all bankruptcy cases, the clerk of court will schedule a meeting of creditors, or section 341 meeting, which is typically held about a month after filing. The staff attorney for the United States Trustee conducts the 341 meeting. The meeting lasts about an hour, and involves a detailed examination into the debtor’s business and financial affairs. Careful preparation for this meeting is very important, in order to avoid wrongly giving the impression of a weak or disorganized case to the U.S. trustee The U.S. trustee perhaps the most important player in many Chapter 11 cases filed in the Poughkeepsie Division of the Bankruptcy Court, which serves Middletown, Newburgh and Orange County as well.
The Bankruptcy Court will also promptly schedule an initial case conference before the court to learn what the case is about and to assist the Court in maintaining close control of the process. At this conference, the representative of the debtor appears along with his or her bankruptcy attorney to explain the reason for filing the case, the debtor’s projections and expectations for business operations going forward, and a preliminary idea of how the debtor intends to reorganize. Also appearing at this hearing will be the staff attorney for the U.S. trustee, and attorney(s) for the major creditors in the case. The case conference will be adjourned and re convened from time to time to keep the court informed about the progress of the case.
The Chapter 11 plan contains the debtors’ proposal for the restructuring of its debts, subject to the requirement of the Bankruptcy Code. Before a Chapter 11 plan can be mailed to creditors, the debtor must propose, and the Bankruptcy Court must approve, a disclosure statement. This disclosure statement lays out the history of the debtor’s business and financial affairs, its assets and liabilities, and describes how the debtor proposes to repay its obligations, in whole or in part. The disclosure statement must contain adequate information from which a creditor can make an informed decision about whether to vote for or against the plan.
Once the disclosure statement has been approved by the Bankruptcy Court, the disclosure statement and the Chapter 11 plan are mailed to creditors. The only solicitation permitted by the Bankruptcy Code to seek the creditor body’s ‘yes’ vote on the plan is the Bankruptcy Court-approved disclosure statement.
A Chapter 11 plan may be confirmed by order of the Bankruptcy Court one of two ways. A consensual plan may be confirmed when ‘yes’ votes are received from all classes of creditors’ claims that are considered “impaired” under the plan. Alternatively, a Chapter 11 plan may be “crammed-down” over the objection of one or more objecting classes of impaired claims if at least one class of impaired creditor claims consents. An impaired class of claims consents to its treatment under a Chapter 11 plan when more than one-half in number and two-thirds in amount of claims in that class vote ‘yes’. If a ‘cram down” plan gets at least one impaired consenting class, and the plan does not discriminate unfairly and is fair and equitable with respect to its treatment of all impaired, non-consenting classes, it may be confirmed by the Bankruptcy Court. It should be noted that negotiation, rather than litigation, produces by far the greatest number of confirmed Chapter 11 plans.
The effect of confirmation of a Chapter 11 plan is to discharge the debtor of its prepetition debts, and to substitute for those debts the obligations set forth in the plan. Once the plan is “substantially consummated”, the Bankruptcy Court will issue a final decree, closing the case and the newly reorganized debtor continues in business.
For individual(s) who need bankruptcy relief but who cannot file or choose not to file a Chapter 7 case, and who exceed the limits placed on secured or unsecured debt to qualify for Chapter 13 relief, Chapter 11 provides the mechanism for getting that relief. The description of business Chapter 11 cases above also generally applies to over-the-debt-limit Chapter 11 cases. While the same general legal requirements apply, in most of these cases the level of complexity and therefore the cost will be lessened.
Secured arrears under mortgages for which there is some home value (see below) may be repaid under a plan of reorganization (“Chapter 11 plan”), just as in a Chapter 13 case. Individual Chapter 11 cases are also like Chapter 13 cases in that the maximum reorganization period is 5 years, and the terms of home mortgages (e.g., interest rate and unpaid balance) that are at least partially secured cannot be modified by Court order. Like in Chapter 13, individual Chapter 11 debtors may pursue a residential loan modification under the supervision of the Bankruptcy Court while pursuing confirmation of their Chapter 11 plan.
And, in cases where home equity loans or lines of credit, traditional second or third mortgages are completely underwater (i.e., completely unsecured), those completely unsecured junior mortgage liens can be avoided by motion practice in the case, known as a “Pond motion,” named after the appellate court case that approved such this practice. If a Pond motion is granted in a Chapter 11 case3 and the client(s) make all of the payments required under their Chapter 11 plan, then the client(s)’ home will no longer be subject to that lien, and any future equity in the property will be the client(s) to enjoy, and not the banks.
At Hayward, Parker & O’Leary Esqs., our business bankruptcy lawyers are well known and respected for their reliable and thorough handling of Chapter 11 cases for New York residents in White Plains, Middletown, Newburgh and Orange County. Put our 55 years of combined experience to work for you. To schedule your free consultation, call 845-343-6227 or contact us online.
If an orderly liquidation under the control of the owners of a business is in the client’s best interests, “reorganization” under Chapter 11 includes a liquidating plan proposed by the company, rather than controlled by its creditors.
2 But see the discussion of first day motions and first day orders in the following paragraphs.
3 This is also true for cases under Chapter 13.