Chapter 11 Bankruptcy
In Chapter 11 bankruptcies, the debtor-in-possession is the bankrupt entity, and it maintains partial control over its estate during the bankruptcy proceeding. In addition, it proposes a plan regarding how it should be reorganized. A US Trustee monitors the debtor’s compliance with statutory requirements. The Bankruptcy Court determines whether the plan should be confirmed, resolves disputes, and issues orders. Creditors submit claim(s) for a right to payment from the debtor. A trustee may, but is usually not, appointed in a Chapter 11 case.
Proper Venue: Any federal jurisdiction where the principal place of business or location of principal assets have been located for 180 days. Because corporations can satisfy the venue requirement in multiple places, they may choose where they file. Three big bankruptcy venues are New York, Delaware, and Texas.
Normally, a debtor will submit a ‘skeletal filing’ to get a bankruptcy started. This skeletal filing will include the bankruptcy petition, a filing fee, and a disclosure of the top twenty largest creditors. More detailed schedules of the debtor’s assets and liabilities, and a statement of financial affairs, will be filed within 14 days after the case is filed (though that period is often extended).
The Adversary Proceeding (AP) Process
Parties may file an adversary proceeding, which is basically a lawsuit filed within the bankruptcy case. The complaint in a AP can seek any relief against the debtor that is within the court’s jurisdiction, including requests for class action treatment and injunctive relief. APs are subject to procedural rules that are similar to the federal rules of civil procedure. See Fed. Rule Bankr. P. 7001 et seq. APs can be filed throughout the case.
Litigators seeking money damages may ask whether they should file a consumer claim as an AP, a claim, or both. Both processes provide a modified discovery/trial process. Because both procedural rules offer similar advantages, some courts prefer adjudicating affirmative claims through the claims process instead of the AP process and instead use APs for issues arising from the bankruptcy itself. The most common issues litigated as APs are fraudulent transfers and avoidance proceedings.
See a sample class claim here.
A debtor-in-possession or a trustee, if appointed, may seek to unwind transfers made prior to bankruptcy via the transfer avoidance process. The debtor-in-possession or trustee may set aside certain pre-petition transfers, including preferences, fraudulent conveyances, and transfers avoidable under the “strong-arm” powers. 11 U.S.C. § 1107(a).
If the debtor-in-possession in a Chapter 11 case fails to pursue meritorious transfer avoidance actions, a creditor can move the Court to appoint a trustee.
To learn more about fraudulent transfers and avoidance proceedings, click here.
Upon filing for bankruptcy, an automatic stay is in effect. A consumer’s attorney must be aware that as soon as a debtor has filed a bankruptcy petition, the consumer and the consumer’s attorney are subject to the automatic stay. Some government enforcement is not subject to the stay. Unless private litigation is well underway, it will be challenging to obtain relief from the stay. For more information on navigating the stay, click here.
In the initial days after filing, the debtor will seek court authorization to assume favorable contracts and leases and reject those that are unfavorable. The Bankruptcy Code allows the debtor to “reject” or exit unfavorable contracts, such as a lease on property that the debtor no longer intends to occupy, and to “assume” or continue the debtor’s prior position within profitable, or favorable contracts. See 11 U.S.C. § 365(a). The debtor will use the initial filings to attempt to reduce its liabilities.
Advocates can look to rejected contracts to get a sense for what operations the debtor intends to continue after the bankruptcy and what it intends to abandon. If the Court allows the debtor to reject a contract, the rejection places the debtor in breach of the contract, and the other party is entitled to liquidated damages in the form of an unsecured claim. Because unsecured claims are low-priority (for a prioritization of claims in bankruptcy, see 11 U.S.C. § 507), it is unlikely that the contract parties will be able to fully recoup their losses.
A US Trustee will monitor the case and will hold an initial debtor interview to learn more about the case. The US Trustee will review the debtor’s first day motions and any applications by the debtor for employment and payment of professionals, and will begin the process of appointing a creditors’ committee.
A trustee typically is not appointed in a Chapter 11 case, and the debtor performs many of the tasks that would be handled by a trustee. However, a trustee can be appointed if the court finds that “cause” exists (such as fraud, dishonesty, incompetence, or gross mismanagement) or if it would be in the interest of creditors. 11 U.S.C. § 1104(a).
