Chapter 1 Pre-Filing Considerations for Individual Chapter 11 Cases

• Jurisdiction: United States

Chapter 1: Pre-Filing Considerations for Individual Chapter 11 Cases

I. Why File an Individual Chapter 11?

The commencement of a chapter 11 case for an individual creates a bankruptcy estate for which the debtor, as a "debtor-in-pos-session," has all of the duties and powers of a bankruptcy trustee.³In a chapter 11 case, there are more administrative and procedural burdens on a debtor that tend to make chapter 11 cases more complex and expensive than those filed under chapter 13. However, the reason why many individuals file a chapter 11 petition versus a chapter 13 is because the amount of debt the individual has exceeds the debt limits that would qualify the person to file a chapter 13 petition.⁴ While there are many provisions that apply to both chapters, there are some significant differences for individuals in chapter 11, including some benefits, that practitioners should be aware of.

A. Eligibility

Unlike a chapter 13, there are no debt or income requirements or limitations for filing a chapter 11 bankruptcy petition. In order to qualify to be a chapter 11 debtor, an individual must simply:

1. be a person; and
2. reside or have a domicile, place of business or property in the U.S. or a municipality.⁵

On the other hand, a chapter 13 bankruptcy is limited to natural persons with regular income.⁶

B. Means to Reorganize

Individuals are not required to have regular income to qualify to be a chapter 11 debtor. However, in order to have a real prospect for reorganization, a debtor will need resources available to him or her that can be used to reorganize and pay administrative expenses. Counsel should analyze whether a debtor has wage or business income, assets that can be liquidated, or other ways to pay creditors.

C. No Co-Debtor Stay

Chapter 13 provides for a stay in favor of co-debtors.⁷ Unfortunately, there is no similar provision for individual chapter 11 debtors.

D. The Debtor Is the Trustee

In an individual chapter 11 case, the individual is a "debtor-in-possession." The debtor-in-possession remains in control of his or her property and has all of the powers of a chapter 7 trustee.⁸ On the other hand, in a chapter 13 case, there is a chapter 13 trustee who administers the chapter 13 case for the benefit of creditors.⁹ Often, a chapter 13 trustee will object to exemptions, as well as the confirmation of a chapter 13 plan, and will ensure that all disposable income is being contributed to pay creditor claims.

A chapter 11 trustee will only be appointed if "cause" is shown, including fraud, dishonesty, incompetence or gross mismanage-ment.¹⁰ The circumstances constituting "cause" can have occurred before or after the case was filed.¹¹

E. Appointment of a Creditors' Committee

Chapter 11 cases provide for the possibility of the appointment of an official committee of unsecured creditors.¹² Subject to bankruptcy court approval, the unsecured creditors' committee can employ professionals to assist them in fulfilling their duties; however, the debtor's bankruptcy estate is responsible for paying the fees and costs of a committee's professionals.¹³

F. Duration of Plans of Reorganization

In a chapter 11 case, there is no set duration for a plan. In a chapter 13 case, there is an applicable duration of the plan known as the "commitment period," which is either three or five years. In a chapter 13 case, a debtor's disposable income determines the applicable commitment period. In a chapter 11 case, while there is no requirement for disposable income, a chapter 11 plan must contribute at least the amount of "disposable income" in a period that is the longer of the duration of the plan or five years.¹⁴

G. Property Settlements Are Not Dischargeable

With some exceptions, most debts can be discharged in a bankruptcy case.¹⁵ The most significant difference between a chapter 11 case and chapter 13 case relates to the dischargeability of debts related to property settlements. A debtor in chapter 13 can discharge debts owed to a spouse or former spouse incurred by the debtor in the course of a divorce or separation, if such debt is not a domestic support obligation.¹⁶ However, a chapter 11 debtor cannot discharge such debts.¹⁷

II. Involuntary Chapter 11 Petition: Is Filing an Involuntary Chapter 11 Petition Against an Individual Constitutional?

Individual chapter 11 cases can be filed as involuntary cases.¹⁸ Section 1129(a)(15) requires an individual debtor to devote post-petition earnings to fund a plan. Further, Section 1115's definition of property of the estate includes both post-petition property and post-petition income. Therefore, a debtor could be forced to repay debt through post-petition earnings, which arguably is peonage. Peonage, a form of involuntary servitude, is forbidden by federal law and may violate the Thirteenth Amendment's prohibition of involuntary servitude and slavery. In the context of an involuntary individual chapter 11 case, one could argue that the confirmation of a plan is forcing a debtor into peonage — that is, involuntary servitude. However, the issue of whether an involuntary chapter 11 petition constitutes involuntary servitude will not be ripe until and after the entry of an order for relief.¹⁹

This problem does not arise in chapter 13 because an involuntary case cannot be filed against debtors, and debtors always have the right to dismiss or convert their case to another chapter.²⁰

III. Representation of an Individual Chapter 11 Debtor

Being a debtor-in-possession can be daunting. In this regard, individual chapter 11 debtors will undoubtedly benefit from being represented by an attorney.

A. Duty of Counsel in Individual Chapter 11 Cases: Who Is Your Client?

As the debtor's counsel, it is important to understand the identity of your client. The debtor will presume that he or she is the client. However, the attorney's obligation is to the debtor's bankruptcy estate, not the individual personally. Counsel's duties include a duty to "maximize the estate" and a duty to "exercise independent professional judgment" on behalf of the estate.²¹ In addition, counsel of a debtor-in-possession owes fiduciary duties to the bankruptcy court.²²

As one court has put it, "Counsel for a debtor in possession is not simply 'a mouthpiece for his client.'"²³ Counsel must be proactive — i.e., prepared to render unsolicited legal advice regarding preventive or corrective action that may be necessary for the debtor in possession to properly discharge his or her fiduciary obligations.²⁴

B. Employment as General Counsel

Attorneys are governed by the rules of conduct adopted in the jurisdictions in which they practice. The Model Rules²⁵ have been adopted in a majority of the states, as well as the District of Columbia, and allow for...