Chapter 11 Dismissal vs Conversion: 5 Factors Under §1112(b)

Once cause is shown, section 1112(b) hands the bankruptcy judge a choice between two endings, and the statute does not ask the owner which one it would prefer. The court "shall convert a case under this chapter to a case under chapter 7 or dismiss a case under this chapter, whichever is in the best interests of creditors and the estate." Conversion to Chapter 7 means a trustee and a liquidation. Dismissal means the company walks out of court with its creditors behind it.

The five factors below are the ones the text of section 1112 itself makes decisive. Local case law elaborates on them in ways counsel will know; the statute's shorter list is the part that governs in every district.

1. Cause Comes First, and the Statutory List Is Only Where It Begins

Nothing happens under section 1112(b) without cause, and section 1112(b)(4) says what cause "includes." Before confirmation, the entries most likely to reach an operating company are substantial or continuing loss to the estate combined with "the absence of a reasonable likelihood of rehabilitation"; gross mismanagement; failure to keep appropriate insurance; "unauthorized use of cash collateral substantially harmful to 1 or more creditors"; failure to comply with a court order; unexcused failure to file required reports; failure to attend the meeting of creditors or to respond to the U.S. trustee; failure to pay postpetition taxes or file postpetition returns; failure to file or confirm a plan within the time fixed; and failure to pay the fees owed under chapter 123 of title 28, which include the quarterly fees the U.S. trustee collects.

The word "includes" matters. The list is not exhaustive, and a court may find cause in conduct the drafters did not name. Section 1112(e) also lets the U.S. trustee seek conversion or dismissal when a voluntary debtor fails to file its schedules and its list of the twenty largest unsecured creditors within fifteen days of the petition, or whatever further time the court allows.

Whether a business that has lost money every month of the case still holds "a reasonable likelihood of rehabilitation" is a question the statute poses and declines to answer.

Thirty days after the motion is filed, the hearing must have begun, and the court must decide within fifteen days after that, unless the movant consents to a continuance or compelling circumstances prevent it. Those are short periods for a company to repair a reporting failure or find the tax money it did not set aside.

2. The Best Interests of Creditors and the Estate Decide Between the Two Endings

The statute supplies the standard and not the factors. What it does supply, in other sections, is a precise account of what each ending does, and that account is what a court compares.

Conversion, under section 348(a), operates as an order for relief under Chapter 7 without changing the petition date. The debtor in possession gives way to a Chapter 7 trustee, whose job is to collect and liquidate. A claim that arose during the Chapter 11 case, other than an administrative expense, is treated under section 348(d) as though it arose just before the petition. The estate's claims survive the conversion, including avoidance actions a trustee may pursue against creditors who were paid shortly before the filing, and the Supreme Court noted in Jevic that conversion was one way a Chapter 7 trustee could press a lawsuit the Chapter 11 estate had not finished.

Dismissal runs in the other direction. Section 349(b) provides that, unless the court orders otherwise for cause, dismissal reinstates avoided transfers and voided liens, vacates certain turnover and recovery orders, and revests estate property in the debtor. It restores the position before the case, or, more exactly, restores most of it, since the court may order otherwise for cause and the months spent in Chapter 11 do not return. A dismissed company resembles a building site after the inspector lifts a stop-work order: the permit is back, the scaffolding stands where it was left, and the subcontractors who were waiting outside the fence come back through the gate with their invoices. Creditors resume their state-law remedies, a funder may resume its lawsuit, and under section 349(a) the company is ordinarily free to file again.

One practical question sits beneath the standard: whether anything is left for a trustee to collect. An estate with unencumbered assets or avoidance claims worth pursuing argues for conversion (the owner's hope that dismissal returns everyone to the starting line misreads what section 349(b) restores). An estate whose every asset is pledged to a secured lender offers a trustee little to administer. Quarterly fees to the U.S. trustee, owed in a traditional Chapter 11 case, stop accruing either way, since the obligation runs until the case is closed, converted, or dismissed.

3. A Trustee or an Examiner Can Be the Answer to Both

Section 1112(b)(1) contains a third path. The court need not convert or dismiss if it "determines that the appointment under section 1104(a) of a trustee or an examiner is in the best interests of creditors and the estate." Section 1104(a) permits a Chapter 11 trustee for cause, "including fraud, dishonesty, incompetence, or gross mismanagement," or where appointment serves the interests of creditors, equity holders, and the estate. The business keeps operating. The owner no longer operates it.

This option does not exist in a Subchapter V case, where section 1181(a) makes section 1104 inapplicable and section 1185 governs removal of the debtor in possession instead.

4. Unusual Circumstances Can Stop Both, on Narrow Terms

Section 1112(b)(2) forbids conversion or dismissal if the court "finds and specifically identifies unusual circumstances establishing that converting or dismissing the case is not in the best interests of creditors and the estate," and a party also establishes two things. First, a reasonable likelihood that a plan will be confirmed within the small business deadlines of sections 1121(e) and 1129(e), or within a reasonable time where those do not apply. Second, if the cause is an act or omission of the debtor, a reasonable justification for it and a cure within a reasonable period the court fixes.

The cure provision does not reach continuing losses with no prospect of rehabilitation. That ground is carved out by name, which leaves an insolvent company with no way to justify itself out of the first entry on the list.

5. The Debtor's Identity Limits Which Ending Is Available

A debtor in possession may convert its own case to Chapter 7 under section 1112(a), unless the case began as an involuntary Chapter 11 or was converted into Chapter 11 at someone else's request. The court may not convert a farmer, or a corporation that is not a moneyed, business, or commercial corporation, to Chapter 7 without its request. Conversion to Chapter 12 or 13 requires the debtor's request and a debtor not already discharged, and section 1112(f) bars conversion to any chapter the debtor could not have filed under in the first place.

An LLC cannot convert to Chapter 13. Only individuals qualify for that chapter, so the option belongs to a sole proprietor and not to the company.

Before a Motion Is Filed

Most of the causes on the statutory list are failures of cash, reporting, or time, and many of them can be seen coming well before anyone files a motion. An owner still outside bankruptcy can ask whether the debts driving the company toward a petition, merchant cash advances first among them, could be restructured by agreement. Delancey Street conducts that review at no charge and in confidence. Being a settlement company, not a law firm, it gives no legal advice and turns to independently licensed counsel for anything that requires it. A company already in Chapter 11 and facing a motion to convert belongs with its bankruptcy counsel, not with a settlement firm.

The statute leaves the choice to the judge. The file the judge reads was written by the company, one monthly report at a time.