Understanding the Terminology In Chapter 11 Bankruptcy Cases
Effectively pursuing Chapter 11 and maximizing the benefits of the bankruptcy process requires informed and strategic decision-making. The bankruptcy process is exceedingly complex, and while financially distressed companies have multiple options available under Chapter 11, simply identifying and understanding these options can prove challenging for those who are unfamiliar with the basic terminology involved.
10 Key Terms in Chapter 11 Bankruptcy Proceedings
With this in mind, we have prepared a glossary of some of the key terms in Chapter 11 bankruptcy proceedings:
1. Automatic Stay
When a company files for business bankruptcy under Chapter 11, the company’s (or “debtor’s”) bankruptcy petition triggers an automatic stay. While the automatic stay is in effect, the company’s creditors are prohibited from pursuing collection, and they must put a hold on any collection efforts that are currently underway. This includes informal collection efforts as well as civil lawsuits and lien foreclosures. The automatic stay provides financially distressed companies with some much-needed breathing room while also helping to ensure that all of the company’s creditors will have due access to the company’s remaining assets during the bankruptcy process.
2. Creditors’ Committee
In Chapter 11 bankruptcy proceedings, the creditors’ committee serves as” an important safeguard to the proper management of the business by the debtor in possession.” As the U.S. Courts further explain, the creditors’ committee serves several specific functions, including:
- Consulting with the debtor (or the debtor’s counsel) during the Chapter 11 bankruptcy proceeding;
- Investigating the debtor and its business operations, as warranted, and,
- Participating in the formulation of the debtor’s Chapter 11 reorganization plan.
The creditors’ committee is typically comprised of the debtor’s seven largest unsecured creditors, and the creditors’ committee can (and generally should) engage legal counsel to ensure adequate representation of all creditors’ rights.
3. Debtor in Possession
In Chapter 11 bankruptcy cases, companies will typically be able to maintain possession of assets to which their creditors may have claims during the bankruptcy process. This is referred to as being a “debtor in possession.” Companies pursuing bankruptcy under Chapter 11 will remain debtors in possession unless and until the bankruptcy court appoints a trustee to manage the company’s business activities—or until the company’s Chapter 11 reorganization plan is confirmed.
4. Discharge
In the Chapter 11 bankruptcy context, “discharge” refers to the release of the company’s liability for an outstanding debt, as affected by an order of the court. While Chapter 11 bankruptcy cases are primarily reorganization proceedings, companies can seek relief from certain debts during the process as well. Additionally, Section 1141(d)(1) of the U.S. Bankruptcy Code provides that confirmation of a company’s Chapter 11 reorganization plan discharges the company from any debts arising before the date of confirmation—with the company’s new debt obligations being determined by the plan.
5. Equitable Subordination
Generally, creditors’ respective rights in Chapter 11 bankruptcy proceedings are determined based on priority, whether their debts are secured or unsecured, and the terms of their contracts with the debtor. But, in some circumstances, lower-priority creditors can seek to jump the line by filing an equitable subordination action. These actions are not based on the creditor’s contractual rights or the U.S. Bankruptcy Code but rather on common law principles that protect creditors from being unfairly disadvantaged in certain circumstances.
6. Fraudulent Transfer
The U.S. Bankruptcy Code prohibits companies from transferring funds or other assets in anticipation of bankruptcy and for the purposes of shielding these assets from the company’s creditors during its Chapter 11 bankruptcy case. Transfers that violate this prohibition are referred to as “fraudulent transfers,” and both creditors and the U.S. trustee can file lawsuits to unwind these transfers as part of the bankruptcy process.
7. Non-Dischargeability
“Non-dischargeability” can refer to either: (i) a specific debt’s ineligibility to be discharged (or eliminated) through the Chapter 11 bankruptcy process; or (ii) a debtor’s ineligibility to seek discharge entirely. There are two main provisions of the U.S. Bankruptcy Code that address non-dischargeability—Section 523 and Section 727—and, along with fraudulent transfers, they establish grounds for non-dischargeability including (but not limited to):
- Destruction or falsification of records
- Refusals to comply with court orders
- Violations during previous bankruptcy filings
- “Willful and malicious” injury to creditors
- Other forms of fraudulent conduct
When contemplating bankruptcy under Chapter 11, company owners should work with their bankruptcy counsel to assess any potential grounds for non-dischargeability. If any such grounds exist (or may arguably exist), addressing them proactively can help facilitate a smooth and cost-effective bankruptcy filing.
8. Preferential Transfer
A preferential transfer is similar to a fraudulent transfer but involves paying one of the debtor’s creditors rather than seeking to shield the debtor’s assets entirely. Like fraudulent transfers, preferential transfers can be challenged—and potentially unwound—by creditors and the U.S. trustee.
9. Reclassification
When filing for bankruptcy, companies must classify their debts as either secured or unsecured. If a creditor disagrees with the classification of its debt, it can file a reclassification action. In some cases, purported creditors can also seek to reclassify their purported debts as equity investments.
10. Reorganization Plan
In a Chapter 11 bankruptcy case, the goal is to “reorganize” the company’s debts so that it can manage its liabilities on an ongoing basis. During the Chapter 11 bankruptcy process, the company and its counsel will work with the creditors’ committee and the U.S. trustee to develop a reorganization plan that they will ultimately submit for the bankruptcy court’s approval. This differs from filing for bankruptcy under Chapter 7, where the primary focus is liquidation. By filing under Chapter 11, companies can stay in business, and they can better manage their cash flow so that they can continue to invest in their operations while avoiding collection actions related to their previous outstanding debts.
Schedule an Appointment with a Chapter 11 Bankruptcy Lawyer in Miami or Fort Lauderdale
If you would like to know more about filing for bankruptcy under Chapter 11, we invite you to get in touch. To schedule an appointment with a Chapter 11 bankruptcy lawyer at our offices in Miami or Fort Lauderdale, please call 305-768-9909 or request a confidential initial consultation online today.
