Hurdles to Creditors Getting Paid in Chapter 11

In a Chapter 11 bankruptcy, creditors often face an uncertain terrain when it comes to recovering payment on their claims. The Bankruptcy Code’s “absolute priority rule” controls in what order available funds are used to satisfy creditors of different types. However, several external factors can impact the timeline for payment, the amount of recovery and even whether a creditor will be paid at all. Creditors need to understand and assert their rights at the onset of the case and going forward.

Below are some of the complications that creditors can encounter during the payout process:

• Claim avoidance — The bankruptcy court may confirm a Chapter 11 reorganization plan that limits or changes the rules for how creditors are paid. This can affect a creditor’s priority, limit the value of their claim or delay the payment. The debtor in possession or the trustee assigned to the case has the power to “avoid” certain transactions or claims. These avoidance powers can impact claims that were improperly transferred before the bankruptcy case began as well as liens that were not correctly executed. If a creditor’s claim is subject to avoidance, they may receive a lower recovery or face delays due to additional litigation. In some cases, creditors can initiate an adversary proceeding to assert their rights if the debtor or trustee fails to take action.
• Claim impairment — A claim is considered impaired if the Chapter 11 plan changes the creditor’s rights, such as modifying payment terms or reducing the claim value. Impairment can occur if the debtor proposes terms that don’t satisfy the full value of the claim, alters the maturity date of the debt or changes other critical terms. However, a debtor can “cure” these issues by making the obligation current and compensating the creditor for any damages caused by default. Negotiating with the debtor over these altered terms can delay the process and affect the creditor’s recovery and expectations.
• Subordinated claims — The Bankruptcy Code allows the court to reorder the priority of claims based on equitable principles, often referred to as “equitable subordination.” This process moves certain claims to a lower payment priority within the same class, meaning creditors with subordinated claims may face lower or delayed payouts compared to other creditors in their class. Subordination can severely limit a creditor’s ability to recover the full value of their claim.
• Cash collateral — A Chapter 11 debtor in possession often needs immediate access to cash or cash-equivalent collateral to continue operations. To use this collateral, the debtor must first seek the secured creditor’s consent. If the creditor agrees, they can negotiate favorable terms in exchange. If the parties can’t agree, a court hearing may be necessary to decide the matter. These negotiations and hearings can impact the creditor’s payout expectations.
• Adequate protection — Adequate protection is a concept in bankruptcy law that ensures secured creditors are compensated for the risk posed by the debtor’s use of their collateral during the bankruptcy process. This could take the form of periodic cash payments, additional liens on assets or payment of post-petition interest. If the debtor offers adequate protection, creditors may secure more favorable payment terms and experience fewer delays.

A Chapter 11 bankruptcy can be an unpredictable process,. Even though creditors’ claims are prioritized, multiple factors can affect how, when and if they will recover payment. An experienced Chapter 11 creditors’ attorney can guide you in the most effective ways to assert your claim.

The Law Offices of Michael Jay Berger in Beverly Hills champions creditors’ rights in Chapter 11 cases, helping secured lenders, investors and other interested parties get the maximum possible relief they are legally entitled to. Our firm has multiple California locations. Contact us online or call 310-271-6223 to schedule a consultation.