After the First Day Orders, the debtor will propose a form of notice and the Court will send notice of case filing to all creditors and/or will publish notice in a news publication. The notice will include: 1) the date and location of the meeting of the creditors (generally 21-40 days after the petition was filed); 2) how creditors can file claims and the deadline for filing claims; 3) the deadline and process for objections to discharge or the exemptions from discharge; 4) a summary of the reorganization plan.
For sample model notice documents, click here.
The U.S. Trustee appoints creditors to a creditors’ committee (commonly the largest creditors). The U.S. Trustee can alter the composition of the creditors’ committee to make sure the committee reflects the interests of the creditors. Consumer creditors typically must ask that they be appointed to the creditors’ committee.
Where there are a large number of creditors with similar claims against the debtor, the Court may form a special committee in addition to the creditors’ committee to represent that group’s unique interests. In the past, this procedure has been used to create special consumer committees or victims’ committees.
The creditors’ committee has a significant role in a Chapter 11 bankruptcy. It can request that a litigation trust be created to preserve the interests of consumers engaged in litigation. For sample pleadings creating a consumer trust, click here.
It can also submit reorganization plans and vote on the debtor-in- possession’s proposed reorganization plan.
The forms that consist of the debtor’s schedules are: Schedule A/B: Property, Schedule C: Exemptions (or property unavailable to pay the claims of creditors), Schedule D: Secured Claims, Schedule E/F: Unsecured Claims, Schedule G: Executory Contracts and Unexpired Leases, Schedule H : Codebtors (parties or entities who are also liable for debtor’s debts), Schedule I: Income, Schedule J: Expenses
Although the bankruptcy rules state that a debtor must file its schedules within 14 days of the case filing, that deadline is almost always extended. If the debtor fails to properly file the schedules, the court has discretion to order the trustee (if appointed), a petitioning creditor, committee, or other party to prepare and file any of these papers within a time fixed by the court. Fed. Rule Bankr. P. 1007(k).
The debtor will propose when the claim bar date (the deadline for when a creditor’s proof of claim must be filed) should be set and provide a draft of the notice that will be sent to creditors. The Court will allow parties who have not filed a proof of claim or who represent a class of creditors who have not yet filed claims to object to the proposed claim bar date and the Court may extend it accordingly.
To see an example of an application to extend the bar date, click here. A proof of claim that is filed after the bar date will be disallowed.
The Claims Process
Filing a Proof of Claim
A creditor must file a proof of claim to participate in the distribution of the debtor’s assets or receive payment under the debtor’s plan. A proof of claim should be filed even if the consumer has no judgment against the debtor, has not begun litigation, or is not certain of the exact amount of the claim. If litigation has begun or a judgment has been obtained against the debtor before the bankruptcy case was filed, a proof of claim must still be filed in the bankruptcy case.
Advocates can file either a class claim or a claim on behalf of an individual. A claim must be filed using Official Form 410, available on United States Courts’ website. The form is relatively straightforward to complete. It requires the creditor to provide their contact information, the basis for their claim, the nature of their claim, the basis for any priority, and the amount sought. In Chapter 11 cases where it is expected that a large number of claims will be filed by individual creditors, the court may order that proofs of claim must be filed with a court approved claims agent, rather than with the court. Information about this requirement will be included in the notice of the bar date for filing claims.
Courts generally apply a two-step procedure in allowing a class proof of claim. This initial analysis focuses on three factors: (1) whether a class was certified pre-petition; (2) whether the members of the proposed class received notice of the claim bar date; and (3) whether class certification will adversely affect the administration of the bankruptcy estate. The final step involves the application of the factors under F.R.C.P. 23 for certifying a class. The bankruptcy court applies these standards as any federal court would in a non-bankruptcy context.
Litigators should draft a claim in the same manner that they would draft a complaint, because the debtor and trustee will have the opportunity to object to the claim, applying a FRCP 12(b)(6)-like standard. If a court action has been filed against the debtor before the bankruptcy is filed, the complaint in that case can be referenced in the proof of claim and attached as an exhibit.
Click here for a sample Class Proof of Claim.
