Successful creditor strategies in Chapter 11 cases requires a high level of analytics and investigation into the debtor’s assets and (often) hidden affairs–something we are very good at. The following is a primer for creditor bankruptcy success:
CREDITOR RIGHTS UNDER CHAPTER 11
Chapter 11 creditors are categorized into classes of claims. At a minimum, Chapter 11 claims will be categorized into the following classes: secured creditors, unsecured creditors and equity interest holders. All claim-holders in each class must have substantially-similar claims and legal rights.
A plan of reorganization does not have to provide for the full payment of all pre-petition bankruptcy debts (and usually does not). Certain classes of creditors may be deemed “impaired” (i.e., whose contractual rights are to be modified or who will be paid less than the full value of their claims under the plan), while other classes may be deemed “unimpaired” (i.e., whose claims will be paid in full in cash or otherwise reinstated on its original terms).
Secured creditors whose loans are secured by collateral receive a greater level of protection from the Bankruptcy Code than do general unsecured creditors. However, that does not guarantee that the contract rights of secured creditors will be preserved entirely.
One important modification of the rights of secured creditors that is the “cramdown” provision of Bankruptcy Code § 1129(b)(2)(A). This provision permits a bankruptcy court to approve a plan of reorganization even over the objection of secured creditors if a creditor is undersecured, but otherwise receives “indubitable equivalent” in value of it security in the collateral.
Unsecured creditors are claimants that do not have a security interest in collateral. Examples of unsecured creditors include: trade creditors, lessors, bondholders, etc. These claims are typically represented by the official committee of unsecured creditors. However, each unsecured creditor can take an individual position notwithstanding the position of the committee.
Typically, the unsecured creditors’ committee is made up of creditors who hold the largest unsecured claims against the debtor. Also known as the Official Unsecured Creditors Committee, these groups will typically consist of an amalgam of trade claimants, landlords, and bondholders. Creditors’ committees play an important role in Chapter 11 cases.
The committee consults with the debtor in possession on the administration of the case, investigates the debtor’s conduct and operation of the business, and participates in formulating a plan, among other things. A creditors’ committee may, with the court’s approval, hire an attorney or other professionals to assist in the performance of the committee’s duties.
Equity Interest Holders
Shareholders are know as “interest holders” in bankruptcy. Shareholders are not entitled to any recovery until all creditors (secured and unsecured) recover in full. This means, practically, that equity is typically wiped out (cancelled) upon emergence from bankruptcy and new stock in reorganized company is issued under the Plan.
NEGOTIATING A RECOVERY AMOUNT
With an understanding of your creditor rights, depending on your class of claims, it is critical to optimize your negotiating position as soon as possible in the case. Strategy and immediate action are at the heart of successful creditor strategies in Chapter 11.
While bankruptcy protection is designed to “freeze” all pre-petition claims so that no claim-holder receives preferential treatment over another, an aggressive and creative creditor can often tilt the rules in its favor through direct negotiations with the debtor.
In this sense, bankruptcy law may have as much to do with negotiating a business solution as it does with presenting a case to the judge.
As with any conflict situation, strategy and tactics therefore become a critical element of preserving the value of a creditor’s claim. Again, strategy and tactics are driven by the relative strength of a creditor’s claim, which are discussed as follows:
Secured creditors are entitled to “adequate protection” of their interests, and often work closely with the debtor throughout a restructuring process, either inside or outside the bankruptcy process. In most bankruptcies, “cash is king” and where it is needed, secured lenders typically provide DIP Loans and use loan terms as a method of controlling the case.
Secured creditors may decide to “double-down” on their secured loan by providing Debtor-in-Possession (“DIP”) financing, and thereby gaining control over the reorganization process. DIP financing also assures a creditor of post-petition claim priority as against other secured and unsecured claims, and many administrative claims. So as long as there is money in the estate, the DIP lender has an excellent chance of recovery.
Unsecured Trade Creditors
Trade creditors of a business typically fall into a class of unsecured claims. However, trade creditors that are critical to sustain the debtor’s ongoing business have a unique advantage. Paying critical vendors from the very onset of a bankruptcy filing is rather common in Chapter 11 cases, for obvious reasons. A Chapter 11 debtor’s ability to obtain trade terms from key vendors often is critical to the survival of the entire business–and the payment of all or many creditor classes. From this perspective, one may deem critical vendor dollars as money well spent.
It therefore becomes critical for a trade vendor to strategically explore the ways its relationship with the debtor may be deemed “critical,” and to negotiate with the debtor for court permission to continue paying the trade vendor as a preferred post-petition claim.
Unsecured General Creditors
Unsecured general creditors (as opposed to unsecured trade creditors) can use multiple strategies to achieve a recovery in Chapter 11-however small that recovery may be in our current challenging economy.
Many will object to “fast sales” of companies in Chapter 11 bankruptcy in attempt to slow down the bankruptcy process and extract concessions from the debtor-company.
Some unsecured creditors will object to a debtor-company’s bankruptcy financing in an attempt to frustrate the debtor and force them to the negotiating table.
And finally, one of the most common methods unsecured creditors are using to win concessions during Chapter 11 bankruptcy is challenging the bankruptcy restructuring plan. Every effort of the debtor-company to present a Chapter 11 bankruptcy plan is often refuted by unsecured creditors in an attempt to extract some type of recovery settlement, even if the bankruptcy plans are sound.
WHAT IS THE PRIORITY OF PAYMENTS UNDER CHAPTER 11?
In theory, there is a strict hierarchy of payment among claims of differing priorities (called the “absolute priority rule”). This well-established bankruptcy principle states that claim holders with higher priority should receive 100% of their claim in full before the next (lower priority) class receives any portion of the reorganization proceeds.
In practice, it is common for chapter 11 bankruptcies to violate the absolute priority rule. For example, “give ups” or “carve-outs” by senior classes of creditors to achieve confirmation of a plan have become an increasingly common feature of the chapter 11 process, as stakeholders strive to avoid disputes that can prolong the bankruptcy case and drain estate assets by driving up administrative costs.
Successful Creditor Strategies in Chapter 11
As can be seen from the above article, finding successful creditor strategies in Chapter 11 cases requires creativity, finding a negotiating edge, and using that advantage to create a win-win solution between you and the debtor. If the debtor benefits from a creative solution to getting paid, the court is much more likely to find a way to approve the proposal for payment.