Law Offices of Nicholas Gebelt

The Standard Chapter 11


In any Chapter 11 case, the debtor places the creditors in priority classes according to the types of claims they have. The debtor does this because section 507(a) of the Bankruptcy Code gives better treatment to some types of claims than other types.

The debtor propounds a plan of reorganization that specifies the treatment of each class. The judge will review the plan, and a related document called the disclosure statement. The disclosure statement must provide adequate information for creditors to intelligently vote on the plan. The plan specifies the treatment of each creditor’s claim, and must satisfy the minimum plan requirements listed in the Bankruptcy Code.

If the judge determines that the disclosure statement contains adequate information, the debtor will send the disclosure statement, plan, and ballots to the creditors.

The Consensual Plan

If each creditor class votes in favor of confirmation of the plan, the judge will enter an order confirming the plan, which is then binding on everyone. A class is deemed to have voted for confirmation if more than one-half of its members and at least two-thirds of the sum of the dollar amounts of all the claims in the class vote in favor of the plan.

Once the judge confirms the plan, the debtor must implement its terms, which will include making payments to the creditors.

The plan funding typically comes from the debtor’s income. However, if that income is insufficient to fund the plan, the debtor may sell assets or incur new debt to make the plan feasible.

The Partially Consensual Plan

Suppose there are creditor classes that vote against confirmation. What can the debtor do? It depends on the facts of the case.

First, with the Court’s permission the debtor may amend the plan to make it more attractive to the dissenting classes, and hope that the dissenting classes will vote in favor of the amended plan. However, this option may not work if the debtor lacks the financial resources to propose the more attractive plan.

Second, if at least one class votes in favor of confirmation, then if the plan satisfies all the other statutory requirements the debtor can get the plan confirmed using a process called cram-down. However, cram-down triggers something called the absolute priority rule that can lead to the business owners losing their interests in the business.

What is the absolute priority rule? To understand the answer to this question it helps to have the image of a multi-level fountain in mind. The water source must fill the top bowl before water spills out into the second from the top bowl. Water must fill the second from the top bowl before water spills out into the third bowl, and so forth. Thus, the bottom bowl gets no water until all the bowls above it are filled.

By analogy, the top bowl represents the top priority class, the next bowl the next priority class, and so on. In a consensual plan, each creditor gets paid according to the plan’s terms. However, in a cram-down plan a lower priority class gets nothing until the classes above it get paid in full. The bottom class is made up of the business owners.

Here’s the rub of the absolute priority rule: Unless all the creditors are paid in full the business owners get nothing — their stock becomes worthless. The only way they can get any ownership interest in the reorganized debtor is by adding new value — i.e., money — to the bankruptcy estate. If they don’t add new value, then under the crammed-down plan they will no longer have an ownership interest in the business.

The Nonconsensual Plan

If there are no consenting classes, the Court cannot confirm the plan.

For more information on Chapter 11 Bankruptcy In The State Of California, a free 20 minute phone strategy session is your next best step. Get the information and legal answers you are seeking by calling (562) 777-9159 today.

Attorney Nicholas Gebelt

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