Bankruptcy FAQs
What is a Chapter 7 bankruptcy?
Chapter 7 is known as "liquidation," and it generally amounts to liquidation of the debtor's non-exempt assets and the cancellation of qualifying debts. Individuals or business entities, such as corporations or limited liability companies, who qualify may file for liquidation under Chapter 7 of the Bankruptcy Code, if they have not filed bankruptcy during the preceding six years. Qualifying business entities may file for Chapter 7 bankruptcy if their total liabilities become more than their total assets, rendering them unable to repay creditors. A sufficient number or combination of creditors may file an involuntary Chapter 7 petition against an eligible debtor.
What is a Chapter 11 bankruptcy?
Chapter 11 bankruptcy allows for reorganization of the debtor, and it applies to eligible business entities and to persons who have a sufficient level of debt. In a business Chapter 11, the debtor attempts to reorganize according to a formal plan that often involves continuing operation as a going concern. Common stock often is cancelled, and debt holders may receive partial payment on their obligations. A reorganization plan often is administered by the debtor itself, but a trustee may administer it as well. A plan may be forced upon dissenting classes of creditors if enough other classes approve the plan. That process is called "cramdown." If a reorganization plan fails, the creditors or the debtor may petition the court to convert the case to liquidation.
What is a "prepackaged" plan?
A prepackaged plan is a device used by Chapter 11 debtors who have the ability to enter bankruptcy in a deliberate manner. In those cases, the debtor develops its reorganization plan before filing the case with the objective of managing the bankruptcy case to a quick ending. That includes obtaining suitable postpetition financing, identifying contracts for acceptance or rejection, securing personnel commitments, and identifying cramdown candidates. Much of the prepackage process involves working with the debtor's existing lenders.
What are "first-day orders"?
On the same day that a business debtor files a Chapter 11 petition, the debtor usually also files a set of motions called "first day motions." Such motions are intended to help the debtor maintain normal business operations with its vendors, employees, customers, and lenders. First day motions often are administrative in nature, but they can be more substantive. For example, they can include motions to continue paying employee compensation and benefits or motions to obtain debtor-in-possession financing. The bankruptcy court considers the first day motions at a "first day hearing," usually on the case's first or second day. The court's orders in response to the first day motions are called "first day orders." First day orders may be interim orders or they may be final orders.
How does plan exclusivity work in Chapter 11?
The Bankruptcy Code provides for a period called the "exclusivity period," in which only the debtor may file a reorganization plan in the debtor's Chapter 11 case. The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA) limits that exclusive filing period to 18 months, and sets a 20-month limit on the debtor's exclusive right to solicit plans. Extensions for cause may not exceed those 18/20-month limits. The 18-month restriction potentially pressures the debtor to devise a working plan on short order, and likely gives creditors an advantage to implement their own vision for reorganizing the debtor.
The Chapter 11 debtor easily can lose control of the reorganization process once the debtor's creditors are able to submit competing plans. The time constraint, creditor pressure, and creditor reluctance to negotiate might be even greater in a liquidating Chapter 11 scenario than in a reorganization case. Although 18 months might appear to be ample time, the reality is that it can require a great deal of time to design, negotiate, and arrange to finance a plan in a complex case. The effect of tight credit conditions on the availability and terms of debtor-in-possession financing can amplify the short exclusivity period's effect on the debtor.
How does BAPCPA affect Chapter 11 debtors' commercial real estate leases?
Under the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA), the Chapter 11 debtor has 120 days (plus a 90-day extension) to assume or reject the debtor's commercial real estate leases. Meeting that deadline may present a challenge to the Chapter 11 debtor, even in average economic conditions. Even as ordinary office space needs may be easy to meet, the logistics of planning such needs in a 120-day time horizon can be daunting. For businesses with special space requirements, the challenge can be far greater.
The 120-day limit is thought to affect retail debtors especially because of their heavy reliance on leased space, the integral roles that location, accessibility, and space design play in retail operations, and retailers' unique liquidity requirements. As a result, the creditors of retail debtors, especially prepetition secured lenders, often have the upper hand in directing the course of retailers' Chapter 11 cases.
How is payment handled for the value of goods that are delivered to the debtor immediately before the debtor files Chapter 11?
Under the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA)'s changes to § 503 of the Bankruptcy Code, the value of goods delivered to a debtor within the twenty days before a Chapter 11 filing are treated as an administrative expense. That change affects the reorganization substantially because a plan may not be confirmed unless the administrative expenses are paid in full. Before BAPCPA became effective, prepetition trade creditors usually received small distributions in a plan. Now, the debtor must pay cash for goods delivered shortly before filing. In the usual case, payment of that new administrative expense must come from a new capital infusion, selling or borrowing against un/under-encumbered assets, or both. A business debtor that cannot pay its administrative expense burden, which is increased by the added cost of paying cash for recently delivered goods, becomes administratively insolvent. That makes it very unlikely that the debtor can complete a reorganization plan, which often makes liquidation inevitable.
