Chapter 11 Bankruptcy Plan

Chapter 11 Bankruptcy Plan

Bankruptcy LawChapter 11 Bankruptcy – Chapter 11 Bankruptcy Plan

Arizona Chapter 11 Bankruptcy Plan

The Plan should classify claims and specify whether or not they are impaired. Each claim in a class must receive the same treatment. That is, the Plan cannot discriminate between class members. Furthermore, under the Plan, the debtor business may assume or rejected executory contracts and leases, sell property, and designate how the proceeds from the sale will be distributed. Finally, the Plan must provide a means to implement the Plan, by keeping property and running the business, or by supplementing the Plan with a cash infusion in exchange for stock or some other equity interest. The Plan may also transfer property in exchange for cash. These are only examples. There is flexibility in making the Plan work.

Once the Plan is drafted and filed, it must be confirmed by the court. There are two types of confirmation hearings: those without a cram down and those with a cram down. A cram down occurs when the Plan is approved in spite of impaired classes rejecting the Plan.

For a Plan to be confirmed without a cram down:

  • The Plan must comply with all the provisions of the Bankruptcy Code;
  • The Plan must have been made in good faith;
  • All payments made under the Plan must have been approved;
  • No creditor in an impaired class has exercised an 1111(b) election and accepts the Plan (see definition of an 1111(b) election below);
  • Each class of claims accepts the Plan or is not impaired under it;
  • All administrative and priority claims have been paid. (An example of an administrative claim is one from a vendor that delivers goods of value to the debtor business within a 20-day window prior to filing. A priority debt is not dischargeable and must be paid. Examples include tax debts incurred within 2 years prior to filing, child support, employee wages);
  • At least one impair class has accepted the Plan without including any acceptance by an insider/owner (more on this below);
  • A liquidation is not likely to follow;
  • The Plan provides for employee retirement benefits;
  • The Plan provides for domestic support obligations;
  • All transfers of property have been made in compliance with non-bankruptcy law.

This is the perfect scenario that rarely happens. Most scenarios, including those of a small business debtor, generally involve a cram down. In a cram down, the interests of secured creditors and unsecured creditors are at opposite ends, and this is where the real battle begins.

If the Plan meets the Bankruptcy Code’s requirements, the court may confirm the Plan even if the impaired classes reject the Plan as long as there is at least one impaired class that accepts the Plan. To confirm a Plan in a cram down, the court must find that the Plan treats each non-accepting class fairly and equitably.

The standard for fair and equitable treatment of secured claims differs from the standard for unsecured claims. The secured creditor is entitled to full payment of its lien, paid overtime with interest, and if the collateral securing the claim is sold, the lien transfers to the proceeds from the sale. If the creditor’s secured claim cannot be satisfied with these two provisions, the creditor is entitled to receive the indubitable equivalent of its allowed claim, meaning substitute collateral of equal value.

However, a secured creditor that is under-secured, whose lien is greater than the value of the collateral, ends up with a claim that is split into 2 claims – one secured, the other unsecured. This creditor can make an 1111(b) election to have its allowed claim treated as fully secured. By making the 1111(b) election, the under-secured creditor waives its right to the unsecured part of its claim and the right to contest the confirmation of the Plan as an impaired class in exchange for payment on the secured portion its claim, without interest. Generally, a secured creditor will want to make this election if it thinks the collateral securing its claim will appreciate in the future.

Fair and equitable treatment for unsecured creditors is defined differently in the Code. To be fair and equitable to an unsecured creditor, the Plan must pay each class in full, and if it cannot pay each class in full, it must pay nothing to junior claim holders. This in essence is the absolute priority rule.

The absolute priority rule holds that a first mortgage has priority over a second mortgage, administrative claims have priority over priority claims, and priority claims have priority over unsecured non-priority claims. At the bottom of the list are the interests of the equity holders, generally the owner and any partners and shareholders. For them to maintain their ownership and equity interests, the claims above them in the absolute priority structure need to be paid off in full. 

So why even go through all this trouble of filing a Chapter 11 and working hard to restructure the business? There is a way around the absolute priority rule but for a small business debtor, it is difficult to do. The way to circumvent the absolute priority rule is for the owners and other equity holders to contribute “new value.” New value is the raising of additional funds to pay off impaired unsecured creditors in the creditor classes above the equity interests.

These are the main concepts to be familiar with when contemplating the filing of a Chapter 11 bankruptcy. Some of these concepts pull the reader right into the weeds and are best left for a one to one discussion with an experienced attorney, who can apply them to the specifics in your case. Furthermore, it is important to note that not all of these concepts apply to the various permutations of Chapter 11, altered to meet specific debtor needs.

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