Chapter 11 Reorganisation

Chapter 11 is typically used to reorganize a business, which may be a corporation, sole proprietorship, or partnership... Unless the court orders otherwise, the debtor must file with the court: (1) schedules of assets and liabilities; (2) a schedule of current income and expenditures; (3) a schedule of executory contracts and unexpired leases; and (4) a statement of financial affairs.

Section 1107 of the Bankruptcy Code places the debtor in possession (“DIP”) in the position of a fiduciary, with the rights and powers of a Chapter 11 trustee, and it requires the debtor to perform of all but the investigative functions and duties of a trustee. These duties include accounting for property, examining and objecting to claims, and filing informational reports as required by the court and the U.S. trustee or bankruptcy administrator, such as monthly operating reports. The debtor in possession also has many of the other powers and duties of a trustee, including the right, with the court's approval, to employ attorneys, accountants, appraisers, auctioneers, or other professional persons to assist the debtor during its bankruptcy case. Other responsibilities include filing tax returns and reports which are either necessary or ordered by the court, such as a final accounting.

The U.S. trustee is responsible for monitoring the compliance of the DIP with the reporting requirements, operation of the business, submission of operating reports and fees, and monitoring applications for compensation and reimbursement by professionals, as well as plans and disclosure statements filed with the court.  The Trustee appoints the creditors committee, which ordinarily consists of unsecured creditors who hold the seven(7)  largest unsecured claims against the debtor. Among other things, the committee consults with the debtor in possession on administration of the case; investigates the debtor's conduct and operation of the business; and participates in formulating a plan.

Considerations under U.S. Bankruptcy Law: 

1. Automatic Stay -  A stay of creditor actions against the Chapter 11 debtor automatically goes into effect when the bankruptcy petition is filed. 11 U.S.C. § 362(a). The stay provides a breathing spell for the debtor, during which negotiations can take place to try to resolve the difficulties in the debtor's financial situation. During this time, all claims, judgments, collection activities, foreclosures, and repossessions of property are suspended and may not be pursued by the creditors on any debt or claim that arose before the filing of the bankruptcy petition.,

2. Relief from the Automatic Stay - Under specific circumstances, secured creditors can obtain an order from the court granting relief from the automatic stay.

• Adequate Protection – relief may be granted pursuant to 11 U.S.C. § 362(d)(1) for cause when a party in interest can show that there is a “lack of adequate protection” of the creditor’s interest in the property.  The basis for such a claim could be in circumstances where a party has a lien interest in some property that depreciates or is being consumed by the debtor in possession. In such circumstances, the Court can order the debtor in possession to post funds with the bankruptcy court in order to provide adequate protection to the creditor.  In re Taylor, 151 B.R. 646 (Bankr. E.D.N.Y. 1993).
• Lack of Equity – Relief from the stay may also be granted when the debtor has no equity in the property and the property is not necessary for an effective reorganization.  The secured creditor can seek an order of the court lifting the stay to permit the creditor to foreclose on the property, sell it, and apply the proceeds to the debt. 11 U.S.C. § 362(d)(2). 
• Waiver of Automatic Stay – Bankruptcy Courts will also recognize pre-petition waivers of a right to an automatic stay contained in contracts or other agreements.  See, e.g., In re Frye, 320 B.R. 786 (Bankr. D. Vt. 2005); In re Excelsior Henderson Motorcycle Mfg. Co., 273 B.R. 920 (Bankr. S.D. Fla. 2002). 

3. Preferences - One of the more controversial powers given in the U.S. Bankruptcy Code is the power of the trustee or DIP, to avoid certain pre-petition transactions as "preferences.”  Generally speaking, a preference occurs whenever a debtor favors one creditor over another in paying out its limited resources. In short, preference is a transfer (i) of property, (ii) to or for the benefit of a creditor, (iii) on an antecedent debt, (iv) made while the debtor was insolvent, (v) made during the preference period (usually the ninety (90) days before the bankruptcy, but one (1) full year for insiders of the debtor), and (vi) that enables to creditor to receive more than it would get in a Chapter 7 liquidation of the debtor.  Preference law is not self-executing. The trustee/DIP must take action to recover the alleged preferential transfer. This is normally done by an "adversary proceeding" in the bankruptcy court.  Some, but not all, preferences may be avoided.  Avoidance means that the transferee is forced to return the transferred property or its value.

4. Exceptions to Avoidance - Preferential payments may not be treated as a recoverable transaction in nine (9) specific circumstances.  Most notably, preferential payments may not be treated as recoverable where the payments are made as part of the parties’ “ordinary course of business.”  Specifically, section 547 of the U. S. Bankruptcy Code provides, in pertinent part, the following: “The trustee may not avoid under this section a transfer - . . . (2) to the extent that such transfer was - in payment of a debt incurred by the debtor in the ordinary course of business or financial affairs of the debtor and the transferee; made in the ordinary course of business or financial affairs of the debtor and the transferee; and made according to ordinary business terms. 11 U.S.C. 547(c)(2).

• Ordinary Course of Business Defense - The "ordinary course of business" defense was established as a matter of policy "to induce creditors to continue dealing with a distressed debtor so as to kindle its chances of survival without a costly detour through, or a humbled ending in, the sticky web of bankruptcy."  However, in order to successfully establish an ordinary course of business defense, a creditor is required to meet the burden of proving each element of the defense by a preponderance of the evidence. 
• Ordinary Business Defined - For your guidance, we note that neither the U. S. Bankruptcy Code nor the implementing case law specifically defines the terms "ordinary course of business" or "ordinary business terms."  In fact, "there is no precise legal test which may be applied to determine whether the requirements of section 547(c)(2) have been met.” In determining whether or not payments were ordinary, a US Bankruptcy court will look at “several factors, including timing, the amount and manner a transaction was paid and the circumstances under which the transfer was made.”  Additionally, in determining "ordinary business standards," courts generally will make an objective determination as to whether "the subject payments were ordinary in relation to the prevailing standards in the creditor's industry and/or the ongoing payment practices of the parties. 

We thank Briton P. Sparkman Esq. of Chalos & Co International Law Firm for this article.