Chapter VIII More on Chapter 11

JurisdictionUnited States

VIII. More on Chapter 11

A. Introduction

In this section, we take a second look at chapter 11, and in particular at some of the rules that drive or define a chapter 11 case.

B. Debtor in Possession: Why and How

In a chapter 7 bankruptcy, the debtor's role is minimal: Upon filing, a trustee is appointed to liquidate the estate and distribute the proceeds.

In chapter 11, the debtor remains in possession (as DIP) until the court says otherwise [§ 1104]. This is one of the signature features of chapter 11, distinguishing it from traditional corporate insolvency proceedings in other jurisdictions.

It may appear shocking and overly debtor-friendly to leave control in the hands of the same debtor that steered the company into bankruptcy; however, there are several possible justifications for this policy. One is that it may encourage the debtor to seek bankruptcy relief while there is still some value to protect. If filing bankruptcy means that current owners or managers of the firm would be ousted from control, this would create an incentive to delay filing for bankruptcy as long as possible.

This "DIP rule" may further preserve value for creditors by leaving in charge those who already know and understand the debtor's business. A court-appointed trustee, in contrast, would have to quickly get up to speed on the debtor's operations and assets, thus causing delay precisely at a time when quick action may be required.

Put differently, in many cases the cheapest and most convenient device for managing the troubled debtor may be the debtor himself, clothed with the powers and responsibilities of a trustee.

Two other qualifications take some of the bite out of the DIP rule. Note that it is not "the debtor" that remains in possession — it is "the DIP," a new entity with the powers and (more importantly) the responsibilities of a trustee. The distinction may seem almost too subtle to discern, but anyone who has ever tried it knows: The DIP is not her own person anymore. She operates under all sorts of constraints and limitations that would not apply if she were truly on her own.

Another qualification: At least in big public-company cases, to speak of "the debtor" is a fallacy of concreteness. Very often, by the time the case gets to court, the managers of the debtor will be "the turnaround team" installed at the behest of the creditors: in other words, a trustee in function if not in name.

Taking all this into account, the practical fact is that in the vast majority of chapter 11 cases, the DIP remains in possession and there is no trustee. While the DIP is the norm, the court does have the power to replace the DIP with a trustee, either by ordering the appointment of a chapter 11 trustee or by converting the case to chapter 7, where the appointment of a trustee is automatic.

C. Use, Sell or Lease

1. In General

The trustee in a liquidating case has a simple job: He turns the property into cash and distributes the cash. The DIP has a more complicated job: She has to operate the debtor's business pending a plan, operating in a framework set forth in § 363.47

Section 363 authorizes the DIP to "use, sell or lease" property of the estate. Section 363 draws an important benchmark distinction, depending on whether the DIP is operating "in the ordinary course of business." Think of the retail widget dealer who offers widgets for sale to customers out of inventory every day. As long as the DIP continues operations as usual, she may do so without notice and a hearing to creditors. Thus, the DIP can operate pretty much as she did before bankruptcy: She can ring up sales and put the cash in the till — even do deals on short-term credit if that was her practice before bankruptcy. She can act, in the language of the Code, "without notice and a hearing" [§ 363(c)(1)].

Suppose instead that the trustee/DIP wants...

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