CHAPTER 11

Chapter 11 is for Individuals with secured debts over $1,000,000 and Businesses who want to keep their business operating but need time to repay and restructure debt. A Chapter 11 filing is different than a Chapter 13, is more complicated, and The process is much more involved than a Chapter 13, is more detailed and requires the debtor to make disclosures in a Chapter 11 Disclosure Statement regarding the historical events that led to financial difficulties and a Chapter 11 Plan that needs to be approved by the Court.

Prior to filing a Chapter 11, the debtor should do careful planning and try to do a workout agreement if possible with its various creditors. If its not possible to do a workout, its desirable to negotiate a prepackaged plan with as many creditors as possible before filing, because the road to confirmation after filing will be a lot smoother. If you can’t get the cooperation of your creditors, then you’re left with the option of closing down the business or filing Chapter 11. Chapter 11 however, requires careful planning before filing, and you’ll never make it through unless you have an action plan together before filing. This includes a thorough, soul searching analysis of the reasons that got you in to where you, including an assessment of current operations, management, economic and market conditions. You have to make a financial evaluation of whether you’re going to be able to afford a Chapter 11 and still survive. If you do not have the funds to finance a Chapter 11, you are better of facing reality and shutting down sooner than later. You’ll save a lot of time and aggravation by making a realistic evaluation of your prospects.

There are various competing interests in a Chapter 11.

The “Debtor or Debtor in Possession”

The person filing a Chapter 11 is called “the Debtor” or “Debtor in Possession.”

The debtor’s primary concern is to restore the general health of the business without:

1. Losing credit availability;
2. Losing your good name and reputation in the business community;
3. Spending more time “putting out fires” than operating the business;
4. Dealing with collection suits, judgments, liens, foreclosures, and the like;
5. Losing the support and backing of “insiders.”

You, the debtor, want to find a way to keep the business alive, fend off creditors, salvage your assets, and somehow come out on the other side.

Trade Creditors

Trade creditors are the people who supply you with goods, products or equipment for your inventory that you need to operate your business.

Trade creditors generally are unsecured creditors, and they to get paid as much, and as soon, as possible. At the same time, they would like to avoid losing a valued customer and long term business relationship. They may, however, be secured creditors, if they have obtained a security agreement and taken steps "to perfect" the security interest usually by the filing of a UCC-1 in the County where the debtor resides or with the Secretary of State.

Secured Creditors

Secured creditors are mortgage lenders, vehicle lenders, or anyone who holds a security interest in your real or personal property. A Secured creditors wants money as much and as fast as possible. A secured lender is usually an insitution, but the bottom line interested for this party is:

1. A performing loan on its books and continued interest income;

2. Savings achieved by not spending time and energy on troubled loans;

3. The avoidance of a loan write-of, write-down, or loss;

4. The freedom from having to repost such loans on reports to regulatory agencies and or stockholders

5. The termination of the lending relationship; and

6. Improvement of the lender’s positi0n during the term of the workout;

Unsecured Creditors

Unsecured creditors are the lowest in the food chain. They get paid last after any distribution, or the scraps left over after everyone else is paid. Usually unsecured creditors do not fare well in a Chapter 11, and end up witih dime on the dollar, if anything at all.

The United States Trustee

The United States Trustee is a Component of the Department of Justice. It is basically an oversight and monitoring functions, to make sure the debtor is in compliance with operating reports and that there is no fraud, mismanagement or abuse.

Documents evidencing obligations

Secured Debts
Real Property
Personal Property

Life in A Fishbowl: More problems arise from lack of communication than misinformation.

Sensitive to internal pressures—earnings, categorization of loans, characterization of nonearning portion of loans, reporting of problem loans.

Loan conservation, loan adjustment department, loss mitigation

Establish the Negotiating Rules:

Start from a clean slate. Forget about the alleged crimes of the past
No agreement until there is an Agreement in Writing.

Short Term workout
Long Term Workout

The Chapter 11 lawyer’s job is a high wire balancing act, to somehow deal with the creditor’s “Sky is falling” view of the world that there is no hope on the one hand, and debtor’s feeling of being pressured and overwhelmed by “Seige Mentality.”

