Bankruptcy Notes
Congress was a hair breath away from sending a new bankruptcy law to the President when a rider was placed relative to abortion funding and bankruptcy. This amendment brought 2 hot items to the forefront and got the measure tabled. What it's starting to look like is Republicans want to support a law for their bankruptcy lobbyist friends and Democrats want to support a law for their bankruptcy lobbyist friends, but neither want to sign a bill just before the November elections when the country is in a recession. So while new flocks rush to file bankruptcy, the old laws are still in effect. Recently, we saw a concise article on bankruptcy matters written by David Kupetz, a Los Angeles attorney and bankruptcy expert. The article was published in the Commercial Law Bulletin and Dave Kupetz was kind enough to allow us to reprint portions. We welcome questions or discussions and can be reached at dkupetz@skbr.com.
Reorganization Versus Liquidation. Chapter 11 of the Code provides a framework for business reorganization (Chapter 11 may also be used for liquidation). In contrast, Chapter 7 solely involves liquidation. Under Chapter 7, an independent bankruptcy trustee is appointed to conduct the liquidation and is charged with the responsibility of marshalling the debtor's assets, liquidating them, and ultimately distributing the net proceeds to creditors in accordance with the priorities set forth in the Code.
Upon the filing of a voluntary Chapter 11 Petition, a reorganization case is commenced. Contemporaneously with the commencement of the case, the debtor (the entity filing the voluntary petition) becomes a debtor in possession. The filing of a bankruptcy petition creates a bankruptcy estate that includes all legal and equitable interests of the debtor in property as of the commencement of the case. The debtor in possession continues to control and possess property of the estate and is authorized to manage and operate its business unless and until otherwise ordered by the Bankruptcy Court. The primary goals of Chapter 11 are rehabilitation of the debtor, equality of treatment of creditors holding claims of the same priority, and maximization of the value of the bankruptcy estate.
Proofs of Claim. In every business bankruptcy case where funds are available for distribution to creditors, there is a deadline (bar date) for filing claims. In a Chapter 7 liquidation case where there are sufficient assets to pay a dividend to creditors, with certain exceptions, a proof of claim is timely filed if it is filed with the Bankruptcy Court no later than ninety days after the first date set for the meeting of creditors called under Section 341 (a) of the Code. In a Chapter 11 case, all creditors with claims not scheduled by the debtor in possession or scheduled as disputed, contingent, or unliquidated must file proofs of claim if they desire to preserve their right to obtain any recovery from the estate. In Chapter 11 cases, a bar date is set for the filing of claims and creditors are provided with notice of the deadline. Failure to timely file a proof of claim can result in disallowance of the claim (even if it is otherwise meritorious).
The debtor and other parties in interest have the right to object to claims and the Bankruptcy Court may determine and allow or disallow claims, including contingent and unliquidated claims. If objected to, the Court will determine the amount of the claim as of the dated of the filing of the petition. It should be kept in mind that, in most Chapter 11 cases, general unsecured creditors will receive pro rata payments in an amount that is substantially less that 100% of their allowed claims.
Although a filed claim is deemed allowed unless it is objected to by a party in interest, before an unsecured creditor files a proof of claim he should carefully consider negative ramifications of such a filing. The filing of a proof of claim will constitute submission to jurisdiction of the Bankruptcy Curt for determination of that claim and any related counterclaims and may constitute the waiver of any right to a jury trial otherwise possessed by the claimant. Accordingly, before filing a proof of claim, the creditor should balance losing his right to participate in any distribution from the bankruptcy estate against submitting to the jurisdiction of the Bankruptcy Court.
Creditors' Committees. In a Chapter 11 case, a committee of creditors is generally appointed ordinarily consisting of persons, willing to serve, that hold the seven largest unsecured claims against the debtor. In very large cases, multiple committees representing different kinds of claims may be appointed. The fundamental rule of the creditors' committee is to investigate the facts of the case and to negotiate a plan of reorganization. This role will vary from case to case depending on the size and complexity of the case. However, in order to play a proper role in the case, members of the creditors' committee must be prepared to devote time, effort and thoughtfulness to the representation of the interests of the committee's constituency.
The benefits of participating on a creditors' committee include the ability to ascertain and understand the facts underlying the case, and monitor and influence the direction of the case and the potential for recovery by creditors. Further, the creditors' committee has the ability to retain professionals to represent the committee at the expense of the bankruptcy estate and to recover reimbursement for expenses incurred by committee members.
A committee member owes a fiduciary duty to the class of creditors the committee represents. Accordingly, when acting in the capacity of a committee member, the member must put the interests of the class he represents above his individual interests, avoid self-dealing, and act in good faith. In instances where the committee member has a conflict of interest with those of the class the committee represents, depending on the scope of the conflict, the committee member must either resign from the committee or not participate in decisions related to the conflict of interest.
Conclusion. In order to preserve and protect their rights, it is essential that creditors understand the deadlines they face and the defenses they may possess in a bankruptcy case. At the same time, creditors should weigh the benefits (potential reward/recovery) against the risks (strategic ramifications/costs) of initiating and/or actively participating in a bankruptcy case.
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