Mike Markham on Chapter 11 – Part 1 of 10 – Individuals

There is much to know about Chapter 11 bankruptcies, and I can cover a good deal of this in a way that should be very useful for business and estate planning lawyer.

Part 1 – Individuals

Let’s start off with individuals.  Individuals can file under Chapter 7 for liquidation, or they can file under Chapter 13 for payment plans, which will normally apply when there is mostly consumer debt. If there is more than approximately $1,000,000 of secured debt or $300,000 of unsecured debt, then they are required to file for a Chapter 11 reorganization if there is mostly consumer debt or when a reorganization works better than a Chapter 7 liquidation for them.  A husband and a wife can file a joint Chapter 11 if they have a joint creditor situation.

 
Sometimes individuals own companies that have to file for bankruptcy, and because the individuals have guaranteed the debt, they may also end up in a Chapter 11 reorganization.

 
As with any bankruptcy filing, the debtor completes a petition with schedules, has a Section 341 creditor meeting, and under Chapter 11 will have to file monthly operating reports showing all revenues and expenditures.  The bankruptcy court is not likely to tolerate things like private school tuition or other “luxury items” that many affluent individuals regard as necessities, so this can be somewhat of a culture shock.  In addition, the Office of the United States Trustee, which is a branch of the Department of Justice, will typically be fairly active in Chapter 11 cases.

 
The goal of a Chapter 11 is normally to prepare the plan that deals with all of your creditors, and then get that confirmed. This is how in a Chapter 11 an individual gets a discharge, which I will talk about a little bit later. The uniqueness of Chapter 11 for individuals is that the absence of equity gives unsecured creditors quite a bit of negotiating power, although some Chapter 11s are intended to keep the business and assets together and operational long enough to get the most value possible for the creditors and to keep the business operational, as discussed below.
Normally, in a corporate Chapter 11, equity is wiped out because the company is insolvent.  You can’t wipe out equity in an individual case, because that individual lives on, and so the rule – the Absolute Priority Rule – is that you can’t force a plan on a dissenting class of creditors, if any inferior class of creditors is receiving or retaining anything under the plan.  For example, unsecured creditors are inferior to secured creditors, and shareholders are inferior to unsecured creditors.  You can’t successfully ask the bankruptcy court to reduce or adjust indebtedness owed to secured creditors unless the unsecured creditors are accepting a lower payment or other alteration, and you can’t ask the unsecured creditors to accept a court required alteration in favor of the debtor if the equity holders are not permitting a sacrifice.

 
It is therefore very important to think about who the creditors and equity holders will be well before a Chapter 11 is filed, because you need some friendly creditors and some cooperative shareholders or proprietors if there is going to be a debt adjustment, as described below.

 

There are interesting dynamics in the individual cases.  If you have creditors that are just never going to agree with you as a debtor because they do not like you, there is some animosity, or they are family members or former partners – individual cases can be very difficult.  Hopefully, you can convince people that as long as the plan provides more than what the person would get in Chapter 7, when the assets are liquidated, then you can convince creditors to vote in favor of the plan.

 

The problem with wealthier individuals that go to Chapter 11 is that they have a lot of non-exempt assets.  If you don’t have a lot of non-exempt assets, Chapter 7 is usually the way to go.  File it, claim your exemptions, get your discharge and move on.  But people with more sophisticated financial situations might have investment properties or own interest in entities that they don’t want to lose through a kind of a fire sale auction process in a Chapter 7.
So a lot of interesting things can happen in Chapter 11, but generally speaking people use it to try to reorganize, and the first question I was asked before when they come to me is,”I’ve got this company and I want to file Chapter 11. I want to try to get reorganized.”  A lot of people think that bankruptcy and Chapter 11 don’t do anything for you on the revenue side of the ledger.  It might stop certain liabilities and put them over to the side for the moment, but the fact of the matter is if you are operating at a loss before you get into bankruptcy, if the budget tells you that you are going to continue to operate at a loss, then Chapter 11 is not going to work.

 

 

One of the critical things that a Chapter 11 lawyer, or advisor of a company that is going in that direction, needs to do is to make sure you have a budget going forward in Chapter 11. Making sure that it is going to work and takes into consideration the cost of the Chapter 11 reorganization and the kind of things that you might have to pay or the kind of things that you might not have to pay in Chapter 11.  Then at least you can operate, and possibly for some period of time you can operate and preserve some value, lop off some bad assets, bad stores, bad locations, and then figure out if you can make the run of it going forward.

 

You see a lot of Chapter 11s get filed in the context of divorce cases.  Frankly, I have seen cases where individual Chapter 11 debtors file in order to get assets sold, because the spouse would not agree during the pendency of the bankruptcy to sell assets, or to just try to level the playing field in a divorce case.  However, the Bankruptcy Court is not going to take jurisdiction over the divorce issues.  They are not going to take jurisdiction over equitable distribution, alimony, support, or any kind of things that could happen in a divorce case.  But you do see individual cases that have a divorce angle to them, and that is fairly common.

 

Since starting with the Johnson Pope Bokor Ruppel & Burns firm in 1988, Michael’s practice has concentrated on bankruptcy and insolvency related Litigation.
Michael has represented corporate and individual debtors, secured creditors, equipment lenders, landlords, creditor’s committees, trustees and petitioning creditors in involuntary bankruptcies.
Michael also has substantial experience in receivership cases.