Long Term Workout

1. Management
2. Economic and Industry conditions, cyclical trends
3. Regulatory problems
4. Problems with Supplier or Customers
5. Overexpansion
6. Increased competition
7. Inadequate Capital
8. Cash Flow Problems
9. Antiquated goods, product or services in the marketplace

Schemes to mask a preference may be construed as attempt to hinder, delay or defraud creditors under §§ 548 (a)

Financial myopathy

Domination and control: question of balancing

Expense
Delay
Worry
Sending in the marines

Additional Loan

Restructuring Repayment Schedule and Amending Certain Covenants on Existing Loans

Useful in assuring adequate protection and good faith, need for restraint.

Lender Beware:
Direct liability of the Lender to Creditors or the Debtor
Interference with Other Creditors
Misrepresentation __Equitable subordination under 510 (c); fraud misrepresentation or detrimental reliance

Breach of Fiduciary duties
Interference with Management
Piercing the Corporate Veil
Securities Law Liability
Leveraged Buyouts
Breach of loan Commitment
Breach of Implied covenant of Good faith: failure to provide notice

Term sheets
Debt-override agreements,
Amendments to Existing loan and security agreements,
Deeds in lieu of foreclosure, management and voting trust agreements
Releases and Waivers
Options to purchase Assets,
Stock options and Warrant Agreements
Proxy Material
Subordination Agreements,
Deferral Agreements,
Consent to Judgment

Acknowledgement of Amount of Debt: Unpaid principal and accrued interest as of the date certain; how interest will accrue from and after that date, Out of pocket expenses, legal fees and right thereto

Acknowledgment of Validity Priority and Enforceability of the Applicable Security interest, if any

Acknowledgment, where appropriate of Guarantors’ and Sureties’ Joint and Several Liability

Workout Agreement as An Executory Contract (see 365 (e) (2) (B)

Management Change Clauses

Post-Petition Workout Agreements:
Acknowledgements of security, interest, surety, guarantees, joint and several liabilities

Lender’s fully secured status

Defaults under a confirmed plan
1. Do nothing
2. Convert the Case to Ch 7
3. If the Plan has not been substantially consummated within the meaning of Bankruptcy Code § 1101 (2) seek to modify the plan pursuant to Bk Cde 1127(b) or
4. if the plan has been substantially consummated, file a second of third Chapter 11 Case

What happens When You file a Chapter 11 Case:

The Chapter 11 Estate:

Upon rhe filing of a Chapter 11 Case, a fictitious entity is created called the Bankruptcy or Chapter 11 estate. It is administered by the Chapter 11 Trustee, which at the time of filng, is usually the debtor, unlike a Chapter 7 where a Chapter 7 Trustee is appointed, or a Chapter 13, where the court appoints a Chapter 13 Trustee t o administer the estate, collect payments, and make distributions. Unlike other cases, the debtor becomes the Trustee for the estate, and its important to understand the distinction because the rules of the game change dramatically, and it's no longer business as usual.

The Debtor In Possession:

In a Chapter 11, the owner remains in possession and continues to operate as the Debtor in Possession (DIP). This is an entity legally distinct from the individual or entity. Although the DIP continues to operate the business of the debtor, those operations are restricted to the ordinary course of business of the debtor. Under normal circumstances, the canons of state law hold that persons in charge of a business entity owe a fiduciary duty only to equity shareholders, not to creditors. However, when you become the Debtor in Possession, the entity operates its business as a fiduciary for both equity interests and creditors. This distinction is critical to be understood, because the failure to comply with the DIP rules means that you can be held civilly and criminally. The debtor in possession becomes The Trustee of the Bankruptcy Estate, with all the attendant rights and obligations. Every decision has to be made not only subject to the best judgment rule, but also in the interests of the debtor and also creditors of the estate.

The newly born Debtor in Possession has various Rights, as Well as Duties:

The Debtor’s Rights Are:

Right to have professional assistance
Right to protection of the automatic stay
Right to claim and protect exemptions
Right to avoid undersecured liens
Right to be free from discriminatory treatment
Right to receive a discharge of unsecured debts.

Individual Debtors:

An individual’s Chapter 11 discharge will discharge preconfirmation as well as prepetition debts. An individuals debts that are not dischargeable in a Chapter 7 case are not dischargeable in Chapter 11. (11 USC 1141 (d) (2)

Business Entity DIP

A business entity DIP has all the rights of an individual DIP, with two important exceptions. First, the Bankruptcy Code (and almost all state exemption statues) does not allow a business entity (Corporation, Partnership, Joint Venture, LLC, ) to claim exemptions. (11 USC 522 (b). Second, an entity that is not an individual is entitled to receive a discharge in a Chapter 11 case if its plan does not provide for liquidation, and if it continues in business after the consummation of its plan.

