How Chapter 11 Restructures Business Debt

When a business finds itself drowning in debt, Chapter 11 bankruptcy can offer a lifeline. Unlike Chapter 7, which liquidates assets to repay creditors, Chapter 11 allows for debt reorganization. This means the business gets a chance to develop a plan to reorganize its debts and return to solvency. Here’s how Chapter 11 tackles these challenges:

The optimal outcome of a Chapter 11 plan is the emergence of a financially healthy business. This involves debt restructuring, by which the business reduces its overall debt burden and/or obtains extended repayment terms, creating a more manageable operation. While no creditor gets everything they’re owed, the plan offers a fair and feasible path to repayment, fostering continued business relationships.

In a Chapter 11, creditors are categorized based on the type of debt they hold. This classification determines their priority in receiving payment under the reorganization plan. Here’s the breakdown:

• Priority claims — These are top-tier claims, including unpaid wages, employee benefits and certain taxes. These must be paid in full before other classes receive anything.
• Secured claims — Secured creditors hold collateral (namely, assets) that secure their loans. Examples include mortgages and car loans. In a Chapter 11 plan, they can choose to keep the collateral if the debt isn’t fully repaid.
• Unsecured claims — These represent general debts with no collateral backing, like supplier invoices and credit card balances. Unsecured creditors typically receive pennies on the dollar, or even nothing, depending on the funds remaining after payoff of superior claims.

The success of a reorganization plan hinges on creditor approval. Creditors receive the plan in advance and have the right to object. Their objections can focus on aspects like the fairness of the proposed repayment amounts, the timeline for repayment and the viability of the business itself. These objections can be fatal to the plan unless remedied. The debtor might need to negotiate with creditors, offering revisions to the plan to address their concerns and secure their votes.

Chapter 11 also addresses ongoing financial obligations like leases and executory contracts (agreements with ongoing performance obligations). The debtor can assume the lease or contract, which means continuing to fulfill the terms, as long as defaults are cured and certain assurances are given. Alternatively, the debtor can reject the contract if it is too burdensome and/or not conducive to returning the business to solvency. The decision depends on whether there is a benefit to the business. Leases for profitable locations might be kept, while unfavorable supply contracts might be rejected.

An experienced Chapter 11 bankruptcy attorney can help you face the intricacies of classifying claims, negotiating with creditors and crafting a viable reorganization strategy. With careful planning and execution, Chapter 11 can be the key to saving your business and regaining its solvency.

At the Law Offices of Michael Jay Berger in Beverly Hills, my team of attorneys routinely obtains plan confirmations for companies in financial straits. Call 310-271-6223 or contact us online to schedule a free initial consultation.