CHARTER 2 Introduction to the Business Bankruptcy System
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CHARTER 2 Introduction to the Business Bankruptcy System
A. The Structure and the Rlayers
All bankruptcy cases are governed by the U.S. Bankruptcy Code contained in title 11. In the business context — which is the focus of this chapter — there are two major types of bankruptcy cases: a liquidation under chapter 7, or a reorganization and/or sale of assets under chapter 11.
In a chapter 7 case, a trustee is appointed as a fiduciary to liquidate all property of the debtor. After satisfying the expenses of administration, the trustee will distribute the remaining proceeds to creditors. After a company has gone through chapter 7, it ceases to exist.
The aim of a chapter 11 is to enable a company to restructure its debts while maximizing the return to creditors and, if possible, to equity-holders. Unless a trustee is appointed, the chapter 11 debtor typically becomes a fiduciary known as a "debtor in possession" (DIP). The DIP may, consistent with its fiduciary duties, continue to operate its business in the ordinary course, including the use of its property and retention of its employees while restructuring or liquidating in an orderly fashion.87
A bankruptcy case starts with the filing of a petition — either voluntary88 or involuntary.89 Venue for bankruptcy cases is quite broad. It can be the location of the debtor's domicile, residence, principal place of business, or principal assets for 180 days immediately preceding the bankruptcy filing.90 Where any such attributes have been located in more than one district during the 180 days immediately preceding the filing, then the case may be commenced in the district in which the attribute existed for the longest portion of the 180-day period.91 Lastly, if there is a bankruptcy case already pending concerning a debtor's affiliate, general partner or partnership, then the case may be commenced in the district in which the affiliate case is pending.92
Bankruptcy courts have authority on referral from the federal district courts, which have original and exclusive jurisdiction over title 11 cases and the property of the bankruptcy estate.93 As to civil proceedings in title 11 cases, the federal district courts have original, but not exclusive, jurisdiction.94 Bankruptcy judges serve as judicial officers of the U.S. district95 and are appointed to renewable 14-year terms by the Circuit Judicial Council for each federal judicial circuit.96 In addition to the judge, who is the fact-finder and decides the relevant legal issues in a bankruptcy case, the typical key players in a complex chapter 11 E&P case include the debtor, U.S. Trustee,97 primary secured lender, second-lien secured lender, bondholders, trade creditors, mineral lienholders, landowners and royalty owners, vendors (including oilfield service providers), taxing authorities, unsecured creditors, equity security-holders and the official committee of unsecured creditors (a "creditors' committee"). Increasingly, regulatory agencies are involved, primarily to address plugging and abandonment (P&A) and other environmental obligations. The debtor must remain in compliance with the regulations of each state in which it operates.
The debtor (and in chapter 11, the debtor in possession, or DIP) is the entity seeking relief under the Bankruptcy Code.98 As a DIP, and with limited exceptions, the chapter 11 debtor has "all the rights ... and powers" as well as "all the functions and duties ... of a trustee...." Generally, a person or organization that files a bankruptcy petition transforms into a "new" entity that has the rights of a bona fide purchaser and a judicial lien creditor, as well as the right to recover monies paid or property transferred within certain periods.
Secured creditors are those claimants whose claims are backed by collateral. Typically, these include taxing authorities, banks and other lending institutions and statutory lienholders, such as mineral lien claimants and, possibly, royalty interest owners.
In the oil and gas context, trade creditors and vendors are typically oilfield service providers and can hold either secured claims, via a mineral lien statute, or unsecured claims. These entities often are pivotal players in an oil and gas bankruptcy.
Equity security-holders are "interest"-holders (not "claimants"), and, to the extent a debtor is able to pay its debts in full over the life of a plan, the equity-holders may be entitled to recover some value for their interest. A plan of reorganization may provide that equity retain its interest in the debtor, but only if the plan provides for payment of all creditors in full (or if the creditors agree to subordinate some portion of their claims or some other treatment).
