Chapter 11 Bankruptcy
Michael Rinne delivered MORE than I expected. I was impressed with his attention to detail and that of his associates. Everything went smooth at bankruptcy court.
Tom V., Aptos, California
Everyone hears about chapter 11 bankruptcy filings in news:
- In 2011, there were headlines on chapter 11 for Borders Group Inc., the famous bookseller, with stores throughout the San Francisco Bay Area, in Santa Cruz, San Jose, Los Gatos, Alameda.
- In 2010, Personality Hotels III LLC, the owner of Hotel Frank and Vertigo Hotel, and Hotel Metropolis II LLC, the owner of Metropolis Hotel, filed bankruptcy petitions in San Francisco.
- In 2009, Young Broadcasting, who paid $823 million for KRON Channel 4 in 1999, voluntarily filed for chapter 11 bankruptcy court protection while it reorganized finances.
Chapter 11 of the Bankruptcy Code generally referred to as “reorganization” bankruptcy usually involves a corporation or partnership. A chapter 11 debtor in Walnut Creek, Sacramento, San Francisco, Fairfield proposes a reorganization plan to keep a business going and pay creditors over time.
In the San Francisco Bay Area and Sacramento region, chapter 11 is typically used to reorganize a business, which may be a corporation, sole proprietorship, or partnership. For a sole proprietor, the owner and the business are one. This means the owner is personally responsible for all of the business's debts. When the business assets are not enough to pay for the business debts, the creditors can go after the personal assets. A bankruptcy case involving a sole proprietorship like someone opening a dim sum take out includes both the business and personal assets of the owners-debtors. A partnership is two or more persons doing business for profit as co-owners like two chefs opening a restaurant together. Partners in a general partnership have personal liability similar to a sole proprietor for business debts. Each partner is personally liable for the all business debts, no matter which partner binds the partnership in a deal. A corporation exists separate and apart from its owners, the stockholders. The shareholders only lose as much as they invest in the business. If a business is organized as a corporation, a shareholder’s personal assets are usually protected from business creditors.
Individuals, such as those who own apartments in the San Francisco Bay Area or small businesses in the Sacramento area, may seek relief in chapter 11 also, after taking a credit counseling course from an approved credit counseling agency, except when a US trustee determines there is an emergency situation or there are insufficient approved agencies to provide the counseling.
How Chapter 11 Works
A chapter 11 case in California begins with the filing of a petition with the bankruptcy court serving the area where the debtor lives. For instance, a debtor living in San Francisco would file a petition in the US Bankruptcy Court, Northern District of California, located at 235 Pine Street, 19th Floor, San Francisco, CA 94104. Each court has its own personality. For example, in 2010 and 2011, judge vacancies in the Northern District created anxiety on court procedures and the number of cases on calendars with creditors, debtors, and attorneys. When filing bankruptcy, consider a law firm like Rinne Legal with offices in a court’s vicinity to understand the politics of the judges, security guards, trustees, and other parties.
In San Francisco, the bankruptcy court is located in a commercial building occupied by various businesses such as law firms in the heart of the financial district, near big name hotels, numerous banks, expensive parking, and tourist spots. During the holiday season, the landlord of the building sometimes holds parties for the tenants in the lobby. In Oakland, the bankruptcy court is located at 1300 Clay Street, Oakland, CA 94612. The courthouse is at a federal building, accessible by BART or other public transportation.
To enter the bankruptcy courts, visitors pass through security. The court does not allow water or food in the courtrooms. In San Francisco, the security is nice enough to let visitors leave their beverages and lunches with the security on the 19th floor while they take care of their bankruptcy business on the 22nd and 23rd floors.
The court usually posts its calendars on the Internet at http://www.canb.uscourts.gov/calendars/calendars-menu so people can prepare ahead of time what to expect when they go to a court hearing. A debtor can find out the line number and order in which a case will be called. The US trustee office may be in the same or close by building as the bankruptcy court.
A California chapter 11 petition may be voluntary, which the debtor files, or it may be involuntary, when creditors file. There are official forms for filing bankruptcy downloadable at www.uscourts.gov/bkforms/index.html.
Along with the petition, the Walnut Creek, San Francisco, Fairfield, Sacramento debtor files with the court:
- schedule of current income and expenditures;
- schedule of executory contracts and unexpired leases;
- schedules of assets and liabilities;
- statement of financial affairs.
Executory contracts are not terminated or unexpired contracts or leases where there is still work to do by each party. If either side does not perform, the non-performance would be a breach. In bankruptcy, a debtor can reject or assume and/or assign executory contracts or leases.
