Corporate or LLC Chapter 11 cases are filed by businesses which are able to reorganize their finances to operate profitably after filing bankruptcy. The automatic stay prevents creditors from seeking collection of any claims after the Chapter 11 case is filed. Businesses in Chapter 11 no longer need to immediately pay tax or general unsecured creditors, although the businesses must pay current post petition obligations as they come due, and must make payments to secured creditors on assets the business needs to retain.
Once a Chapter 11 case is filed, one of the corporate officers and bankruptcy counsel meet with the United States Trustee's (UST) office within a week of the filing. At the meeting, the UST reviews their operating guidelines and reporting requirements. In general, the guidelines and reports require the business to change its bank accounts from whatever bank held the accounts pre-filing, to certain banks which are approved by the UST's office. The business must set up at least 2 accounts (general checking and payroll) and the checks must note that the business is a Chapter 11 Debtor in Possession and reference the case docket number on the checks. The guidelines and reports also require the business to disclose that all insurance policies necessary for the operation of the business are current and paid to date. Finally, the guidelines set forth the form of the monthly business reports that the business must send to the UST with copies of profit and loss statements, a listing of accounts payable, and copies of bank statements. In general, the guidelines and reports mandate that the business demonstrate that it can operate profitably while it is in Chapter 11.
Several weeks later, an authorized representative from the corporation and its counsel appear at a meeting of creditors, otherwise known as the Section 341 meeting. The UST conducts the meeting, which is recorded and the corporate representative testifies under oath. Creditors are invited to appear and ask the representative questions about the current financial condition of the corporation, how the corporation got into financial trouble, and the route the corporation hopes to take to reorganize.
After the meeting, the corporation is expected to initiate its reorganization, by assuming or rejecting leases or contracts, surrendering secured property or providing adequate protection to secured creditors to retain assets necessary for the reorganization. If the corporation needs to hire new workers or layoff some of its existing workforce, the next few months provide the corporation the time, free of creditor collection efforts, to restructure it business.
The corporation is then required to create a disclosure statement and plan. The disclosure statement is a plain English version of the legalistic plan. A disclosure statement provides creditors with a financial history of the corporation before bankruptcy, a description of the significant events in the Chapter 11 case, and breaks down each secured creditor's claim into a separate class, with all unsecured creditors placed in their own class. The corporate debtor then describes how the corporation will treat each class of claims in the plan, whether that class is "impaired" (by altering the contractual rights of the parties), or whether the class is "unimpaired". The disclosure statement is the simple and clear "roadmap" for creditors to assist them in voting on the plan. The disclosure statement is reviewed by the Bankruptcy Court to determine whether it is a sufficiently clear and accurate description of the plan to permit it to be sent to creditors.
Once the disclosure statement is approved by the Court, it is mailed to all creditors, along with the plan. Creditors can vote in favor or against the plan, and/or they can object to heir treatment proposed in the plan. After all votes are tabulated, the Debtor provides the Court with the voting results. For the Court to approve the plan, all creditor classes that are "impaired" need to vote in favor of the plan, and no objections filed against the plan. For a class to approve the plan, more than ½ in number of 2/3 in amount of the creditors in that class must vote in favor of the plan. If one impaired class votes against the plan, the plan can still be approved by the Court as long as one "impaired" class votes in favor of the plan, and the plan provides creditors with a greater dividend than they would receive if the corporation filed a Chapter 7 bankruptcy.
In addition, the owners of the corporation must give up its ownership rights, if unsecured creditors are not paid in full through the plan and those creditors object to the ownership of the corporation retaining its rights to control the corporation. The right of unsecured creditors to demand payment in full is known as the "absolute priority rule". Although not provided for clearly in the Bankruptcy Code, some courts have held that there is a "new value corollary" to the absolute priority rule. The "new value corollary" holds that ownership can retain its rights in the corporation, notwithstanding that it doesn't pay unsecured creditors in full, if ownership contributes cash or makes an additional investment in the corporation, in exchange for remaining in control of the corporation.
Court approval of Chapter 11 plans can be a complex undertaking, with an emphasis on the corporate debtor negotiating in good faith with its creditors. Courts encourage Chapter 11 debtors to create a plan and reorganization strategy that will garner significant creditor support. A Chapter 11 debtor has numerous tools under the Bankruptcy Code to restructure its business, but creditors have leverage to make sure they are treated as well as possible in the reorganization process.