Chapter 11 Bankruptcy


Chapter 11 is a very flexible tool for individual debtors whose home loans exceed the limits of a chapter 13 (currently $1,149,525)or for business owners who need to restructure their debts so as to continue doing business in a feasible fashion. Chapter 11 may also be used by a business owner looking for an orderly way to control the liquidation of that business.

Individual Debtors:  Chapter 13 or Chapter 11?

When the code was rewritten in 1979 the real estate market was quite different than it is today, especially in Southern California. The Chapter 13 plan was designed as a way to help homeowners deal with arrears on their home loans and retain their homes.  Congress set limits on how much secured and unsecured debt could be treated in a chapter 13. Currently the limits are as follows:

Secured Debt:  $1,149,525.00

Unsecured Debt: $383,175.00

If you are trying to save your home, chapter 13 is the preferred plan. However, if you exceed either of these debt limits, you are required to file a plan under chapter 11. In an effort to reduce costs to individual debtors Southern California bankruptcy courts have drafted special forms and procedures to streamline the process. However, even with these procedures, Chapter 11 bankruptcies require far more work on the part of the debtor and debtor’s counsel and cost substantially more.

Business Debtors: 

Chapter 11 is ideal for business debtors because it allows the business owner to remain in control of the business and continue to do business as the case proceeds toward confirmation of a plan. For  example, a small group of investors own a strip mall in Mission Valley with a 10 year note. The note became due and payable 4 months ago. However, due to the current financial climate, they are not able to refinance the note and they have been unsuccessful in selling the property. Chapter 11 allows them the breathing room they need to either find new lending, sell the property, or even ask the court to restructure the note, all the while continuing to operate the mall.

However, even with this benefit, once the case is filed, the bankruptcy court retains ultimate jurisdiction over the case and the ‘debtor-in-possession’ can be removed and replaced or, the case can be converted to a chapter 7 and the business can be lost, if the business owner is not diligent in following all the procedures of the local court and the rules set out in the code.

TYPICAL CHAPTER 11 PROCESS

Like any bankruptcy case, the process begins with preparing your petition, schedules and statement of affairs.  Basically this is a list of your creditors, broken into similar classes such as secured creditors, priority creditors (like taxing authorities), and unsecured creditors, a list of all your assets, and a budget which will demonstrate your ability to continue to operate  your business and to propose a feasible plan.

However, unlike chapter 7 or 13, there are many issues that crop up the first day your case is filed.

Debtor’s Income:  Whether an individual or a business debtor, your income is property of the bankruptcy estate that is created when your case is filed.  The estate must immediately open special ‘debtor-in-possession’ bank accounts at approved depositories and must be accountable for every penny that goes into and out of those accounts.

Cash Collateral:  If your note and deed of trust includes an assignment of rents, then any income from your property is the ‘cash collateral’ of the lender.  A chapter 11 debtor may not use cash collateral without negotiating its use with the creditor or getting an order from the court.  Using cash collateral without authority is grounds for immediate conversion to chapter 7 or the appointment of a chapter 11 trustee.

Compensation: If you are normally paid a salary by your business this is called ‘insider compensation’ and must be approved by the court prior to any payments.  Once again, not following this rule can be disastrous and my lead to conversion or appointment of a trustee.

Sales not in the ordinary course of business:  If part of your strategy is to sell some of your assets to reduce your costs and/or help fund your plan, this must also be done with court approval after notice and a hearing.

CONFIRMING A PLAN

The chapter 11 plan changes the relationship of the debtor with its creditors and is, in effect, a new security instrument.  As such, before the plan can be sent to the creditors for their approval, a disclosure statement must be prepared and approved by the court. This is the document you use to sell the plan to the court and the creditors.  It must be carefully and accurately drafted.

Once the disclosure statement has been approved, the debtor mails the plan to all the creditors of the estate along with a ballot.  All that is needed to approve a plan is for ONE CLASS of creditors to approve the plan. The court can force the other classes to accept the plan if it is reasonable to do so. This makes preparing the different classes of creditors in the plan a very important step and gives the debtor a lot of flexibility in proposing a plan.

Confirmation of the plan is the immediate goal of the chapter 11 debtor.  Once confirmed, this becomes the controlling document as between the debtor and its creditors.  Consummating the plan may result in a discharge as well if your plan does not pay all your creditors in full.

REPORTING REQUIREMENTS

The chapter 11 debtor has monthly and quarterly reporting requirements to the Office of the United States Trustee. This Office oversees all chapter 11 cases in its district and uses these reports to do so.  Most individual debtors do not have to prepare these kinds of reports in their daily lives so there is a steep learning curve after your case has been filed.  The operating reports are due monthly and must document what has occurred in each account of the debtor (such as checking, tax account, payroll, etc) by showing income, income sources, and expenses.  Failure to file these reports in a timely fashion may also lead to conversion, dismissal, or appointment of a trustee.

WHY IS CHAPTER 11 SO COSTLY?

As you can see by the descriptions above, there is a LOT of work for you and your attorney to do to get the case filed, to manage the estate, to draft a disclosure statement and plan, attend status conferences and deal with any motions brought by creditors.

Once the case is filed, professionals may only be paid upon approval by the bankruptcy court and this approval may only be sought once every 120 days. As a result, the standard practice is to collect a large retainer from the client prior to filing the case. A portion of the retainer is used prior to filing the case in the preparation of schedules, etc., and the balance is held in trust for the professional to draw upon as the case proceeds with court approval.

Our chapter 11 attorney has handled cases here in San Diego and in the Los Angeles/Riverside Courts. Most recently he helped investors successfully liquidate their property in Las Vegas, pay all their creditors, and retain enough funds to invest in another 1031 exchange. Please give us a call to set up a consultation. As you can see, waiting until the last moment only complicates matters and, ultimately, increases costs to you.

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