Chapter 11 Bankruptcy
Bankruptcy does not guarantee a debtor keeps assets, but it can buy time for the debtor to work things out with creditors or save cash that can be used to pay taxes or guaranteed debts. When a business or individual files bankruptcy, the automatic stay immediately stops creditors from foreclosing on a house or liquidating personal property.
Under certain situations, the secured creditor can obtain a court order granting relief from the automatic stay. For example, when the Walnut Creek, San Francisco, Fairfield, Sacramento debtor has no equity in the property like when there is more debt than market value, and the property is not necessary for an effective reorganization, the secured creditor can seek a court order lifting the stay to let the creditor foreclose on the property, sell it, and apply the proceeds to the debt.
The majority of courts define equity as the difference between the property market value and the total amount of encumbrances against it. This majority view is followed by the 9th Circuit. California is a member of the 9th Circuit district courts.
After a creditor for relief from automatic stay shows a debtor has no equity in property, the Walnut Creek, San Francisco, Sacramento, Fairfield debtor must show the property is necessary for an effective reorganization. Unless the debtor demonstrates the property is necessary to an effective reorganization, the property is of no value to the debtor.
A showing that property is necessary for an effective reorganization requires a showing that if there is conceivably to be an effective reorganization, the property will be needed for it; and that the property is essential for an effective reorganization that is in prospect. There must be a reasonable possibility of a successful reorganization within a reasonable time. United States Savings Ass’n of Texas v. Timbers of Inwood Forest Assocs., Ltd., 484 U.S. 365, 375 (1988).
The Bankruptcy Code lets professionals apply for fees during the case. A trustee, a debtor's attorney, or any professional person appointed by the court may apply to the court at intervals of 120 days for compensation and reimbursement payments. Those following the press on the Bernard Madoff bankruptcy are familiar with Irving Picard, the trustee in the case, and getting paid huge fees before any payments to many creditors. Professional fees come from the bankruptcy estate. Although professional fees may be paid if authorized by the court, the debtor cannot make payments to creditors which arose before the filing bankruptcy.
Who Can File a Plan
The debtor in a chapter 11 usually has a 120-day period during which it has an exclusive right to file a plan. This exclusivity period may be extended or reduced by the court. After the exclusivity period, a creditor or the trustee may file a competing plan. The US trustee may not file a plan.
As played out in the press with the Bernard Madoff bankruptcy case, a chapter 11 case may continue for many years. The creditors' right to file a competing plan incentivizes the debtor to file a plan within the exclusivity period and prevents delays in the case.
A Sacramento, Fairfield, San Francisco, Walnut Creek debtor’s most significant asset in bankruptcy may be preference claims against creditors. As played out in the press on the Bernard Madoff bankruptcy case where many people are being sued to return funds received from the bankruptcy estate though they themselves lost money in the ponzi scheme, “preference” means the transfer of an interest (tangible or intangible) of the debtor in real or personal property:
- to or for the benefit of a bankruptcy creditor;
- for or on account of an antecedent debt owed by the bankruptcy debtor before making the transfer;
- made while the debtor is insolvent, on or within 90 days before the bankruptcy or within one year before the filing if the transferee creditor is an insider;
- that enables the creditor to get more than such creditor would have receive if the debtor filed chapter 7.
As seen with Irving Pickard, the trustee in the Bernard Madoff bankruptcy case, the debtor-in-possession or the trustee has avoiding powers to undo a transfer of money or property made during a certain period of time before the bankruptcy filing. By cancelling a property transfer, the debtor-in-possession or trustee avoids the transaction and forces the return of payments or property by a creditor, which then are available to pay all creditors. A preference claim action can put a creditor in debt from the attorneys’ fees to negotiate a settlement with the trustee or debtor-in-possession or the repayment of funds. Avoiding powers prevent unfair prepetition payments to one creditor at the expense of all creditors.
