Chapter VII The Endgame

• Jurisdiction: United States

VII. The Endgame - Confirmation & post-Confirmation Problems

Expediting Chapter 11 Liquidating Debtor's Distribution to Creditors¹

Written by:
Pamela M. Egan
Pachulski Stang Ziehl & Jones LLP
San Francisco

Bankruptcy professionals today face a new reality: Gone are the days of a debtor using chapter 11 to restructure its business operations over the course of several years and promulgating a reorganization plan to embody that restructuring. Increasingly, chapter 11 is a tool for a failing company to shed its assets and distribute its unencumbered cash proceeds, if any, to creditors.² The exit strategies clearly provided for chapter 11 debtors—confirmation of a liquidation plan or conversion of the case to chapter 7, with their attendant delay, expense and risk—no longer adequately address the goals of the various constituencies within a liquidating chapter 11, principally the general unsecured creditors whose funds are being used to pay for the lengthy wind-down process.

The Bankruptcy Code should therefore be amended to plainly provide for two expedient and less-costly exit strategies for liquidating debtors seeking to distribute their assets through a pot plan by authorizing: (1) a "structured" dismissal of the chapter 11 case, i.e., a dismissal of the case, along with a grant of authority to the estate fiduciaries to make a distribution to creditors; and (2) a combined disclosure statement and plan hearing (similar to the procedure embodied in §1125(f) of the Bankruptcy Code for small business debtors). While many bankruptcy courts have authorized these alternative exit strategies as being permitted by the Code, the time is ripe to make crystal clear that these procedures are in fact authorized by the Code.³ Clarifying that liquidating chapter 11 debtors have access to these exit strategies will benefit general unsecured creditors by increasing the funds available for distribution while reducing the administrative burden on bankruptcy courts by closing cases more quickly and efficiently.⁴

Bankruptcy Code-Authorized Exit Strategies for Chapter 11 Debtors

The Bankruptcy Code clearly provides two alternative exit strategies for a liquidating chapter 11 debtor: (1) confirmation of a liquidation plan in conformity with the requirements of the Bankruptcy Code or (2) conversion to a case under chapter 7. In the case of a debtor seeking to make an expeditious de minimis distribution to its creditors in a liquidating chapter 11 case, these statutory options are fraught with delay, excessive cost or risk.

The Chapter 11 Liquidating Plan

Promulgating a chapter 11 liquidating plan is both time-consuming and expensive. Bankruptcy Rule 3017(a) requires that creditors receive no less than 28 days' notice of the hearing to approve a disclosure statement. Assuming that the disclosure statement is approved by the bankruptcy court, Bankruptcy Rule 2002(b) requires an additional 28 days' notice of the time to file objections to a plan. When combined with the additional time needed for service and a period of time in which to solicit votes on a plan, the plan-confirmation process—from the date of filing the plan to confirmation thereof—typically ranges from 75-90 days.⁵

At the same time, there are significant costs relating to (1) drafting the plan and disclosure statement; (2) obtaining approval of the disclosure statement and the procedures for soliciting and tabulating votes on the plan; (3) soliciting the plan, which includes service of the plan-related documents; (4) retention of a claims and noticing agent, whose fees are not subject to bankruptcy court approval and often run in the tens of thousands of dollars in small cases to hundreds of thousands of dollars in larger cases; (5) confirming the plan; and (6) implementing the plan, including the fees and expenses of a plan administrator and/or disbursing agent.

Conversion to Chapter 7

Conversion of a chapter 11 case to chapter 7 is likewise fraught with delay because, upon conversion, a chapter 7 trustee must spend time getting up to speed on the case. These "start-up" costs, incurred even in a case in which the debtor has sold substantially all of its assets, typically provide no benefit to unsecured creditors, whose only remaining interest is receiving a distribution as quickly as possible.

Furthermore, a chapter 7 trustee may be tempted to pursue avoidance actions, most particularly preference actions, even in a case where the official committee had determined that pursuit of preferences was (1) inequitable to unsecured creditors already poised to receive pennies on the dollar, (2) not a worthwhile endeavor in the case and/or (3) likely to further delay distributions while not materially increasing the potential recovery for creditors. Thus, conversion may be an unattractive option for estate professionals seeking to make an efficient and timely distribution to creditors.