A husband and wife in Walnut Creek, San Francisco, Sacramento, Fairfield may file a joint petition or individual petitions. If the debtor is an individual as opposed to a business entity, there are additional filings:
- credit counseling certificate;
- debt repayment plan developed through credit counseling;
- evidence of payment from employers like paystub received 60 days before filing;
- statement of monthly net income and anticipated increase in income or expenses after filing;
- record of any interest the debtor has in federal or state qualified education loans.
Property of the bankruptcy estate for an individual debtor in Walnut Creek, San Francisco, Sacramento, Fairfield includes the debtor's earnings and property acquired by the debtor after filing until the case closes, dismisses or converts. Funding of the reorganization plan may be from the debtor's future earnings. The plan cannot be confirmed after a creditor objects without committing all of the debtor's disposable income over five years unless the plan pays the claim in full, with interest, over a shorter time. For the individual not educated in the law, s/he may engage a business attorney like Rinne Legal, with experience in bankruptcies to understand fundamental issues pertinent to debt elimination so s/he can competently create strategic reorganization plans in a chapter 11 and ensure all paperwork is timely filed with the court.
The Northern and Eastern District California courts in San Francisco, Sacramento, Bakersfield, Oakland, Santa Rosa, and San Jose, charge a $1,000 case filing fee and a $39 miscellaneous administrative fee. The fees must be paid to the court clerk upon filing or with the court's permission, paid by individual debtors in up to four installments. The final installment must be paid no later than 120 days after filing the bankruptcy petition, unless extended by the court. The $39 administrative fee may be paid in installments. If a joint petition is filed, the court charges only one filing fee and one administrative fee. Failure to pay fees may result in case dismissal.
The voluntary petition includes the Walnut Creek, San Francisco, Sacramento, Fairfield debtor's name(s), social security number or tax identification number, address, location of principal assets if a business, debtor's reorganization plan or intention to file a plan, and a request for relief under chapter 11.
The Walnut Creek, San Francisco, Sacramento, Fairfield debtor usually files a written disclosure statement and a plan with the court. The disclosure statement has information on the assets, liabilities, and business affairs of the debtor enough to let a creditor make an informed judgment about the debtor's plan. In a small business, the debtor may not need to file a separate disclosure statement if the court determines the plan contains adequate information. The plan classifies claims and specifies how each class will be treated under the plan. Creditors whose contractual rights are to be modified or who will be paid less than 100%, vote on the plan. After the court approves the disclosure statement and votes from creditors are counted, the court conducts a confirmation hearing to determine whether to confirm the plan.
A confirmation hearing in a Northern or Eastern District court may be a long proceeding, with people walking in and out of the courtroom. There are many other cases, sometimes over 40, heard at the same time. People may have side conversations in the hallways or meeting rooms outside of the courtroom. In a confirmation hearing in San Francisco or Oakland, some senior attorneys may be seen reading novels in the audience because they are familiar with the hearing lasting 2-3 hours. The hearing is open to the public. In San Francisco, a case at a confirmation hearing may be designated as dismissed, contested, or not contested.
When a case gets dismissed it is usually because the Walnut Creek, Fairfield, San Francisco, Sacramento debtor is unable to file a reorganization plan. Bankruptcy judges like those in Oakland and San Francisco courts are no nonsense, and do not hesitate to dismiss cases when a debtor or attorney does not follow court procedures. For instance, a judge looks lowly on an attorney who persuades a debtor to file chapter 11 to take advantage of the automatic stay, knowing the debtor does not have funds to payoff debts according to a plan. Since the hearing is public, other attorneys and people in the audience get to know an attorney’s or debtor’s reputation by listening to judges’ rulings. A debtor represented by Rinne Legal, with offices in Walnut Creek will get an attorney who does not waste the court’s time, or a client’s money, fighting over what is not worth fighting over. Attorneys at Rinne Legal prepare to know the difference.
When a case is contested, it means a creditor objects to a plan because it does not pay the creditor 100%. A creditor like a bank may appear by telephone to object.
When a chapter 11 case is not contested, it means there are no objections to the plan by a creditor and the debtor has all paperwork in order. The cases that are not contested are usually heard first at a confirmation hearing. A confirmed chapter 11 reorganization plan binds the debtor and each creditor.
Chapter 11 Debtor-in-Possession
In a few cases, a trustee may be appointed in a chapter 11. The trustee reviews the debtor's schedules and represents the interests of the creditors in the bankruptcy case. The trustee manages and legally owns the bankruptcy estate assets. Though the bankruptcy estate pays the trustee’s fees, the trustee is not allowed to use the bankruptcy estate assets for him/herself or the debtor’s benefit. Instead, the trustee manages the bankruptcy estate for the benefit of the creditors.