For the creditor served with a complaint asserting preference claim, there may be defenses to limit the debtor’s ability to require the creditor to return the payment. One defense is the “ordinary course of business defense”. All payments a debtor makes to a creditor in the 90 days period are preference payments, but whether a creditor has to repay the funds depends on the strength of defenses. The trustee or debtor-in-possession uses invoices and communications with the debtor to calculate the amount of preference payments. The creditor defends by calculating the regular payments by the debtor during the course of a business relationship. The creditor averages the time period between invoicing and payment receipt. If the payments are made within the average, there is a strong argument they are made in the ordinary course of business. If sometimes the creditor allows late payments, payments within the standard deviation of the average may still be within the ordinary course of business, but the defense is not as strong. The court may not require the creditor to give back the challenged payment.
Another defense, the “subsequent new value” defense, looks at whether the creditor delivers product or services after its receipt of a payment within the 90 days before the bankruptcy filing. If “yes”, the creditor may not be required to return the payment. Even if there does not seem to be a strong defense, the creditor may settle the preference action rather than pay 100%. The trustee or debtor-in-possession may want a quick settlement if working on contingency since the more time spent on a preference case, the less money gets returned to the pool for distribution to creditors after attorneys’ fees and litigation costs.
Cash Collateral and Adequate Protection
The debtor-in-possession may use, sell, or lease property of the bankruptcy estate in the ordinary course of its business, without prior approval, unless the court orders otherwise. If the sale or use is outside the ordinary course of its business, the debtor must obtain court approval.
A debtor-in-possession may not use cash collateral without the consent of the secured party or court authorization, which first examines whether the interest of the secured party is adequately protected. Adequate protection refers to the protection creditors get to ensure payment. Cash collateral means cash, negotiable instruments, documents of title, securities, deposit accounts, or other cash equivalents, in which the bankruptcy estate and an entity other than the estate have an interest. For the debtor in Walnut Creek, Oakland, Sacramento, or Fairfield, cash collateral includes business proceeds, products, profits, facility charges like for hotel rooms, and rent subject to a creditor's security interest.
When a debtor spends cash collateral, the secured creditors are entitled to receive additional protection to protect the value of the creditor's interest in the property the debtor uses. The debtor may make periodic or lump sum cash payments, or provide an additional lien.
Delays in filing and obtaining confirmation of a reorganization plan, prompts creditors to file motions for relief from automatic stay, or dismiss a case. Before confirmation of a reorganization plan, a debtor may need the help of an experienced bankruptcy attorney at Rinne Legal to navigate complex contested motions. Common motions are those seeking relief from the automatic stay, or the use of cash collateral. There may be litigation over executory contracts, unexpired leases, and the assumption or rejection of contracts.
A claim is:
- a right to payment; or
- a right to an equitable remedy for a performance failure if the breach gives rise to a right to payment.
Any creditor whose claim is not listed by the debtor on the schedules or is scheduled as disputed, contingent, or not liquidated must file a proof of claim. The claim needs to attach evidence on the validity and amount. If a scheduled creditor files a claim, a properly filed proof of claim supersedes any scheduling of that claim. The debtor’s petition contains lists on the creditors. The debtor uses this list to notify creditors on the schedules of their right to file claims, and that their failure may prevent them from voting upon the debtor's reorganization plan or participating in any distribution.
Conversion or Dismissal
A Walnut Creek, Sacramento, Fairfield, San Francisco debtor in chapter 11 has a one-time right to convert the chapter 11 case to a chapter 7 unless:
- the debtor is not a debtor-in-possession;
- the chapter 11 originally is commenced as an involuntary; or
- the case converts to a case under chapter 11 other than at the debtor's request.
A Walnut Creek, Sacramento, Fairfield, San Francisco debtor in a chapter 11 case does not have a right to dismiss a case upon request. When a debtor wants dismiss a case, there may be a status conference for the court to review if the dismissal is in the best interest of the debtor. The difference between dismissing a case and converting to Chapter 7 is that when a debtor dismisses a case, the creditors can go after the debtor again right when he dismisses, whereas in a chapter 7 conversion, the automatic stay is still in place until chapter 7 discharge. Also, in a dismissal, the debtor does not benefit from any discharge. The debtor is left in the same place as if he never filed bankruptcy whereas in a chapter 7, unsecured claims may be discharged. In a chapter 7, the court may discharge unsecured claims like any loans from a family member.
