What Unsecured Creditors Need to Know About Chapter 11 Bankruptcies

While unsecured creditors’ rights are limited in Chapter 11 bankruptcy proceedings, these creditors still can—and should—take action to protect their claims to the fullest extent possible. Although secured creditors will generally have superior rights, there are a variety of steps that unsecured creditors can potentially take to ensure that they receive at least partial (if not full) payment. Learn more from an experienced Miami creditors’ rights attorney:

The Difference Between Secured and Unsecured Claims in Chapter 11 Bankruptcies

Secured claims are those that are protected (or “secured”) by the availability of an underlying asset. Commercial mortgages, for example, are secured claims. If the debtor doesn’t make its mortgage payments when they are due, the bank can foreclose on the mortgaged property to mitigate its losses.

While secured creditors have rights outside of the bankruptcy process, they have rights during the bankruptcy process as well—and these rights are generally superior to those of their unsecured counterparts. In a Chapter 11 case, for example, if the debtor is unable to reorganize its debts successfully, its secured creditors may be able to force liquidation of the debtor’s secured assets to collect the monies they are owed.

Once a debtor files under Chapter 11, for unsecured creditors, the ideal scenario (aside from asserting a successful defense to discharge) is for the debtor to reorganize its debts and pay what it owes over time. If it doesn’t, its unsecured creditors may be left with unrecoverable losses they are forced to write off. With this in mind, it can be especially important for unsecured creditors to take a proactive approach to protecting their claims during the Chapter 11 bankruptcy process.

Protecting Unsecured Creditors’ Rights During the Chapter 11 Bankruptcy Process

Given that this is the case, what can—and should—unsecured creditors do when a client or customer files for bankruptcy? Here are some key steps for protecting unsecured creditors’ rights:

1. File a Proof of Claim

Once a debtor files for bankruptcy under Chapter 11, unsecured creditors must be proactive to protect their claims. A key first step in this process is to file a Proof of Claim with the U.S. Bankruptcy Court. Unsecured creditors that fail to timely file a Proof of Claim may be barred from participating in the bankruptcy process or seeking to collect in the future, unless they can show that their failure to file is due to “excusable neglect.”

While filing a Proof of Claim may technically not be necessary in some Chapter 11 cases, unsecured creditors can file regardless—and there is no harm in doing so. This will help avoid any unnecessary issues, and it will provide confidence and certainty regarding unsecured creditors’ participation in the bankruptcy process going forward.

2. Object to the Debtor’s “First Day” Hearing Motions (as Warranted)

When filing for bankruptcy under Chapter 11, debtors may also file a variety of motions focused on securing rights and benefits that are available under the U.S. Bankruptcy Code but that are not afforded to debtors automatically. The U.S. Bankruptcy Court will then consider these motions during a “first-day” hearing. Unsecured creditors will want to object to these motions in many cases.

Some common examples of “first-day” motions include requests to immediately pay certain unsecured claims and requests for approval to seek debtor-in-possession (DIP) financing. Both of these can have significant impacts on unsecured creditors’ ability to protect their claims. While these motions are frequently granted, unsecured creditors will have valid arguments against granting them in some cases—and it will be well worth consulting with a Miami creditors’ rights attorney about the options your company has available.

3. Assess Potential Defenses to Discharge

Along with assessing potential challenges to the debtor’s “first-day” motions, unsecured creditors should also assess potential defenses to discharge. This includes defenses to discharge of unsecured creditors’ specific claims as well as defenses to the debtor’s eligibility to seek discharge in general. There are several possibilities, and here too, unsecured creditors will want to work with an experienced Miami creditors’ rights attorney to ensure that they are making informed and strategic decisions.

If an unsecured creditor is able to file a successful defense to discharge, it may then be able to enforce its debt outside of the bankruptcy process. Keep in mind, however, that the debtor still may not be able to pay—which could ultimately mean that either (i) collection efforts will prove futile or (ii) the debtor will seek to liquidate and wind up its operations under Chapter 7.

4. Consider Possible Preference Claims (and Concerns)

Another way unsecured creditors can help to maximize their chances of securing payment is by asserting preference claims. Preference claims allow creditors to claw back funds that the debtor paid prior to (or, in some cases, during) the bankruptcy process. Importantly, when considering possible preference claims, unsecured creditors will want to consider the possibility that they may face preference liability as well.

5. Participate in the Chapter 11 Reorganization Process (to the Extent Possible)

Unsecured creditors can have varying degrees of ability to participate in the Chapter 11 reorganization process depending on the specific nature of the debtor’s filing (i.e., a standard Chapter 11 filing or a Subchapter V filing) and the current status of their claims. As the process moves forward, unsecured creditors should participate to the extent possible, as this will also help to maximize their chances of securing a favorable outcome. Working with experienced legal counsel is critical here as well, as unsecured creditors must satisfy all substantive and procedural requirements for asserting their legal rights.

Schedule a Consultation with a Miami Creditors’ Rights Attorney at Edelboim Lieberman

If you need to know more about protecting unsecured claims during the Chapter 11 bankruptcy process, we invite you to get in touch. To schedule a consultation with a Miami creditors’ rights attorney at Edelboim Liberman, please call 305-768-9909 or tell us how we can contact you online today.