Upon filing a voluntary petition for relief under chapter 11 if there is no trustee, the debtor automatically becomes a debtor-in-possession. To the outside world, the debtor may look the same, continuing to be in control and possession of assets. However, the debtor-in-possession no longer owns the property for personal benefits, but assumes the duties of a trustee. The debtor-in-possession is a fiduciary for the creditors of the bankruptcy estate, and owes the creditors a duty of care and loyalty.
In a duty of care, the debtor-in-possession complies with the prudent investor rule to exercise the degree of care, skill and prudence exercised by a reasonably prudent person in managing property or business. The duty of loyalty requires the debtor-in-possession to avoid conflicts and self dealings, and not favoring any creditors.
Other fiduciary duties include filing tax returns, accounting for property, examining and objecting to claims, and filing monthly operating reports required by the court and the US trustee.
The debtor-in-possession or trustee, with the court's approval, may employ attorneys, accountants, appraisers, auctioneers, or other professionals to assist the debtor during its bankruptcy case. The fees for professionals come from the bankruptcy estate.
The US trustee monitors the progress of a chapter 11 case. The US trustee often makes appearances at chapter 11 status conferences, and gets to know debtor’s attorneys and creditor’s attorneys. The US trustee monitors applications for compensation and reimbursement by professionals, debtor plans and disclosure statements, and creditors' committees. The US trustee conducts a meeting of the creditors, referred to as the "section 341 meeting," in a chapter 11 case. At a 341 meeting, the US trustee and creditors question the debtor under oath concerning the debtor's acts and property. If a debtor does not show up for a 341 meeting, the debtor’s plan does not go to confirmation. Any confirmation hearing scheduled would be continued to after the debtor appears for the 341 meeting. If the confirmation hearing gets continued too many times, the court may dismiss the case.
The US trustee requires the debtor-in-possession file reports on monthly income and operating expenses, establishing bank accounts, and paying current employee payroll taxes.
Besides using the monthly operating reports to keep parties informed on the cash flow of the bankruptcy estate or allow secured creditors to calculate rents or income generated by properties securing debts, the debtor-in-possession pays the US trustee a quarterly fee based on the monthly operating reports.
The US trustee fees ranges from $250 to $10,000 each quarter, depending on the debtor's disbursements. If a debtor-in-possession fails to comply with the reporting, or fails to take steps to bring the case to confirmation, the US trustee may file a motion to convert the debtor's chapter 11 to chapter 7, or dismiss the case.
When a case gets dismissed, the debtor returns to the place prior to filing bankruptcy. The automatic stay gets lifted, the property goes back to being owned by the debtor for the debtor’s benefit, and the creditors can go after the debtor to collect by filing default notices or lawsuits in a California Superior Court.
The US trustee appoints creditors' committees. Committees consist of unsecured creditors who hold the seven largest unsecured claims against the chapter 11 debtor. The committees:
- consult with the chapter 11 debtor-in-possession on case administration;
- investigates the debtor's conduct and business operation; and
- helps formulate a plan.
Small Business Debtor
In a small business chapter 11, the US trustee may be unable to find creditors willing to serve on a creditors' committee, or the committee may not be actively involved. Whether a debtor is a small business debtor depends on the:
- debtor engaging in commercial activities other than primarily owning or operating real property with total non-contingent liquidated secured and unsecured debts of $2,190,000 or less.
- debtor's case must be one in which the US trustee has not appointed a creditors' committee, or the court determines the creditors' committee is not sufficiently active to provide debtor oversight.
In a small business chapter 11, the debtor-in-possession attaches to the petition, recent balance sheet, statement of operations, cash-flow statement, and tax return. The debtor makes ongoing court filings on profitability, projected cash receipts, and disbursements, and reports whether it complies with the Bankruptcy Code, the Federal Rules of Bankruptcy Procedure, and reports whether it has paid taxes and filed tax returns.
The small business debtor attends an initial interview with the US trustee. At the initial interview, the US trustee evaluates the debtor's viability and plan. The US trustee monitors the activities of the debtor during the case to identify whether the debtor will confirm a plan.
Single Asset Real Estate Debtor
According to the Bankruptcy Code, single asset real estate (SARE) means:
[R]eal property constituting a single property or project, other than residential real property with fewer than 4 residential units, which generates substantially all of the gross income of a debtor who is not a family farmer and on which no substantial business is being conducted by a debtor other than the business of operating the real property and activities incidental.
