When Can a Chapter 11 Case Be Converted or Dismissed for Cause?

Chapter 11 offers a debtor the opportunity to reorganize their business and attempt to become profitable again. However, a Chapter 11 plan must be in the creditors’ best interests. There are instances where a party in interest, such as creditors or the U.S. trustee, may file a motion to convert the case to Chapter 7 or to have it dismissed entirely. This requires showing sufficient cause. The debtor’s attorney then has the opportunity to raise defenses.

Under the U.S. Bankruptcy Code, specifically 11 U.S.C. § 1112, a party filing a motion to convert or to dismiss a Chapter 11 case for cause must clearly state the asserted grounds, which may include the following:

• Substantial or continuing losses — If the debtor’s operation is continuously losing money and there is no reasonable likelihood of rehabilitation, creditors may push for conversion or dismissal to mitigate further losses.
• Incompetence or gross mismanagement — This might include fraud, dishonesty, or gross mismanagement of the debtor’s affairs.
• Unauthorized use of cash collateral — It must be shown that this misuse is substantially harmful to one or more creditors.
• Failure to file required reports — This includes failure to file schedules and statements of financial affairs in a timely manner, which are crucial for assessing the debtor’s position.
• Failure to pay taxes or other debts post-petition — This can indicate the debtor’s inability to manage their financial responsibilities during the bankruptcy process.
• Material default by the debtor — Alternately, the moving party can assert the debtor’s inability to effectuate substantial consummation of a confirmed plan.

The Bankruptcy Code sets out several other grounds for a motion to convert or dismiss. The motion is filed with the bankruptcy court, giving notice to all creditors and other parties in interest.

The debtor’s Chapter 11 attorney has various tools available to oppose motions for conversion or dismissal. Effective strategies to oppose such motions include:

• Challenging the grounds of the motion — The attorney can argue against the validity of the causes cited in the motion. For instance, if the motion claims gross mismanagement, the attorney might present evidence showing competent management and decision-making.
• Proposing an alternative plan — If the original reorganization plan is deemed unfeasible, the debtor’s attorney can propose modifications to the plan that address the court’s and creditors’ concerns.
• Demonstrating improvement — Evidence of recent improvements in profitability or effective cost-cutting measures can be used to argue that the debtor is on the path to recovery.
• Negotiating with creditors — The attorney can negotiate with creditors for better terms or more time, which might persuade them to withdraw their motion or sway the court’s opinion in favor of continuing the Chapter 11 proceedings.
• Legal defenses — A debtor’s attorney may argue that the filing of the motion was procedurally improper or that the facts do not meet the legal standard for cause.

If the motion is granted after a hearing, and the case is converted to Chapter 7, the business assets will be liquidated to pay creditors, which may lead to the debtor’s dissolution. If the case is dismissed, the debtor is left subject to its pre-bankruptcy rights and liabilities. If the motion is denied, the Chapter 11 continues, with any plan modifications the court deems necessary.

The Law Offices of Michael Jay Berger in Beverly Hills has extensive experience representing debtors in Chapter 11 cases, using strategic planning to promote their successful emergence from reorganization. Call 310-271-6223 or contact us online for a free consultation.