How Different Types of Debt Are Reorganized in Chapter 11

Chapter 11 offers financially troubled companies relief from unsustainable levels of debt and a path for returning to profitability. In this type of bankruptcy, the debtor — or in rare cases, a creditor — proposes a plan outlining how debts will be partially repaid over a set period of time. A plan will be confirmed if it meets legal requirements and is deemed fair and equitable to all creditors. 

However, the reorganization plan also must be approved by creditors. Their claims fall into one of three or more classes — priority, secured and unsecured — and repayments are prioritized accordingly. Each class gets to vote, with approval typically requiring a majority in number and two-thirds in value within each class.

At the top of the hierarchy are priority debts, which must be paid in full before any other type of debt. These include the administrative expenses of the bankruptcy, such as lawyer fees and court costs. They also include salaries, wages and benefits owed to employees for a specific period before the filing and unpaid federal, state, and local taxes accrued up to a certain point in time.

Secured creditors hold collateral, such as property or assets, that guarantees debt repayment. Secured debts can be treated in the reorganization plan as follows:

• Repayment in full — The debtor proposes to repay the secured debt in full, possibly over time.
• Cramdown — The court allows the debtor to modify the terms of the debt, such as reducing it to the fair market value of the collateral.
• Foreclosure — If no agreement is reached, the secured creditor can foreclose on the collateral and sell it to recoup their losses. If the collateral securing the debt is sold, the proceeds are used to pay off the secured portion.

The option chosen can depend on secured creditors’ assessment of the debtor’s future viability and the value of the collateral. 

Unsecured creditors have no collateral backing their debt. They face the highest risk of receiving only a fraction of what they’re owed or nothing at all. However, there are different levels of unsecured debts:

• Priority unsecured — Certain unsecured debts like child support and student loans are given preferred treatment, which often aligns with that given to priority debts.
• General unsecured — Credit card debt, medical bills, and personal loans fall under this category. They have the lowest priority and are typically subject to significant reduction in the reorganization plan. Ongoing lawsuits against the debtor are treated as general unsecured claims. This makes Chapter 11 an excellent way to deal with lawsuits against the debtor.

Two options for reorganizing these debts are to make periodic payments over a span of years or to make one lump sum payment at the end of the Chapter 11 case. Most Chapter 11 cases involve a repayment plan over 5 years.

Getting creditor approval can be difficult. Creditor objections are fairly common and are a major reason why you need an experienced Chapter 11 lawyer’s help.

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.