When Can a Chapter 11 Be Converted to a Chapter 7?

Businesses under financial distress can pursue a Chapter 11 bankruptcy if they believe they can reorganize and return to profitability. However, as the reorganization proceeds, there may be obstacles that cannot be overcome. In certain circumstances, a conversion to a Chapter 7 liquidation plan may be necessary.

A Chapter 11 debtor usually has the right to convert the case to Chapter 7 voluntarily at any time. Additionally, a creditor may ask the court to convert the case from Chapter 11 to Chapter 7 “for cause” — namely, that the debtor appears to be using Chapter 11’s restructuring process to frustrate creditors’ rights..

Motions to convert to Chapter 7 for cause may be granted if the court, after thorough factfinding, determines any of the following to be true:

• The debtor has no profitable core business around which to structure a reorganization.
• The debtor cannot or will not formulate a reasonable reorganization plan.
• The debtor’s financial picture indicates little or no ability to generate income and as such there is little reasonable likelihood of rehabilitation.
• The debtor’s business is suffering continuing operational losses, which may be shown by its negative cash flow during Chapter 11 and/or its inability to pay ordinary costs of business such as insurance, taxes and interest.
• The debtor has failed to comply with the court’s filing and reporting requirements, thus showing that it has not exercised the due diligence expected of a Chapter 11 debtor.
• The debtor is not using Chapter 11 for a legitimate reorganization effort or is otherwise not acting in good faith.

Upon finding that conversion to Chapter 7 is in the best interest of creditors, the court will grant the motion and a trustee will be appointed to liquidate the debtor’s assets and distribute the proceeds to creditors.

For most debtors, the prospect of an involuntary conversion from Chapter 11 to Chapter 7 is a harrowing one. Conversion means a cessation of business, which is a hard pill to swallow. A debtor wishing to challenge a conversion motion must have highly experienced legal counsel to rely on.

The Law Offices of Michael Jay Berger in Beverly Hills represents California businesses and individuals seeking protection under Chapter 11. Please call 310-271-6223 or contact us online to schedule a free initial consultation.