To be within the SARE definition, a chapter 11 debtor in Walnut Creek, San Francisco, Fairfield, Sacramento must satisfy:
- single property or single project, other than residential real property with fewer than four residential units;
- property or single project generating substantially all revenue; and
- no business other than operation of real property and incidental activities.
The Bankruptcy Code provides circumstances under which creditors of a SARE debtor may obtain relief from the automatic stay. On request of a creditor with a claim secured by the SARE and after a noticed hearing, the court grants relief from the automatic stay to the creditor unless the debtor files a feasible plan or makes interest payments to the creditor within 90 days from the date of case filing, or within 30 days of the court's determination that the case is a SARE. The interest payments must be equal to the non-default contract interest rate on the value of the creditor's interest in the real estate.
Whether a debtor falls under the SARE definition is sometimes debatable. A debtor in Walnut Creek, Sacramento, or Fairfield may engage an attorney at Rinne Legal to analyze the debtor’s defenses to a motion for relief from automatic stay based on SARE.
If a single property or project is involved, courts analyze whether the SARE is used in the operation of a business or whether it is for income. A SARE case usually involves passive rent without other active business that generates revenue for the debtor. A SARE determination is factually driven, with courts evaluating whether the debtor conducts substantial business other than operating real property. In the Matter of Scotia Pacific Company, LLC, 508 F.3d 214, 221 (5th Cir. 2007).
In In the Matter of Scotia Pacific Company, LLC, revenues of the debtor came from the active labor of the debtor’s employees, not passive investment income. The debtor’s operations did not constitute real estate. The court focused on the debtor’s substantial business operations on the real estate not being the mere passive collection of money from owning timberlands when it held:
In order to be single asset real estate, the revenues received by the owner must be passive in nature; the owner must not be conducting any active business, other than merely operating the real property and activities incidental thereto. Under the prior jurisprudence, those passive types of activities are the mere receipt of rent and truly incidental activities such as arranging for maintenance or perhaps some marketing activity, or ... mowing the grass and waiting for the market to turn.
A business would not be a SARE debtor if a reasonable and prudent business person expects to generate substantial revenues from the operation that are separate from the sale or lease of the underlying real estate.
In Kara Homes, Inc. v. Nat’l City Bank (In re Kara Homes, Inc.), 363 B.R. 399, 406 (Bankr. D.N.J. 2007), the court identified three criteria for a chapter 11 debtor to be considered a SARE debtor:
- real property constituting a single property or project, other than residential real property with fewer than four residential units;
- real property must generate substantially all the income of the debtor;
- debtor not be involved in any substantial business other than operation of its real property and activities incidental thereto.
In Kara Homes, Inc. v. Nat’l City Bank (In re Kara Homes, Inc.), the court held that debtors in the business of acquiring land, constructing, and selling homes were SARE debtors. Without the sale or lease of the property, the debtors had no income expectation.
A debtor can establish it is not a SARE case if it shows property is not being used only for rental. For example, a country club or hotel in Sacramento or San Francisco would not be considered a SARE debtor because it generates revenues from catering, restaurants, spa services, and gift merchandise, not just operation of the property. According to Centofante v. CBJ Dev., Inc. (In re CBJ Dev., Inc.), 202 B.R. 467 (B.A.P. 9th Cir. 1996), hotel operations are not the mere operation of a property because it requires:
- substantial number of employees;
- actively maintaining each room;
- cleaning bed sheets and towels; and
- providing guest amenities like phone service.
In In re Club Golf Partners, L.P., No. 07-40096, 2007 WL 1176010 (E.D. Tex. Apr. 20, 2007), the debtor is a limited partnership that owns and operates a golf club with golf course, a driving range, tennis courts, clubhouse, and restaurant. The court holds the debtor is not a SARE because it operates revenue-producing activities on the property, including the employment of third-party personnel integral to revenue production, selling memberships, charging fees or prices for access to the golf course, use of golf carts, use of driving range, use of tennis courts, sale of merchandise in its shop, sale of food and beverages (beer, wine) in the restaurant, and use of clubhouse for events.
Appointment of a Trustee
Although the appointment of a case trustee is rare in a chapter 11 case, a party in interest or the US trustee can request the appointment of a case trustee prior to confirmation. Some reasons for appointing a trustee include fraud, dishonesty, incompetence, or gross mismanagement, or if such an appointment is in the interest of creditors, any equity security holders, and other interests of the estate.
The US trustee appoints the trustee who manages of the property of the bankruptcy estate, operation of the debtor's business, and the filing of a plan of reorganization. Prior to filing the reorganization plan, the trustee may do a study of the estate assets to determine the market value.