Alternative Exit Strategies for the De Minimis Asset Debtor

Confronted with the delay and expense associated with promulgating a chapter 11 liquidating plan and the uncertainty and additional cost of a chapter 7 conversion, professionals have utilized alternative exit strategies that limit the amount of time expended and professional fees incurred before making a distribution to creditors. One alternative is the "structured dismissal," which takes the form of a court order dismissing the bankruptcy case, together with one or more of the following provisions: (1) releases for the benefit of the debtor or nondebtor entities, (2) a modified claims-resolution mechanism and (3) a distribution to creditors, either on account of a carve-out or gift by senior creditors for the benefit of junior creditors, or in the form of estate assets to creditors.⁶

Three Code provisions are often cited as authority for structured dismissals: (1) § 1112(b), which provides that a court "shall convert a [chapter 11] case to a case under Chapter 7 or dismiss [the case]...whichever is in the best interest of creditors and the estate, if the movant establishes cause;" (2) § 305(a)(1), which provides that a court may dismiss a case if "the interests of creditors and the debtor would be better served by such dismissal;" and (3) § 105(a), which grants bankruptcy courts broad equitable power to carry out the provisions of title 11. While one or a combination of these statutory bases have been accepted by some courts, that acceptance is not universal. In fact, the Office of the U.S. Trustee has taken the position in some cases that structured dismissals are not authorized by the Code and may sacrifice critical bankruptcy safeguards included in the traditional plan or conversion options.⁷ Likewise, some bankruptcy courts have been unwilling to dismiss bankruptcy cases while including provisions for creditor distributions and releases.⁸

Other estate professionals have recently borrowed sections from the small business provisions of the Bankruptcy Code by seeking to obtain preliminary approval of a disclosure statement upon little to no notice to creditors and on a final basis at a joint hearing to consider both approval of the disclosure statement and confirmation of the plan.⁹ Practitioners have sought to implement the small business confirmation procedures because those procedures were intended to make the plan-confirmation process less expensive and more expeditious. This procedure also has its share of critics who argue that the Code requires that a disclosure statement be approved on a final basis before it may be solicited, and that only small business debtors may avail themselves of these special Code provisions.

The Solution

It is time for the Code to clearly provide for the more expedient and less costly exit strategies for liquidating chapter 11 debtors seeking to distribute their assets through a pot plan by plainly authorizing the structured dismissal and joint plan and disclosure statement proc-ess already being used by practitioners today. However, these alternatives should not be available to all liquidating debtors. Conditions to the use of these expedited distribution provisions should include (1) the debtor holding less cash to be distributed than some maximum amount, and (2) establishing, by a preponderance of the evidence, that (a) proceeding in the requested fashion is in the best interests of all creditors and (b) confirming that a chapter 11 plan of liquidation would be overly burdensome or impractical under the specific facts of the case.¹⁰ Furthermore, specific concerns about the provisions occasionally found in structured dismissal orders, such as those expressed by the Office of the U.S. Trustee, could be addressed as follows:

• Prohibit debtor releases, which would merely be a restatement of the law, given that § 1141(d)(3) already prohibits debtor releases under liquidating plans; and
• Permit modification of the claims reconciliation procedures based solely upon good cause shown, which would include not unfairly burdening claimants in connection with such process.¹¹

To see the benefits of a Code-authorized structured dismissal, take the following example: A debtor, after having sold all of its assets, is left with $1.1 million in cash, aggregate administrative and priority claims of $100,000, and $10 million in allowed general unsecured claims. Before calculating the impact of requiring the debtor to confirm a chapter 11 liquidating plan, general unsecured creditors would be poised to receive a 10 percent return. However, as set forth above, the costs of confirming a liquidating plan are material and, if compelled to address formal and informal responses to the plan, could easily cost $250,000.¹² In that case, general unsecured creditors would see 25 percent of the available cash eaten up merely by the plan-confirmation process.¹³ In addition, the plan-confirmation process would delay distributions by at least three months.

If the Code plainly permitted a structured dismissal, the costs of preparing...