7 Stages of Chapter 11 Bankruptcy for a Business, From Petition to Confirmed Plan

Commercial bankruptcy, even the so-called reorganization under Chapter 11, is not a single court date. It is a process, with several steps, and each step requires preparation. Here are the steps: preparation before filing, filing the petition and getting the automatic stay, operating the business as debtor in possession, reporting and the meeting of creditors, sorting out creditor claims, proposing a plan and the vote, and confirmation. Your business may continue operating, but your finances are restricted by court orders. Creditor claims have to be settled, and plans for the future have to be written and approved by court and creditors.

Before You File

The first stage of the Chapter 11 process is before filing. Before you file, your lawyer will want to see a full schedule of your secured and unsecured debts, with copies of the notes, any UCC filings, any tax claims, and any lawsuits. You’ll need to lay out for your lawyer who owns what collateral, and the value of that collateral. You’ll need copies of any leases, and a good ledger showing receivables and pending bills, and payroll. If any of the owners or principals have personal guarantees on any debt, those will have to be disclosed too. It also makes sense to have a sense of how much working capital you need to operate in the short term, because filing the petition doesn’t stop the need to make payroll, pay insurance, and buy inventory.

The second stage of the process is filing the petition. You’ll have to pay a court filing fee of $1,167 plus an administrative fee of $571. Right away, filing the petition creates an automatic stay stopping almost all collection actions. That’s the breathing spell that lets you think about how to save the business. With the petition you have to file or later produce schedules of assets and liabilities, and a statement of financial affairs, to be filed within 14 days unless the court extends that date.

Debtor in Possession

Stage three: running the business as debtor in possession. In most Chapter 11 cases, the business debtor remains in possession of its assets and continues operating in an effort to save itself. However, the debtor in possession is not free to do whatever it wants. There are special rules on bank accounts, taxes, insurance, record keeping, reporting, and other things. You are not supposed to do anything outside the ordinary course of business without court approval. There are also special rules for hiring professionals. It’s like moving to a new state. Maybe your drivers license is still valid, but everything else changes.

Some cases need to address vital and urgent issues in the first few days. One is getting court permission to use cash collateral of secured lenders. You may have to convince secured lenders that they are adequately protected. Payroll, utilities and financing to keep running for the near term are also critical first-day issues, since no business can continue without meeting payroll and keeping the lights on. There may be a need to stop a pending foreclosure. A simple professional practice may need far less than a big hotel or a manufacturer.

The fourth stage of the Chapter 11 case is reporting and the meeting of creditors. The debtor in possession has to file monthly operating reports with the court, which are also shared with the U.S. Trustee and creditors. Those monthly operating reports are critical. Within 40 days, the U.S. Trustee will hold what is called a 341 meeting of creditors. It’s a chance to question you under oath about your financial affairs.

Creditor claims is the fifth stage of the Chapter 11 process. Creditors may file proofs of claim, which the debtor must review for wrong claims, duplicate claims, or claims that are unsupported or not backed up. Secured claims may need to be valued. Tax claims may need to be reconciled. Contracts and leases may have to be analyzed and either assumed or rejected.

The sixth step in the process is the plan. The plan sets out how the debtor proposes to treat all secured and unsecured creditors, and any owners. How will payments be changed? What collateral will be given up? Will property be sold? How will defaults be cured? How will taxes be paid? How are payouts to unsecured creditors proposed to be handled? The debtor is the only party that may file a plan for the first 120 days. The court may extend that period, or can shorten it, but never past 18 months.

Before creditors get to vote, the court generally has to approve a disclosure statement, a document with enough information about the debtor and its finances that creditors can make a reasoned decision. There are exceptions for plans called prepackaged, a small business plan if it has enough information, and one under Subchapter V, unless the court orders a disclosure statement. When the vote comes, a class is deemed to accept the plan only if, among other things, more than half of its creditors by number vote yes.

Finally, there is confirmation. Getting court confirmation of a plan is not automatic. The court can only confirm a plan if it finds that plan feasible, in good faith, and that it meets the provisions of the Bankruptcy Code. Plan issues include classification of claims, priority of claims, the treatment of equity, valuation, collateral, and the cram down. The plan doesn’t have to be unanimous, but all objections must be resolved or overcome. Confirmation of a plan generally discharges many or most pre-confirmation debts, with exceptions. However, all that is just on paper. Then the debtor actually has to deliver the results the plan promises. It has to be able to make the payments and keep the reports up to date.

Subchapter V tries to move through these stages faster. A debtor qualifies for it only if total debts are no more than $3,424,000. At least half of that debt must come from the business. A status conference must be held within 60 days, with a plan due within 90 days. Only the debtor may file a plan. Faster can mean lower cost, but a debtor who is not ready before filing is setting a trap for itself.

It helps to remember that the petition itself can be filed fast. What takes time is preparing for reorganization and building a case for what you hope to do. Your lawyer should have a solid understanding of your company, its assets, its liabilities, what makes it tick, and its alternatives. That takes time, thought, and research, and the time to do it right is not when the petition is being typed.