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Strategic Use of Chapter 11 for Your Business: Chapter 11 Basics

by Bill Porter


What options exist for a company whose existence is threatened by too much debt? Most businesses will first seek to improve liquidity through revenue enhancement, cost reductions, sale of assets, or equity/debt financing. Concurrently, or after, they may seek accommodations from creditors, especially their senior secured lender.


Before starting a dialogue with the bank, owners must have a basic understanding of Chapter 11, the federal law that allows businesses to force a reworking of debt obligations on lenders and other creditors. Why? Because the negotiation might fail, and Chapter 11 might be necessary. But more importantly, being armed with an understanding of Chapter 11 can tip the balance of power and make reaching an agreement more likely. As we often say, a successful loan workout happens “in the shadow” of Chapter 11. Here is what business owners and their non-bankruptcy advisors need to know about Chapter 11.


Chapter 11 is a complex legal action, and no company would choose it as a first resort. But when survival is on the line, Chapter 11 protection is a powerful tool that can be the difference between revitalization and liquidation. If a company is considering using Chapter 11, it can be helpful to think of the process in 3 phases: (1) Preparation and Filing; (2) Confirming a Plan; and (3) Emergence from Chapter 11.


Step 1: Preparation and Filing

Chapter 11 is a large undertaking for a company’s management, so understanding and preparing for it is the first step. Companies will need to work in conjunction with their restructuring counsel to prepare a petition by completing a list of company assets, debts, income, and expenses and a summary of finances. Chapter 11 requires full and open disclosure of a company’s finances, but in exchange, companies have the opportunity to restructure or even reduce their debt obligations.


As soon as the case is filed the automatic stay goes into effect. This is a stay that springs into existence upon the filing of the case that requires all collection activities by the creditors to stop (with some limited exceptions). The stay is like a protective forcefield and provides a breathing spell which is an opportunity for the company to stockpile cash, focus on improving profitability, and attend to the restructuring.


Once the case is filed, there is an intense period of activity that includes:


Cash Collateral and Post-Petition Financing: In many cases, businesses will need to use cash that is subject to a lien of a secured creditor and/or obtain postpetition financing to continue operating postpetition. Section 363 of the Bankruptcy Code permits a debtor to use the cash that is subject to a lender’s lien. A motion at the beginning of the case will set the conditions on which that cash can be used. However, if a business cannot rely solely on existing cash or post-petition accounts receivable, and it has a lender willing to advance new money, a motion will be filed to permit post-petition financing. In most other respects, during the time between the filing and confirmation, business will continue as usual, subject to the provisions of the orders regulating cash collateral and/or post-petition financing.


What Payments are Made During Bankruptcy: During the period between filing and confirmation, certain payments are made and others are not. For example, payments to secured creditors cease during this period (except in some circumstances), but payments due for current post-petition lease obligations would continue. Chapter 11 counsel should explain what obligations must be paid and which obligations temporarily stop.


Assume or Reject Contracts and Leases: Many businesses become “stuck” in leases or contracts which are burdensome to the financial future of the company. Chapter 11 gives a company the opportunity to decide which contracts and leases it wants to keep and which ones can be “rejected.” If the contract or lease is rejected, the damages for such rejection are specifically defined in the Bankruptcy Code and generally are treated as unsecured claims as of the petition date. An experienced restructuring attorney will counsel clients to make informed business decisions on assuming or rejecting contracts.


Potential Sale: Many companies decide to file Chapter 11 to sell assets or the business. Oftentimes, this process occurs prior to confirmation of a plan. The sale process is straightforward, but specific procedures must be followed. Typically, companies will market their assets, file a sale motion with the court, and get a court order approving the sale.


Step 2: Confirmation

The goal and pinnacle of most Chapter 11 cases is confirmation of a plan of reorganization that restructures debt and wraps up litigation and other challenges. The process for getting a plan confirmed must be steered by experienced Chapter 11 counsel and includes such steps as: (1) negotiating terms with creditors, (2) filing a disclosure statement with all required elements and information (except in most Subchapter V cases); (3) proposing a plan of reorganization that meets all the statutory requirements of the Bankruptcy Code, and (4) where necessary, putting on proof at an evidentiary hearing to confirm the plan of reorganization.


A plan of reorganization must meet all statutory requirements of the Bankruptcy Code and provide for, among other things:

  • designation of the classes of creditors’ claims that will be affected by the plan

  • designation of unimpaired and impaired classes of creditors

  • a summary of how creditors will be treated;

  • an adequate, viable means for implementation of the plan

  • provide the same treatment for each claim or interest of a particular class, unless the holder of a particular claim or interest agrees to a less favorable treatment;

  • provide, if relevant, for the sale of all or any part of the property of the estate,

  • provide for the assumption, rejection, or assignment of any executory contract or unexpired lease of the debtor not previously rejected; and

  • where appropriate discharge debts and other obligations


There are many other technical and statutory requirements that must be met to confirm a chapter 11 plan, but experienced bankruptcy counsel can guide a company to make sure a plan complies with all statutory and legal obligations. Confirmation is a watershed event for a business in Chapter 11, and reorganization of a business is cause of celebration.


Step 3: Emergence from Chapter 11

After the Plan is confirmed, there is still some work to be done before a business can completely exit Chapter 11. A Chapter 11 debtor must comply with all post-confirmation reporting requirements, implement the terms of the plan, and where appropriate, object to the claims of creditors and pursue any causes of actions that may result in recovery for the estate. Generally, post-confirmation debtors are required to file certain financial reports required by the United States Trustee. These reports are consistent with the overall goal of transparency and disclosure. Debtors must also implement the terms of the confirmed plan and begin making plan payments on the effective date (as defined in the plan). The confirmed plan is essentially a new contract between the reorganized debtor and its creditors, and it is the reorganized company’s obligation to fulfil the new contract obligations.


Generally, a confirmed plan provides for the repayment of “allowed claims.” What is an allowed claim is defined in the Bankruptcy Code and the confirmed plan. When a debtor disagrees with a claim asserted by a creditor, the debtor can object to that claim. The claims allowance process often takes place after confirmation and any claim that is disallowed is not paid and the holder of that claim cannot attempt to collect it post-confirmation.


Finally, if the confirmed plan retained the right to do so, then the reorganized debtor can pursue any cause of action that is beneficial to the reorganized debtor. Often a debtor’s beneficial claims are a valuable asset of the estate and are an important part of wrapping up a Chapter 11 case and the affairs of the reorganized debtor.


Conclusion

Chapter 11 is a complex process, but the benefits can be substantial for a business struggling under the weight of too much debt. Having a basic understanding of how it works can help owners or managers weigh the benefits against the costs. Perhaps more importantly, when lenders know that borrowers understand their options, it can even the playing field in a negotiation to voluntarily rework loans.

 

Bill Porter is a partner with EmergeLaw, PLLC based in the firm's Orlando, Florida office. For more than 25 years Bill's practice has focused on bankruptcy, creditors’ rights, and commercial litigation in the Middle and Northern Districts of Florida. He represents debtors, lenders, creditors, and lessors in out-of-court disputes and in bankruptcy court in Chapter 11 reorganizations and Chapter 7 liquidations. He is particularly skilled at representing small businesses in Subchapter V restructurings.

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