As noted in the article Corporate Bankruptcy Overview, a Chapter 11 bankruptcy allows a company in financial distress to reorganize and continue operating as a going concern business. The key document in a Chapter 11 bankruptcy is the bankruptcy reorganization plan, also known as the bankruptcy plan. Under Federal Bankruptcy law, a debtor cannot emerge from a Chapter 11 bankruptcy until a bankruptcy plan meeting all of the Bankruptcy Code’s requirements has been approved by the court. Although any party in interest to the bankruptcy may propose a reorganization plan, the debtor is given the exclusive right to propose a plan during the first 120 days of the bankruptcy. This 120 day period of time is known as the “exclusivity period.” 11 U.S.C. Section 1123 establishes the many elements that must be addressed by a bankruptcy reorganization plan. Among these, the most important are:
- A grouping of claims into “classes” representing creditors with the same priority and similar interests.
- An explanation of what each class of claims will receive under the plan.
- An explanation of how the plan will be implemented, including what property will be retained by the debtor.
- An explanation of any modifications to existing liens, debentures, credit agreements, and any extensions of bond maturity dates or changes in interest rates.
- An explanation of whether any new stock or bonds will be issued by the debtor and to whom.
- List which contracts the debtor is assuming (keeping in force) and rejecting (terminating).
- An explanation of any other changes needed for the company to emerge from bankruptcy
Court Approval of a Bankruptcy Reorganization Plan
Under the Federal Bankruptcy Code, a judge cannot approve a bankruptcy plan unless the judge finds that several requirements are satisfied. The requirements that must be satisfied in order for a bankruptcy plan to be approved are stated in 11 U.S.C. Section 1129. Although Section 1129 contains a variety of requirements, the most important requirements of a bankruptcy plan are:
- Acceptance. The plan must either be actually accepted by each class of claims or treated as accepted by each class by operation of law, discussed below.
- Any class that is “impaired,” (meaning members of a class will receive less under the reorganization plan than members of that were entitled to before the bankruptcy), must receive at least as much as they would have received if the company was liquidated under chapter 7.
- All creditors must receive at least as much as they would receive in a Chapter 7 liquidation. This provision, found in the Bankruptcy Code at 11 U.S.C. Section 1129(a)(7) is sometimes referred to as the “best interests” test. Although parties must receive at least as much as they would receive in liquidation, they do not need to receive the same TYPE of payment. For example, a creditor who wants to be paid in cash may be paid in equity (stock) as long as the value of their equity interest is at least as much as what they would receive in liquidation.
- The plan must restore the company to solvency. A plan that leaves the company insolvent cannot be approved.
- Feasibility Test. Under 11 U.S.C. Section 1129(a)(11), the court cannot approve a plan if the debtor cannot meet the requirements of the plan. Generally, if the debtor is unlikely to remain solvent while implementing the plan, a court will find a debtor cannot meet the requirements of the plan.
Acceptance of a Reorganization Plan
Ordinarily, a reorganization plan must be accepted by a majority of the creditors of each class. A class is considered to have approved of a bankruptcy plan if the plan is approved by creditors holder at least 2/3 of the amount of claims in the class or by more than half of the creditors. Any party receiving nothing under the plan is presumed to have rejected the plan.
To facilitate findings of acceptance and eliminate the ability of an angry creditor to prevent plan acceptance, the Bankruptcy Code provides several conditions under which parties are treated as having accepted a reorganization plan even if they have not in fact accepted. First, if a class of creditors is “not impaired,” they are conclusively presumed to have accepted the plan and their vote is not required to be solicited for plan approval. Under certain conditions, the court can also “cram down” a reorganization plan on dissenting creditors; meaning the court approves the plan despite the fact that a class of creditors rejected the plan.
In order to cram down a reorganization plan, the court must find three conditions:
- At least 1 class of impaired creditors has consented to the plan.
- The plan does not discriminate unfairly among the classes of creditors.
- The plan is fair and equitable.
In a practical sense, conditions 2 and 3 mean that the “Absolute Priority Rule” must be followed and that creditors of equal priority must receive a pro rata share, rather than some creditors at an equal priority level receiving more and others receiving less. The Absolute Priority Rule is satisfied as long as no class with lower priority than the impaired class receives anything under the plan. Under the Bankruptcy Code, priority proceeds in the following order: Secured creditors, unsecured creditors, preferred shareholders, and finally common shareholders. Some provisions of the code may also give certain post-bankruptcy creditors “super-priority”; meaning they are paid before secured creditors.
Consequences of Plan Approval or Rejection
Once a reorganization plan is approved by the court, all parties, including creditors, shareholders, and tort claimants are bound by the terms of the plan. After a plan is approved, the company may be able to emerge from Chapter 11 bankruptcy.
If a proposed plan is not approved, the company cannot emerge from Chapter 11. If a plan is rejected during the exclusivity period, the debtor can propose a new bankruptcy plan. If the plan is rejected after the expiration of the exclusivity period, any party in interest can propose an alternative bankruptcy plan. If no reorganization plan can be approved, the court can either (1) convert the case to a Chapter 7 bankruptcy and begin proceedings to liquidate the company or (2) dismiss the bankruptcy case entirely. If the case is dismissed, parties must attempt to settle and collect on their debts under the applicable state or federal law rather than under federal bankruptcy law.
Legal Disclaimer
This website provides information addressing legal topics of interest to the general reader. You should not consider this information designed or adequate to meet any of your particular legal needs, concerns or inquiries. You should consult with a lawyer licensed to practice law in the jurisdiction appropriate to your legal situation to assess your situation and provide you with appropriate legal advice. A good starting point for finding a lawyer is to contact your state’s bar association.
This article is copyrighted by Knowledge Website, LLC – 2010