What Is A Chapter 11 Bankruptcy?

Chapter 11 is a provision of the bankruptcy code that allows individuals, corporations, LLCs, and partnerships to reorganize their debts when they are having financial problems. What a Chapter 11 allows them to do is to keep operating, and in so doing, get a sense of whether the business can survive financially. There is no free ride in a Chapter 11; the debtor needs to be able to maintain its ongoing expenses while simultaneously being able to propose a plan that will repay its creditors. The ultimate goal of a Chapter 11 is for the debtor to propose a plan of reorganization which provides for the manner in which its creditors will get paid, and a disclosure statement that addresses how they got to where they are and how they plan to get out of it along with financial information sufficient to allow the debtor’s creditors to determine if the debtor’s plan is viable.

From a practical point of view, Chapter 11 is very expensive, and most debtors do not last to confirmation. Even if the debtor manages to get its plan and disclosure statement approved, voted upon and confirmed, few survive past the first year after confirmation. In my experience, there are other ways to enable a business having financial problems to rid itself of its debt.

Who May File A Chapter 11 Bankruptcy?

Any entity may file a Chapter 11, with the exception of a Massachusetts nominee realty trust that is not an eligible debtor.

In Massachusetts, a realty trust is a very popular way to hold real estate. The property is held in the realty trust’s name and a trustee is named, but the trust’s beneficiaries do not have to be disclosed. If you own investment or commercial property, think twice before you place it into a realty trust.

In the past, when we would be dealing with a client’s realty trust facing a foreclosure, we would set up a corporation, convey the property from the realty trust into the corporation, and then file the Chapter 11 for the corporation. However, one of the bankruptcy judges at the time, followed by all of the others, decided that this was a bad faith filing. Consequently, this practice has ceased and, when dealing with a realty trust, the property is now conveyed to the individual owner who files the Chapter 11.

The cost of filing a Chapter 11 is prohibitive. The court filing fee is nearly $2,000 and the attorney’s retainer for a Chapter 11 can run from $5,000 to $25,000 (and even more) depending upon size and complexity of the case.

When a Chapter 11 is filed, there are two parts of the judicial system that you must keep happy . . . the judge who has been appointed to preside over your case and the Office of the United States Trustee, an arm of the Justice Department, that oversees a debtor’s compliance with the operating and reporting requirements of a Chapter 11. As I tell my clients, if you do everything right, you should not have to visit with the judge until you file your plan and disclosure statement.

Then, there is the Office of the United States Trustee, which is an arm of the Justice Department. As noted supra, they are here to administratively oversee Chapter 11 debtors. When a Chapter 11 is filed, there are certain operating report and reporting requirements that must be strictly adhered to. Immediately upon filing a Chapter 11, the debtor has to confirm that is has all required insurance coverage (I once represented a demolition company whose liability insurance expired. The judge asked what the debtor would do if one of its projects went awry and there were damages. My debtor reinstated its insurance by the end of the day).

The debtor is also required to open up a new “debtor-in-possession” bank account to use for all of its business activity. The checks for this account must state “debtor-in-possession” on it with the case docket number. Moreover, the debtor is required to provide monthly cash-flow statements, copies of bank statements, comparative balance sheets, summary of accounts receivable, schedule of post-petition liabilities, income statement and statement of sources and uses of cash. But wait there’s more . . . all taxes must be paid in a timely fashion.

As you can see, in a Chapter 11, there is someone always looking over the debtor’s shoulder. If the debtor is not in compliance with the operating reports and reporting requirements, the Office of the United States Trustee can (and will) file a motion to convert the Chapter 11 to a Chapter 7 (liquidation). The reason . . . the debtor’s failure to pay its bills, pay its taxes or file its reports.

What Relief Do Debtors Get When They File A Chapter 11 Bankruptcy?

The relief that debtors get when they file a Chapter 11 is the same as in a Chapter 7 or a Chapter 13: the automatic stay goes into effect. The Chapter 11 debtor still has to pay its ongoing expenses. If the debtor has secured debt, they will have to go into court on an emergency basis to get authorization to use the secured creditor’s collateral, and oftentimes to get the payment of post-petition payroll approved or to have additional loan advances approved (a secured creditor’s lien needs to be extended post-petition). Otherwise, it is business as usual.

The debtor in a Chapter 11 doesn’t receive a discharge, its debts are paid through the terms of the confirmed plan. After some time in a Chapter 11, the debtor will file a disclosure statement, similar to a stock prospective, a document calculated to allow the uninformed creditor to make an informed determination on the viability of the debtor’s proposed plan. The plan shows how creditors are going to be paid.

The disclosure statement divides debts into categories, such as secured debt and tax claims. Generally, the tax claims are paid over five years. Secured debt usually continues to get paid pursuant to its terms. However, the debtor may propose to modify the terms and amount of its secured debt. The debtor continues to operate its business while it is in Chapter 11. As noted above, if it has secured debt, it may have to go into court and get the court’s approval to use what is called cash collateral. Cash collateral is the term used when a bank has a security interest in the assets of a business and the debtor wants to use that after the filing, because the bank’s security interest terminates when the Chapter 11 is filed. The secured creditor must have its security interest extended to post-petition. The debtor must grant them a new security interest and get the court’s approval to use their money.

For more information on Chapter 11 Bankruptcy In Massachusetts, a initial consultation is your best next step. Get the information and legal answers you’re seeking by calling (978) 922-8440 today.