Business Reorganizations under Chapter 11
| Author | Gregory Germain |
| Pages | 351-394 |
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Chapter 13: Business Reorganizations under Chapter 11
13.1. Introduction to Chapter 11 of the Bankruptcy Code
Chapter 11 is a very flexible chapter for reorganizing businesses. Because of the chapter’s
flexibility, it is also very expensive. Chapter 11 is designed to be a negotiated plan with the
creditors. It provides for negotiating the plan terms with the relevant class of creditors, and for a
voting mechanism to bind minority creditors who are not willing to go along with the will of the
majority. Chapter 11’s fundamental purpose is to address the holdout problem – the problem that
some minority creditors will always hold out for a better deal – that often prevents an out-of-court
workout from proceeding.
We begin by understanding the plan process: what provisions must be contained in a
disclosure statement and plan, how the plan is negotiated, and how does the voting process work.
We will then look at the requirements for confirming the plan, including the so-called “cramdown”
for confirming a plan over the objection of an impaired class of creditors. Finally, we will consider
a popular method of reorganization that avoids the strictures of Chapter 11 – the pre-plan
bankruptcy sale of the debtor’s entire business to a new entity. This procedure was recently
employed b y giant corporations like General Motors and Chrysler at the federal government’s
behest. We will consider whether such sales are consistent with the purposes of Chapter 11.
13.2. The Chapter 11 Process
The Chapter 11 process generally begins very much like a Chapter 7 case. The Debtor files
a petition and schedules closely mirroring the ones the debtor would file in Chapter 7. Unlike
Chapter 7, however, a trustee is not automatically appointed to take control of and liquidate the
debtor’s assets. Instead, the individual debtor in an individual case, or the prepetition management
of the debtor in an entity case, continue to operate the business in Chapter 11 as a “debtor in
possession.” Except for the right to compensation, the debtor in possession has the powers under
the Bankruptcy Code given to a trustee. 11 U.S.C. § 1107(a). The court retains the power to appoint
Chapter 11 trustees are the exception not the rule.
The official committee of unsecured creditors, consisting of the seven creditors holding the
largest claims who are willing to serve, is organized by the United States Trustee, and serves to
balance and operate as a check on the powers of the debtor in possession. 11 U.S.C. § 1102(b)(1).
The members of the official committee are fiduciaries acting on behalf of all unsecured creditors,
and will generally retain counsel at the expense of the debtor’s estate to review and monitor the
debtor in possession’s activities. The creditors’ committee can seek the appointment of a Chapter
11 trustee if the committee loses confidence in the debtor in possession’s management, and the
committee plays an important role in the plan negotiation process.
In an appropriate case, the Court can appoint additional official committees who are
entitled to administrative claims against the bankruptcy estate for their costs and attorney fees – to
represent other constituents in the case (such as stockholders, bondholders, secured creditors, etc.).
Unofficial committees are often formed by interested groups to act jointly in the case to protect
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their own interests. Unofficial committees must show that they have rendered benefit to the estate
in order to recover their costs and fees from the bankruptcy estate as an administrative expense.
If there are doubts about the debtor in possession’s honesty or competence, the Court can
upon request appoint an examiner – a professional (usually lawyer, business expert or accountant)
– to review a particular issue or more broadly consider whether to recommend the appointment of
a Chapter 11 trustee. 11 U.S.C. § 1104(c).
One can imagine that the costs of multiple sets of professionals reviewing each other’s
work can quickly skyrocket, which is one reason that large Chapter 11 cases are so expensive. The
bankruptcy court has to carefully consider the size and complexity of the case in deciding whether
multiple official committees are appropriate.
13.3. The Exclusivity Period
Only the debtor in possession can file a plan of reorganization during the exclusivity period.
This gives the debtor in possession a great deal of power in the Chapter 11 process by requiring
all creditors and equity security holders to negotiate with the debtor in possession for a
reorganization plan. Once the exclusivity period ends, any party in interest can file a plan
(including a liquidating plan), which can promptly doom the reorganization.
The initial exclusivity period is 120 days from the filing of the case for the debtor to
and (c).
