A long time purchaser of your inventory has just filed bankruptcy under Chapter 11 of the Bankruptcy Code while still owing you a large sum of money. A creditor's initial reaction is often despair. They believe that it is the end of the world and that they will be lucky to recover a few cents on the dollar. Do not despair! There is some hope for recovery of your money.
Plan of Reorganization
In a Chapter 11 bankruptcy, the debtor's goal is to reorganize and reemerge as a functioning entity. This goal is accomplished by developing a business plan, which must be approved by the bankruptcy court.
A Chapter 11 bankruptcy may be beneficial to both debtors and creditors. Debtors benefit because they continue to operate their businesses while creditors cannot seize their assets. Creditors benefit because there is the possibility for recovering the debt owed and because long standing business relations can be continued. The theory behind allowing debtors to remain in possession of operations is that current management is familiar with the business dealings and is best equipped to restore it to viability.
The Automatic Stay
Debtors also benefit from the "Automatic Stay in Bankruptcy". The Automatic Stay is immediately effective, and operates to prohibit actions against property of the debtor's estate. It provides the debtor with breathing space to allow it to formulate how best to pay off its creditors and reorganize its affairs.
Debtors are also provided with additional benefits under Chapter 11 of the bankruptcy code. Under certain circumstances, debtors may sell property free and clear of liens. In addition, when appropriate, the debtor in possession may assume, reject or assign executory contracts or unexpired leases, even if the terms of the contract do not permit it. Nevertheless, creditors may be surprised to discover that the Automatic Stay not only assists the debtor, but can also serve to protect a creditor. By staying all actions against property of the debtor's estate, the assets of the debtor can be preserved and a single creditor cannot deplete all of the debtor's assets to the detriment of other creditors. The Stay allows for orderly distribution of assets to creditors and/or time for the debtor to formulate a plan to treat all of its creditors fairly.
Creditors may also obtain relief from the Automatic Stay upon a showing of cause warranting such relief, such as the proof of a lack of adequate protection for creditors or failure to pay post-filing obligations on contracts and leases. Property with no equity and that is not necessary for an effective reorganization may be subject to relief from the Stay.
Benefit to Creditors
Creditors can also benefit from a Chapter 11 reorganization if the debtor is able to reemerge as a functioning entity. A Chapter 11 reorganization plan may lead to payment of the debt. While the payment may not be immediate or in full, it is often more than what would have been received in a Chapter 7 liquidation.
Finally, creditors will have an element of control over the debtor. Upon the filing of a Chapter 11, the debtor provides the court with schedules listing all of its assets and liabilities. These schedules inform the creditor as to where all of the debtor's assets are located and what priority will apply to the creditor. The creditor can therefore monitor the debtor's reorganization and assert some control over the debtor's actions. In short, a creditor will discover that the filing of a Chapter 11 bankruptcy is not necessarily the end of the world and that the creditor as well as the debtor can actually benefit.
The above is not meant to replace legal counsel. If you'd like to speak to one of Gross & Romanick's attorneys, please contact the firm directly by calling (703) 273-1400 or by filling out our online information request form.