Powers of the DIP

As the Trustee, or "Debtor in Possession," the Debtor has the same powers and rights of any Bankruptcy Trustee, which include the

1. Power to sue to obtain turnover of estate property;
2. Power to Avoid preferential and fraudulent transfers;
3. Power to avoid statutory and landlord’s liens (11 USC 545)
4. Power to Assume or reject executory contracts;
5. Power to use, sell, or lease estate property;
6. Power to sell estate property free and clear of liens, community property claims, and co-ownership claims.
7. Power to abandon burdensome or inconsequential property of the estate
8. Power to incur debt.

Duties of the DIP

The DIP is saddled with almost all the duties of a trustee. (11 USC § 1106 (a) 1107 (a). The duties of a DIP in a Chapter 11 case include, but are not limited to

1. Be accountable for all property received;
2. Examine proofs of claim if necessary
3. Furnish information regarding the estate upon request.
4. File periodic accountings, reports, and summaries of the operation of the business of the debtor, including a statement of receipts and disbursements;
5. File a Plan of Reorganization;
6. File any back tax returns.
7. After the plan is confirmed, file such postconfirmation reports as are necessary.

DIP Rights to Compensation

A DIP has no right to receive compensation as does a trustee. A debtor corporation normally will continue to pay its officers as an integral part of running its business. However, the DIP should expect that the compensation of its officers will be subject to review by the court after notice and hearing if a party in interest requests review. Certain local bankruptcy rules provide that payment to an officer or director of a corporation or the drawing of compensation by an individual debtor may only be done upon notice to all the creditors and opportunity for a hearing.

Because officers, directors, and other controlling persons of a DIP are by definition “insiders,” not only should creditors examine all transfers to such persons prior to the order for relief, but creditors should also investigate the compensation currently being paid to such officers and directors. If such compensation appears to be extravagant, the creditor or party in interest may request court review. An individual debtor has the duty to impose imitations on self-compensation; court may regulate compensation of persons employed by the estate.

Compensation of Corporate Officers:. Generally, approval or “retention of corporate officers is not required. Court approval for severance packages and extraordinary perquisites may be prudent.)

Impact of Insolvency on Corporate or Partnership Governance.

Developing case law indicates that “at least where the corporation is operating in the vicinity of insolvency, a board of directors is not merely the agent of the residual risk bearers, but owes its duty to the corporate enterprise. Where the corporation is insolvent, it has been held that the directors owe a fiduciary duty to its creditors.

Debtor in possession financing, business plans, day to day operations, and hiring and firing decisions must all be weighed from the viewpoint of a creditor whose assets are at stake in the insolvent debtor. This means that the debtor has to consider all the consequences to creditors as part of the determination of whether the debtor is exercising reasonable business judgment. Similarly, the business judgment of the creditors having something to lose should be given as much deference as the debtor’s business judgment.

Appointment of a Chapter 11 Trustee:

The debtor is allowed to continue to operate the business but can be booted out for cause on motion of a party in interest or the United States Trustee. Grounds for appointment for cause include fraud, dishonesty and gross mismanagement. Simple mismanagement or disagreement with the debtor’s business judgment will not per constitute grounds for appointment of a Chapter 11 Trustee.

Proof of embezzlement or other fraud will lead to the appointment of a trustee. Other examples of “gross mismanagement” include:
1. Failure of the DIP to pay post-petition taxes or file tax returns;
2. Failure of the DIP to maintain proper insurance coverage;
3. Failure of the DIP to investigate or pursue voidable preferences
4. Commingling of personal and business assets;
5. Failure of the DIP to keep assets of the estate in good repair;
6. Stalemate among members of the Board of Directors;
7. Lack of loyalty of current management and no confidence in that management’s ability to run the business by secured creditors.
8. Failure to provide adequate or accurate financial information
9. Failure to list assets of the estate;
10. Failure and or inability to make any adequate protection payments or ability to meet debt service.
11. Conflicts of Interest;
12. Continuing losses to the estate post-petition;
13. Questionable intercompany, undocumented transfers
14. Unauthorized post petition transfers.

Chapter 11 Plan Confirmation:
The Chapter 11 process

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