In the early days of the Bankruptcy Code, the bankruptcy court could extend the exclusivity
period indefinitely, and in large cases often did so right at the beginning of the case to center
negotiating authority with the debtor in possession. However, in 2005 Congress amended the
Bankruptcy Code to put real limits on the bankruptcy court’s power to extend the exclusivity
period: the 120 day period to propose a plan cannot be extended beyond 18 months from the filing
date, and the 180 day period to confirm a plan timely filed cannot be extended beyond 20 months
from the filing date. 11 U.S.C. § 1121(d)(2).
The exclusivity period also ends automatically if a Chapter 11 trustee is appointed. 11
U.S.C. § 1121(c)(1).
13.4. Negotiating a Plan and the Disclosure Statement
The Bankruptcy Code prohibits a plan proponent from soliciting acceptance or rejection of
a plan unless the proponent provides the solicitee with a copy of the plan and a bankruptcy-court-
cart before the horse, because one would have to complete the plan and obtain court approval for
the disclosure statement before negotiating the plan terms with creditors. As long as a formal vote
is not being solicited, a plan proponent may have general discussions about plan terms with
creditors without violating the rule. Care must be taken during planning stages not to seek formal
voting commitments during the negotiations.
After some general negotiations, the plan proponent must draft a plan of reorganization
and disclosure statement. The disclosure statement is like a security prospectus – it must contain
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“adequate information” which is defined in the Bankruptcy Code as all information that a
reasonable investor typical of holders of claims and interests would require to make an informed
judgment in voting on the plan. Unlike security offerings outside of bankruptcy, however, the
proponent does not have to make a guess about what information need be disclosed and then bear
the risk of a lawsuit if the information is deficient. Instead, the proponent must obtain the
bankruptcy court’s approval for the disclosure statement, and is protected from later claims of
The process of seeking approval of a disclosure statement is rather convoluted because of
the prohibition against seeking acceptances before the disclosure statement has been approved by
the bankruptcy court. The plan proponent files the proposed plan and disclosure statement with
the bankruptcy court, and sets a date for the hearing on the disclosure statement. The disclosure
statement and plan can only be mailed out to the debtor, trustee, the committees and the SEC.
Creditors and other parties in interest just get a notice stating the hearing date, the deadline for
filing objections to the proposed disclosure statement, and that the proposed disclosure statement
is available from the court or will be sent to anyone else who in writing requests a copy. Only
those who request a copy of the proposed disclosure statement will receive one. See Bankruptc y
Rule 3017.
Proper objections at the disclosure statement stage are only to the adequacy of disclosure,
not the merits of the plan itself. Parties in interest who believe that the disclosure statement
contains insufficient disclosure or is confusing can ask for additional disclosure or clarification
before the statement is approved by the Court. Courts are liberal in requiring additional disclosure
or clarification. Some courts will consider the merits at the disclosure statement stage if, under a
summary judgment type standard, the plan is not confirmable on its face. Arguments about
confirmation that depend on the result of the votes, of course, are not proper at the disclosure
statement stage and should be held for the confirmation hearing after the voting has occurred.
It is common for additional modifications to be made to the disclosure statement both
before the disclosure statement hearing, and after in response to the bankruptcy court’s
requirements.
After the bankruptcy court approves the proposed disclosure statement, an order approving
the disclosure statement, setting the date for the confirmation hearing, the deadline for filing
objections to confirmation, and the deadline for submitting a ballot, along with the approved
disclosure statement, plan of reorganization, ballot and voting instructions is mailed to all creditors
and parties in interest. The plan proponent then receives and tabulates the ballots. If sufficient
votes are obtained for confirmation, the case proceeds to confirmation. If not, the proponent can
start over.
The confirmation hearing can be a full blown trial on whether the requirements for
confirmation can be met, or can be a rather simple affair if there are no major contests. Some
judges accept an offer of proof and confirm the plan if the requirements are met and there is no
material opposition. Other judges require the proponent to call witnesses and prove each of the
requirements for confirmation even in the absence of a material objection. Confirmation is
governed by Section 1129 of the Bankruptcy Code, which we will review in some detail.
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