A Chapter 11 proceeding offers attractive options for rightsizing debt and organizational structure of a reorganizing company. The more complex elements of Chapter 11 reorganization center around fundamental business issues, such as: asset valuation, income and expense adjustments, customer and vendor relationships, legal claims and employee / retiree benefits. Of these issues, the valuation question can often become the most contentious, and the most central variable to the plan confirmation.
The Automatic Stay
The automatic stay provides a period of time in which all judgments, collection activities, foreclosures, and repossessions of property are suspended and may not be pursued by the creditors on any debt or claim that arose before the filing of the bankruptcy petition. The stay automatically goes into effect when the bankruptcy petition is filed and provides a breathing spell for the debtor, during which negotiations can take place to try to resolve the difficulties in the debtor’s finances.
Objection to Claims
Filing a proof of claim is the most fundamental method by which a creditor protects its rights in a bankruptcy case. Completing the proof of claim form and filing it with the bankruptcy court is a relatively simple process. However, once the claim is timely filed, a creditor needs to remain aware of the potential that the debtor, the official committee of unsecured creditors, the trustee, or other parties in interest may file an objection to the claim or otherwise seek to limit the creditor’s rights with respect to the claim.
Objections to claims are filed in writing and provide claimants with an opportunity to respond prior to a hearing that is scheduled at least 30 days after the filing of the objection. In Chapter 11 cases, the debtor’s plan of reorganization often sets deadlines for the filing of objections to claims.
If an objection is filed to a particular claim, the creditor is generally required to prove the existence of the claim’s validity. Whether or not a claim is allowable typically turns on the application of state law. Claims that would not be enforceable outside of bankruptcy are not enforceable in the context of the bankruptcy case.
The Chapter 11 Plan
Under Chapter 11, the debtor has an exclusive right to file a “plan of reorganization” within 120 days from the date the petition is filed. This time period may be extended for an additional 60 days upon an order of the court.
In order for the plan to be confirmed, it must contain certain information, such as:
- the plan must designate classes of claims and interests, and describe how each will be treated under reorganization. Typically, a plan will classify claim holders as secured creditors, unsecured creditors entitled to priority, general unsecured creditors, and equity security holders.
- Creditors whose claims are “impaired” (i.e., those whose contract rights will be modified or who will be paid less than the full value of their claims under the plan) vote on the plan by ballot.
- The debtor must provide in the disclosure statement a “liquidation analysis” as part of the information provided to creditors that will vote on the plan of reorganization.
The liquidation analysis helps the judge analyze whether each holder of an impaired allowed claim or interest will receive under the plan property of a value, as of the plan date, that is not less than the value it would receive or if the applicable debtor were liquidated under Chapter 7. This is referred to as the “best interests” test.
To make these findings under a liquidation test, a bankruptcy court must:
(1) estimate the cash liquidation proceeds that a Chapter 7 trustee would generate if each of the debtor’s Chapter 11 cases were converted to a Chapter 7 case and the assets of such debtor’s estate were liquidated;
(2) determine the liquidation distribution that each non-accepting holder of a claim or an interest would receive from such liquidation proceeds under the priority scheme dictated in Chapter 7; and
(3) compare the holder’s liquidation distribution to the distribution under the plan that the holder would receive if the plan were confirmed and consummated.
After the disclosure statement is approved by the court and the ballots are collected and tallied, the court will conduct a confirmation hearing to determine whether to confirm the plan.