The deadline to file a proof of claim in a Chapter 7 bankruptcy is 70 days after the petition is filed. The deadline to file in a Chapter 11 bankruptcy is established by the court based on the bar date approved by the court.
While a variety of parties will assert claims for payment in a bankruptcy, the likelihood they will recover depends upon how their claim is classified. The hierarchy of claims is: 1) Secured Claims, 2) Priority Unsecured Claims (including administrative expenses), 3) General Unsecured Claims, 4) Equity Security Interests. Each class of claims must be addressed before the next class of claims is entitled to a distribution of assets.
Not all unsecured creditors share equally in the funds that are left over after secured creditors are paid. Some are given favored treatment as “priority” claims. Under 11 U.S.C. § 507, unsecured creditors with a higher priority are paid in full before those with lower priorities receive payment. If there are not sufficient funds to pay all unsecured creditors within a priority level, those creditors receive a pro rata share of the remaining funds, and creditors with lower priority levels will not get paid.
Unsecured creditors that do not have priority, referred to as general unsecured creditors, often do not receive any distribution in either Chapter 11 or Chapter 7 cases. However, in cases in which the interests of consumers with legal claims against the debtor have been represented on the creditor’s committee (or through a special creditor committee), negotiations have resulted in the debtor proposing in the Chapter 11 plan to create a fund for the payment of unsecured consumer claims.
Administrative expenses are the first priority unsecured claims that must be paid in full when the plan takes effect, unless creditors with those claims waive the right to immediate payment. Administrative expenses include the post-petition wages of the debtor’s employees, court costs, and the fees for the attorneys, accountants and other professionals who worked on the case.
After the claims bar date has passed, the claims adjudication process will begin. The debtor will review the filed claims to determine if an objection to the allowance of the claim should be filed. Section 502 of the Bankruptcy code permits objections to claims on various grounds, including that the claim is not enforceable against the debtor. In cases in which a separate fund has been created to pay unsecured consumer claims, the court may appoint a party other than the debtor to review the claims and litigate objections. For example, in the Chapter 11 case of the large mortgage lender and servicer Ditech, a consumer representative was appointed to serve this role as the Consumer Claims Trustee on behalf of the Ditech Holding Corporation Consumer Creditor Recovery Trust.
If an objection to a proof of claim is filed and seeks only the disallowance of the claim and no other relief, it will be treated as a “contested matter.” Typically, the debtor or trustee is seeking simply disallowance of the claim and no other relief. If other relief is sought, the matter will be treated as an adversary proceeding, subject to Bankruptcy Rules 7001-7087. Contested matters are governed by Bankruptcy Rule 9014, which provides that some but not all of the adversary proceeding rules apply. In either case, the parties will be afforded the opportunity to conduct discovery. The party objecting to the claim may seek to have the claim disallowed based on the standards set out in Fed. R. Civ. P. 12(b)(6), that the proof of claim fails to assert a claim upon which relief may be granted. If a dispositive motion is not granted or settlement not reached, the claim may be adjudicated through a trial on the merits in the bankruptcy court.
In the section 341 meeting, 11 U.S.C. § 341, creditors can question the debtor under oath about its conduct that led to the bankruptcy filing, the operation of its business, and its plan for reorganization. However, more meaningful input and information generally is exchanged with the debtor through the creditors’ committee. The creditors’ committee may consult with the debtor about the administration of the case and participate in formulating the debtor’s reorganization plan.
In practice, the section 341 meeting tends to be too cursory to be useful. If too many questions are asked of the debtor, the US Trustee will instruct parties to seek a separate discovery process via a Fed. Rule Bankr. P. 2004 examination, which a party must request by filing a motion. Under Bankruptcy Rule 2004, any interested party can move the Court to require the debtor to produce documentation or testify on matters related to the bankruptcy. This is commonly called a 2004 examination.
The disclosure statement must provide information about the assets, liabilities, and business affairs such that the creditor can make an informed judgment about the debtor’s plan of reorganization. These documents tend to be very long, but can provide useful information to litigators representing consumers.
The Court will hold a disclosure statement hearing. Parties must file objections to the disclosure statement prior to the hearing. 11 U.S.C. § 1125; Fed. Rule Bankr. P. 3017. The Court must approve the disclosure statement before the debtor can solicit voting on the reorganization plan.