There is often a creditors' committee, which is tasked with representing the interests of many similarly situated creditors. The theory behind an official committee is that the size of unsecured claims, standing alone, would not justify the cost of meaningful participation in a bankruptcy case. The U.S. Trustee appoints the creditors' committee. The Code provides for the appointment of a creditors' committee under both chapters 7 and 11, although in chapter 7 there is typically little distribution left for unsecured creditors, and thus, not much need for a creditors' committee. In a chapter 11, however, the creditors' committee often plays an important role, including (1) consulting on case administration, (2) undertaking its own investigation of the conduct and financial affairs of the debtor, (3) investigating the extent and validity of liens, (4) participating in plan of reorganization negotiations and (5) being a "watchdog" in case there is a need for the appointment of a trustee or examiner. In addition to the "official" unsecured creditors' committee, groups of similarly situated creditors and/or other constituencies may also form official or ad hoc committees.99
The U.S. Trustee has general oversight responsibilities over a bankruptcy case. The U.S. Trustee is an official of the U.S. Department of Justice and has the right to be heard on any matter coming before the bankruptcy court and to file motions with the court in furtherance of its duties.100 If a chapter 11 or 7 trustee is ordered by the bankruptcy court, the U.S. Trustee selects the trustee.
B. Property of the Estate
When the bankruptcy petition is filed, an "estate" is created.101 This bankruptcy estate is comprised of all legal or equitable interests of the debtor as of the commencement of the bankruptcy case.102 The estate includes every type of property to which the debtor is entitled, including tangible and intangible property, causes of action, contract rights, etc.
C. Turnover of Property of the Estate
Creditors in possession, custody or control of property that a DIP may use, sell or lease must deliver the same to the DIP, and account for the property or the value of such property.103 A creditor that controls property and fails to turn over property to the debtor may be held liable for willful violation of the automatic stay in § 362(a) of the Bankruptcy Code. Entities that owe a debt that is property of the estate must pay the debt to the debtor, unless the debt may be properly offset against a claim of the creditor.104
D. Meeting of Creditors
Within a reasonable time frame after the initial bankruptcy filing, the U.S. Trustee (in a chapter 11) or chapter 7 trustee (in a chapter 7) will convene and preside at a meeting of the creditors, or so-called "341 meeting."105 The bankruptcy judge does not attend the 341 meeting.106 At the 341 meeting, the debtor (or, in the case of a business bankruptcy, a representative of the debtor) will answer questions under oath regarding indebtedness, collateral, operations, etc.107
E. Adequate Protection
Under 11 U.S.C. § 361, creditors are entitled to have their interests in property of the debtor protected.108 Bankruptcy courts will generally grant adequate-protection relief to maintain the status quo position of secured creditors and the respective collateral.109 Adequate protection includes periodic cash payments, granting of liens, replacement liens, or other relief as will result in the realization by the protected party of the "indubitable equivalent" of the party's interest in such property.110 To the extent a creditor is undersecured or at risk of becoming undersecured, periodic adequate-protection payments are often ordered to equal the amount of depreciation in the value of a secured creditor's collateral.111 The essence of "adequate protection" is to preserve and protect a creditor's collateral position. There are numerous issues raised by § 361, including valuation methods, lien attachment, factors determining whether adequate protection is necessary, and what is appropriate adequate protection in a given scenario. These questions are beyond the scope of this book, but should be analyzed by any secured creditor on or before the inception of a bankruptcy case.
F. Automatic Stay
The filing of the petition results in the imposition of an automatic stay, which is a federal injunction preventing creditors from enforcing pre-petition claims or from seeking recourse against a debtor's assets without first being granted permission from the bankruptcy court.112 The automatic stay operates to prevent collection efforts against a borrower in bankruptcy, although it does not enjoin or otherwise prevent governmental units from proceeding against a debtor pursuant to the governmental units' police or regulatory powers.113
A creditor may obtain relief from the automatic stay for cause, including lack of adequate protection.114 Also, a creditor may obtain relief from the automatic stay if the debtor has no equity in the property and the property is not necessary for an effective reorganization.115
G. Use, Sale or Lease of Property of the Estate
A debtor may use, sell or lease property of the bankruptcy estate in the ordinary course of business without notice or hearing.116The...
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