How Becoming a Debtor in Possession Changes a Business Owner’s Role

Chapter 11 bankruptcy is a remedy designed to help a distressed business gain debt relief, reorganize and return to solvency. A defining feature of Chapter 11 is that the existing equity owner often remains in control of the company as a “debtor in possession” (DIP). However, an important transformation occurs. The business owner’s role shifts from that of an entrepreneurial leader to that of a fiduciary, with legal duties to creditors and to the bankruptcy court.

As a DIP, the business owner is tasked with managing the business exclusively in the best interests of the bankruptcy estate, meaning their actions are intended to maximize value for the company and creditors. A DIP has the rights and powers and performs the functions and duties of a Chapter 11 trustee.

The following are the principle responsibilities of a debtor in possession:

• Obtain court approval for major actions — While in charge of day-to-day operations, the DIP cannot make all decisions unilaterally. Significant actions such as selling key assets, incurring new debts or entering substantial contracts require advance approval from the bankruptcy court. This safeguards against favoritism or rash decisions that could negatively affect creditors.
• File reports and disclosures — The DIP must regularly submit financial documents, including monthly operating reports, detailed tax filings and up-to-date financial statements. These filings allow the court, the U.S. Trustee and creditors to track the business’s financial status, to ensure compliance and to monitor whether the business is improving or declining.
• Manage assets and claims — Protecting and preserving the value of the estate is paramount. The DIP is required to prevent waste, neglect or misuse of assets. They must also evaluate and, if necessary, challenge questionable or inflated claims submitted by creditors.
• Develop a reorganization plan — A central duty is to draft and propose a practical plan of reorganization. This plan must address how debts will be restructured and how the business will emerge as a viable enterprise. Often, the process involves negotiating adjustments to contracts, leases and payment schedules directly with creditors.
• Hire professionals (with court approval) — When expertise outside management’s scope is needed, the DIP may hire professionals such as legal counsel, accountants or appraisers. Each professional engagement requires court approval, however, and fees are subject to review.

Serving as a DIP comes with strict fiduciary duties. All actions must serve the creditors’ best interests, not the owner’s personal or financial gain. Should creditors suspect self-dealing, fraud, mismanagement, or bad faith, they may petition the court to remove the DIP and appoint a trustee to take over.

It is advisable for a DIP to work closely with a skilled Chapter 11 attorney. An attorney provides guidance on a DIP’s rights and duties, ensures proper procedures are followed, seeks court approvals when required and defends against any allegations of wrongdoing. 

The Law Offices of Michael Jay Berger in Beverly Hills is one of Southern California’s most experienced Chapter 11 bankruptcy law firms, with 12 locations across the region. If your business is facing overwhelming debt, please call 310-271-6223 or contact us online to schedule a consultation.