Close Menu

10 Common Roadblocks in Chapter 11 Bankruptcy Cases

While most Chapter 11 bankruptcy filings go smoothly, it is possible for a variety of issues to arise along the way. Overcoming these issues costs time and money, and thus it is generally best to avoid them if possible. Hiring experienced business bankruptcy counsel can mitigate the risk of issues getting in the way of a streamlined filing, but there are also several potential roadblocks over which businesses and their counsel have no control.

What are some examples of issues that can interfere with a Chapter 11 bankruptcy? Here are 10 common adversary proceedings and other issues that can present roadblocks in Chapter 11 bankruptcy cases:

1. Priority Disputes Between Creditors

Priority disputes between creditors can delay the conclusion of a Chapter 11 bankruptcy case. Essentially, a priority dispute involves a disagreement over which creditor has the right to be paid first. Priority can impact creditors’ rights during Chapter 11 cases in several ways, and creditors will often litigate their priority claims as part of the bankruptcy process.

2. Issues Raised By the U.S. Trustee

In a Chapter 11 bankruptcy case, the U.S. trustee plays a central role. As the U.S. Courts explain:

“The U.S. trustee is responsible for monitoring the debtor in possession’s operation of the business and the submission of operating reports and fees. Additionally, the U.S. trustee monitors applications for compensation and reimbursement by professionals, plans and disclosure statements filed with the court, and creditors’ committees. . . . The U.S. trustee . . . may [also] question the debtor under oath at the section 341 meeting concerning the debtor’s acts, conduct, property, and the administration of the case.”

If, through the performance of its duties, the U.S. trustee finds reason to object to the business’s bankruptcy filing or the business’s conduct during the bankruptcy proceedings, this can also lead to litigation that delays—and potentially compromises—the process.

3. Reclassification Litigation

When filing for bankruptcy under Chapter 11, businesses must classify their debts on various schedules attached to the Chapter 11 bankruptcy petition. If a creditor disagrees with its classification (i.e., if a creditor claims that it has been improperly classified as unsecured), this can lead to reclassification litigation.

Another type of reclassification litigation that can arise involves efforts to recharacterize purported debt as equity. If the substance of a purported loan is more akin to an equity investment, then the bankruptcy court may determine that the purported creditor is not entitled to participate in the bankruptcy process.

4. Fraudulent and Preferential Transfer Litigation

Under the U.S. Bankruptcy Code, businesses are generally prohibited from making transfers in anticipation of filing for bankruptcy. The purpose of this prohibition is to protect the business’s creditors against efforts to shield assets by transferring them to third parties (fraudulent transfers) or to pay off certain creditors to the disadvantage of others (preferential transfers). If a creditor (or if the U.S. trustee) alleges that a Chapter 11 filer has executed a fraudulent or preferential transfer, it can initiate litigation in an effort to unwind the prohibited transaction.

5. Post-Petition Transfer Litigation

Similar to fraudulent and preferential transfers, creditors and U.S. trustees can also initiate litigation to challenge post-petition transfers that move assets out of the business’s bankruptcy estate. While businesses that file for bankruptcy under Chapter 11 are entitled to continue operating as a matter of course, they can run into problems if they execute extraordinary transactions without the U.S. Bankruptcy Court’s approval.

6. Creditor Objections to the Dischargeability of Debt

While Chapter 11 bankruptcies are generally reorganization proceedings, businesses can seek to eliminate (or discharge) certain debts through the Chapter 11 bankruptcy process as well. If a creditor objects to having its debt discharged, either in whole or in part, rather than being fully included in the debtor’s reorganization plan, the creditor can object—and this can lead to litigation as well.

7. Creditor Objections to Claimed Exemptions

The U.S. Bankruptcy Code provides for several potential exemptions in Chapter 11 bankruptcy proceedings. While most of these exemptions are only applicable to individual bankruptcies, some apply in the business bankruptcy context as well.

One of these is the “new value exception.” As the American Bankruptcy Institute (ABI) explains, “the new value exception allows a debtor to essentially buy property from the bankruptcy estate under the guise of contribution of new value. However, . . . the contribution of new value must be (a) ‘new’ and ‘money or money’s worth;’ (b) necessary; and (c) reasonably equivalent to the interest being retained.” Creditors seeking to maximize their ability to collect may object to businesses’ claims of “new value,” and this too can lead to delays in the bankruptcy process.

8. Turnover Actions

Rather than waiting to collect under a business’s Chapter 11 reorganization plan, some creditors may seek to have their debts satisfied in full by filing a “turnover” action. These are civil proceedings under Section 542 of the U.S. Bankruptcy Code that seek to force entities to turnover property owed to the business or its bankruptcy estate.

9. Equitable Subordination Actions

Along with priority disputes and other creditor actions, equitable subordination actions can also lead to costs and delays for Chapter 11 filers. In an equitable subordination action, the filing creditor seeks to gain priority not based on contract terms or the relevant provisions of the U.S. Bankruptcy Code but instead based on common-law principles designed to protect against certain creditors receiving an unfair advantage.

10. Filing Deficiencies and Other Debtor-Related Issues

Finally, businesses can run into roadblocks during Chapter 11 bankruptcy proceedings if they fail to meet all relevant filing requirements or if they make other mistakes or ill-advised decisions during the bankruptcy process. While these issues are common, they are also entirely preventable—provided that businesses engage experienced bankruptcy counsel to represent them.

Discuss Your Business’ Financial Situation with an Experienced Chapter 11 Bankruptcy Attorney

If you have questions about the issues that can arise during Chapter 11 bankruptcy proceedings, we encourage you to contact us for more information. To speak with a Chapter 11 bankruptcy lawyer at our offices in Miami or Fort Lauderdale, please call 305-768-9909 or request an appointment online today.

Facebook Twitter LinkedIn