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What Is A Debtor In Possession And What Is Required Of It In A Chapter 11 Bankruptcy Case?

In a Chapter 7, when the debtor files for bankruptcy protection, the court appoints a Chapter 7 Trustee to administer the case. That Trustee will liquidate the nonexempt assets for the benefit of the creditors. In a Chapter 13 case, the court will appoint a Chapter 13 Trustee, who also has an administrative role. That trustee receives monthly plan payments from the debtor, and distributes them to the creditors according to the terms of the judge-confirmed Chapter 13 plan.

In a standard Chapter 11 case, there is no chapter trustee. Instead, the debtor serves as a quasi-trustee, called the debtor in possession because the debtor remains in possession of all the assets of the estate. Among the duties of the debtor in possession are to manage the affairs of the debtor in such a fashion that maximizes the benefit to the creditors. In order to be sure that the debtor in possession is doing this, each month the debtor in possession is required to file a monthly operating report that gives a financial accounting of the debtor for the month in question.

The monthly operating report includes copies of that month’s bank statements, so that the office of the U.S. Trustee can see whether or not the debtor is managing its finances responsibly. A debtor in possession is also required to make quarterly payments to the U.S. Trustee. The size of those payments is tied to the amount that the debtor has disbursed over the prior quarter.

The debtor in possession must undo fraudulent or unauthorized transfers, and recover the transferred assets for the benefit of creditors. The debtor in possession must also undo preferences — i.e., unusual payments to creditors shortly before the petition date — and recover the funds for the benefit of creditors.

In sum, the debtor in possession serves the role of a trustee to manage the Chapter 11 estate for the benefit of creditors.

Is The Debtor Permitted To Operate Its Business During A Chapter 11 Bankruptcy Case?

If the debtor is a business, then unless the debtor is shutting down, the point of the bankruptcy filing is to reorganize the debt so that it can become a profitable enterprise. Thus, the debtor most certainly will be permitted to continue to operate.

Of course, the operating of the business has to be done in an efficient fashion, so that it maximizes the benefits to creditors, and thus offers the real hope that the business, upon getting the discharge, will be a solvent operation.

One could argue that if the business is in a Chapter 11 bankruptcy case, it was mismanaged prior to filing the bankruptcy, and therefore should not be allowed to continue. However, the vicissitudes of the market can sometimes intrude into the smooth functioning of a business, so the business’s problems might not be the result of mismanagement. Even if there was prepetition mismanagement, the postpetition management may be different from the prepetition management. And even if the management remains unchanged, it could have learned from the prepetition mistakes, and be in a good position to turn the debtor into a profitable business.

Is A Trustee Appointed In A Chapter 11 Bankruptcy Case?

In a classic Chapter 11 case where the debtor reorganizes and restructures debt, there is no Chapter 11 Trustee unless things have gone terribly wrong and the Court appoints one.

However, there is another kind of Chapter 11 case, called a Subchapter V Chapter 11 case in which the Court appoints a Subchapter V Trustee as soon as the case is filed. The Subchapter V Trustee’s main task is to work towards the confirmation of the plan. If the plan is confirmed as a consensual plan — i.e., the creditor classes all vote in favor of plan confirmation — then the role of the Subchapter V trustee ends. If the Court confirms a nonconsensual plan — i.e., some or all of the creditor classes vote against plan confirmation — then the Subchapter V Trustee will be a part of the case throughout its life.

The previous paragraph provides a nice segue into a big difference between a classic Chapter 11 and a Subchapter V Chapter 11. First, a little vocabulary is needed.

  1. Creditor Classes
  2. In any Chapter 11 case, the creditors are divided into classes according to the kinds of claims they have. All creditors in a particular class have to be treated the same way, and all creditors in a class should have the same kind of claim against the bankruptcy estate.

  3. Impaired v. Unimpaired; Consenting v. Nonconsenting; Consensual v. Nonconsensual
  4. If the treatment of a creditor’s claim is the same as if the debtor had not filed for Chapter 11 protection, the claim is said to be unimpaired. Otherwise, it is impaired. Only impaired classes are permitted to vote on the plan. A class is deemed to have voted in favor of confirmation if more than one-half of the creditors in the class and at least two-thirds of the dollar amounts of the claims have voted in favor of confirmation. Such a class is referred to as a consenting class. Otherwise, it is a nonconsenting class.

    If all the voting classes vote in favor of confirmation, the plan is called consensual. Otherwise, it is nonconsensual.

  5. Confirmation Of The Plan
    1. The Consensual Plan

    Regardless of whether the case is a classic Chapter 11 or a Subchapter V, the Court will confirm a consensual plan.

    1. The Nonconsensual Plan In A Classic Chapter 11

    The Court can confirm a nonconsensual classic Chapter 11 case as long as there is at least one consenting class. However, the Court’s confirmation of a nonconsensual plan triggers something called the absolute priority rule, under which the debtor loses all estate assets unless all the creditors are being paid in full. The only way the debtor can keep any estate assets is by buying them back from the estate by adding new, reasonably equivalent value to the estate.

    1. The Nonconsensual Plan In A Subchapter V

    Unlike a classic Chapter 11, in a Subchapter V case, the Court can confirm a nonconsensual plan even if there are no consenting classes. And unlike a classic Chapter 11, there is no absolute priority rule in a Subchapter V. Thus, the debtor retain all the estate assets, even if none of the creditors voted in favor of the plan.

For more information on Business Bankruptcy In 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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