When a Walnut Creek, Sacramento, Fairfield, San Francisco debtor decides to dismiss a voluntary chapter 11, the judge may allow dismissal when the debtor pays administrative fees spent to evaluate properties, taxes, and other debtor assets. The debtor would pay trustee, US trustee, trustee's attorneys, trustee's accountants the lesser of the realizable value of the assets in the bankruptcy estate. Assets may not actually need to be sold to pay for the fees. The debtor just needs to come up with the cash for the fees equal to the value of the properties. A third party like the son of a debtor parent may contribute the money to pay off the fees. For example, if the only assets of any value in the bankruptcy estate are trucks, the judge may order the debtor to pay administrative fees up to the value of the trucks or each person's fees and expenses to date of the chapter 11 dismissal, whichever is less. Sometimes trustee’s attorneys or accountants risk not getting paid anything when a bankruptcy estate does not have assets. For vehicles, the parties look to the Kelly Blue Book to find out the market values of what a debtor would get if the vehicles are sold on the market like on craigslist.org. In a dismissal, the court treats the case like a chapter 7 - distribution to creditors won't be more than realizable value of the bankruptcy estate such as the trucks in the bankruptcy estate. If fees are more than value of bankruptcy estate, each creditor gets prorated fees.
If the chapter 13 has a trustee, the trustee may ask the court to convert to a chapter 7. For example, if bankruptcy estate is worth less than the debt, like when there are too many properties valued at less than the loan amounts, the trustee may request a conversion because estate management like fixing sidewalk cracks in San Francisco may be a burden without much payback in trustee fees, as opposed to liquidation.
The debtor files and gets court approval of a written disclosure statement before a plan vote. The disclosure statement provides information on the debtor’s affairs to let a claim holder make an informed decision about the plan. In a small business case, the court may determine the plan contains adequate information and a separate disclosure not necessary.
After the debtor files the disclosure, the court holds a hearing on whether to approve the disclosure statement. Acceptance or rejection of a plan usually cannot be voted on until the court approves the disclosure statement, unless the initial solicitation of the party occurred before bankruptcy. This would be the case in prepackaged bankruptcy plans, where the debtor negotiates a plan with significant creditor constituencies before filing bankruptcy. After the court approves the disclosure statement, the debtor solicits acceptances of the plan, and creditors may solicit rejections.
Upon approval of a disclosure statement, the debtor mails to the US trustee and creditors:
- plan, or a court approved summary of the plan;
- court approved disclosure statement;
- notice of the time within which plan acceptances and rejections may be filed; and other information as the court may direct, including any court opinion approving the disclosure statement or a court-approved summary of the opinion.
The debtor mails to creditors entitled to vote on the plan:
- notice of the time fixed for filing objections;
- notice of the date and time for the hearing on plan confirmation; and
- ballot for accepting or rejecting the plan and, if appropriate, a designation for the creditors to identify their preference among competing plans.
In a small business case, the court may conditionally approve a disclosure statement subject to final approval after a plan confirmation hearing.
Acceptance of Reorganization Plan
The San Francisco, Walnut Creek, Fairfield, Sacramento debtor has exclusivity to file a reorganization plan during the first 120-day period after filing bankruptcy. The California Northern or Eastern District court may extend this exclusive period up to 18 months after the petition filing. The debtor has 180 days after the petition date to get acceptances of its reorganization plan. The court may extend up to 20 months or reduce the acceptance exclusive period. People in the San Francisco Bay Area or Sacramento region involved in litigation or the court system come to realize that things are rarely done according to time deadlines set out in statutes. Debtors typically get extensions on both the plan filing and plan acceptance deadlines.