The Court will begin the process to approve a reorganization plan after the disclosure statement is approved.
The debtor has the exclusive right to file a plan for 120 days, and the exclusive right to solicit acceptance of the plan for 180 days, after the case is filed. This “exclusivity period” is often extended by the court. After the exclusivity period expires, or if a trustee has been appointed in a case, then “any party in interest” including a trustee (if appointed), a creditors’ committee, an equity holder, or a creditor may file a plan. However, even during the exclusivity period a creditors’ committee can work with the debtor to formulate a plan.
A reorganization plan must state how the debtor plans to treat creditors. 11 U.S.C. § 1123. 11 U.S.C. § 1129 establishes what distribution is fair for each class of claims. The reorganization plan will propose a way to pay off or compromise claims. Priority claims must be paid in full, unless those claimants agree to different treatment. (see 11 U.S.C. § 507 for the prioritization of claims). The Bankruptcy Code allows the plan to be formulated in different ways, with some provisions being mandatory (11 U.S.C. § 1123(a)), and others permissive (11 U.S.C. § 1123(b)).
In addition, the plan will classify creditors as priority, secured, or unsecured and specify the treatment of each class of claim. Creditors can object to how they are classified in the reorganization plan. Alternatively, creditors can agree to less favorable treatment to the treatment provided to others of the same class/interest. In addition, the plan will describe actions that may be taken when the plan is implemented (i.e. curing defaults, voiding liens, selling property, amending the debtor’s charter, etc.). Of note to consumers is that the debtor may propose to sell assets free and clear of claims against the debtor under certain circumstances. However, a 2005 amendment to the Code preserves many consumer defenses from attempts to sell assets free and clear of these claims. 11 U.S.C. § 363(o). For more on preserving consumers’ claims, click here.
The reorganization plan will typically include a proposal for exit financing. The DIP financing used by the debtor to operate during the duration of the Chapter 11 proceeding will likely get paid off with this approved credit.
The Bankruptcy Code generally requires that all impaired classes of creditors approve the plan. However, if at least 1 class approves the plan but other classes of creditors have not, the court may still confirm the plan and force the other classes to be subject to the plan if the Court determines that the fairness tests for treatment of creditors in 11 U.S.C. § 1129 are met. This confirmation of the plan despite creditor objection is commonly referred to as “cram down.”
Voting on the Plan Within One Class
For a class with many creditors to approve a plan, at least half of the creditors, representing 2/3rds of the aggregate dollar amount owed, must approve. 11 U.S.C. § 1126. A creditor that fails to vote will not be considered when determining aggregate amounts.
The Court may confirm only one plan. If multiple plans satisfy the requirements for confirmation, the court will consider the preferences of the creditors’ committee and equity security holders in deciding which plan to confirm. 11 U.S.C. § 1129(c).
An order confirming the plan may be revoked only if, at the request of a party in interest made within 180 days of confirmation, the Court finds that the order was procured by fraud. 11 U.S.C. § 1144.
After the plan is confirmed, the debtor must begin making the payments and other distributions required by the plan and carry out any other required provisions. Payments made under the plan may be funded by the operation of the debtor’s business or through the liquidation or recovery of assets. The debtor-in-possession, or a trustee if one has been appointed, must provide periodic reports on the status of implementation of the plan. Fed. R. Bankr. P. 2015.
The provisions of the confirmed plan are generally binding on the debtor and all creditors and entities acquiring property under the plan. 11 U.S.C. § 1141(a).
The plan proponent or the reorganized debtor may move to modify the plan after confirmation at any time before “substantial consummation” of the plan. 11 U.S.C. § 1127(b). The Court may confirm the modified plan if it meets the usual requirements for plan confirmation.
Corporations and other Chapter 11 debtors who are not individuals do not receive a discharge in bankruptcy. However, confirmation of the plan can operate like a discharge of the debtor’s debts because the terms of the plan replace any prepetition contracts and creditors are left with only the rights that are provided under the plan. In addition, the order confirming the debtor’s plan may release the debtor and some third-parties from liability on certain claims.
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