Reorganizing Various Classes of Debt in a Chapter 11 Plan

Chapter 11 bankruptcy, also referred to as reorganization, is primarily utilized by corporations, partnerships and LLCs to restructure and partially repay their debts while continuing their business operations. The principle behind this remedy is that a debtor company is more valuable as an operating entity than in liquidation (i.e., through a chapter 7 bankruptcy), thereby allowing creditors to recoup a portion of outstanding debt. 

The Chapter 11 organization plan, to be approved by the bankruptcy court, must be found to be in the creditors’ best interests. The plan must provide for reorganizing various classes of debt, as follows:

• Priority debt — Priority debts include certain taxes, wages owed to employees and costs associated with the bankruptcy process itself. These debts generally cannot be discharged or reduced and must be paid in full in most Chapter 11 cases. However, the payment schedule for these debts can be adjusted. For example, back taxes might be spread out over several years to alleviate immediate financial pressure on the debtor.
• Secured debt — These are debts backed by collateral. In Chapter 11, they are typically prioritized. The reorganization plan must ensure that secured creditors receive at least the value of their collateral. Debtors may choose to continue making regular payments or may propose a refinancing that could extend the payment period or reduce the amount of principal or interest. For instance, terms of a mortgage might be renegotiated to lower the monthly payments and to extend the duration of the loan.
• Unsecured debt — Credit card debts, trade credits and other loans without collateral backing and are more flexible in terms of reorganization. The debtor may propose to pay a reduced percentage of the owed amount or extend the payment period. The specifics depend largely on the debtor’s ability to generate future revenues, as projected in the reorganization plan. The plan must be fair and equitable and in order to gain approval from creditors and the court.
• Equity securities — Holders of equity, such as stockholders, are the last to receive consideration in a Chapter 11 reorganization. In many cases, existing equity interests may be diluted or wiped out as new equity is issued to creditors as part of debt-for-equity swaps, a common strategy to reduce outstanding debt and provide the company with a healthier balance sheet.

The reorganization of different classes of debt requires balancing the interests of the debtor with those of the creditors. Each class of debt offers different challenges and opportunities for restructuring. An experienced Chapter 11 attorney can help you create a viable plan that allows your business to emerge from bankruptcy as a sustainable entity. 

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.