If the exclusive period expires before the San Francisco, Walnut Creek, Fairfield, Sacramento debtor files and gets acceptance of a plan, other parties in a case like a creditor, may file a competing plan. Another party usually files a competing plan when the plan the debtor files does not remedy all of the party’s interests. If a trustee gets appointed, the trustee must file a plan, report why the trustee will not file a plan, or a recommend the case for conversion to another bankruptcy chapter or dismissal.
In a chapter 11, a debtor may file a liquidating plan similar to a chapter 7. The difference between a chapter 7 and a chapter 11 liquidation is that in a chapter 11, creditors actively participate in the liquidation and the distribution of the proceeds.
Generally, a reorganization plan classifies claims as secured, unsecured entitled to priority, general unsecured, and equity security. An entire class of claims is deemed to accept a plan if the creditors that hold at least two-thirds in amount and over one-half in number of the allowed claims in the class accept the plan.
The debtor or party that proposes a plan may modify the plan before confirmation. When there is a proposed modification, there is a court hearing for the court to decide if the proposed modification does not adversely affect the treatment of any creditor who has not accepted the modification in writing. The modification is deemed accepted by all creditors who previously accept the plan.
Every proposed plan and modification must be dated and identified with the name of the party submitting the plan or modification. The court considers the preferences of the creditors in determining which competing plan to confirm.
Any party in interest may file an objection to confirmation of a reorganization plan. After a noticed hearing, the court determines whether the plan:
- is feasible (plan not likely followed by liquidation unless liquidating plan);
- is proposed in good faith (unlikely further financial reorganization); and
- proponent complies with the Bankruptcy Code.
Confirmation of a plan discharges a debtor from any debt before the date of confirmation. After the court confirms the plan, the debtor makes payments. The confirmed plan creates new contractual rights, superseding pre-bankruptcy contracts.
Confirmation of a plan discharges any type of debtor (individual, limited liability company, corporation, partnership) from most prepetition debts after making all payments under the plan. It does not discharge debts after the petition filing or debts not dischargeable in bankruptcy. Debts not discharged include debts for alimony and child support, certain taxes, educational loans, intentional property torts, debts for death or personal injury caused by the debtor's operation of a motor vehicle while the debtor was intoxicated from alcohol or other substances, and debts for certain criminal restitution.
When debts are not discharged, the debtor continues to be liable to the extent that they are not paid in the chapter 11. Debts for money or property obtained by false pretenses or fraud, and intentional property torts, may be discharged, unless a creditor timely files and wins an action to have such debts declared nondischargeable.
Confirmation does not discharge the debtor if the plan is a liquidation plan, unless the debtor is an individual. When the debtor is an individual, confirmation of a liquidation plan results in a discharge after payments.
Postconfirmation Plan Modification
After confirmation and before substantial consummation of a plan, the proponent of a plan may modify the plan for changes in circumstances such as events like being hit by a truck or cancer that lead to inability to make plan payments. There is a hearing for the court to confirm the plan as modified.
Revocation of the Confirmation Order
Revocation means to cancel. Revocation of the confirmation order means undoing the plan confirmation. A request for revocation must be made by a party within 180 days of confirmation. There is a hearing for the court to decide on revocation.
A final decree closing the chapter 11 enter according to local bankruptcy court policies after the estate fully administers.
Retaining and attracting business customers or rebuilding personal credit comes from reliability and trust. After bankruptcy, the debtor rebuilds credit by attaining a secured business or individual credit card. A business owner or individual may need to pay an initial deposit to secure the card. These cards may have high interest rates and card fees, but the card issuer extends a line of credit equal to the amount of the deposit to allow the card holder to earn a credit line after consistent timely payments for a certain period. In addition to getting a secured credit line, establish lines of credit with vendors or other creditors. Then, be sure to pay all obligations on time.
Get advice from a Rinne Legal business attorney with bankruptcy experience before filing bankruptcy. Bankruptcy stays on a credit report for up to ten years, and can make it hard for an individual to obtain credit or a small business owner to open another business. Rinne Legal, with staff fluent in Russian, can advise on the bankruptcy process and pre-bankruptcy planning.