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Chapter 11 Bankruptcy
Debtor Exclusivity for filing plans
Chapter 11 enables debtors, both individuals and businesses alike, to, among other things, save real property from foreclosure by curing delinquent mortgage and property tax payments over time, avoid eviction, assume or reject contracts, modify secured claims, including sometimes mortgage liens encumbering a principal residence, and to discharge most types of pre-petition debts, including, but not limited to, credit cards, utilities, medical bills, old income taxes, deficiencies, lines of credit, rejected contract obligations, personal loans, personal guarantees, condo/HOA dues, mortgages and car loans.
In a traditional Chapter 11 case there are no debt limits or other eligibility requirements.
While the case is pending, the debtor remains in exclusive possession and control of all property of the estate, and is empowered to use, sell or lease such property, even outside the ordinary course of business upon Court approval. There is no automatic appointment of a trustee. There is no co-debtor stay.
In a traditional chapter 11 case, the debtor has 120 days exclusivity to file a plan, but has no specific deadline by which to do so. Creditors vote to confirm a chapter 11 plan. Generally, to achieve court approval (confirmation) in a traditional chapter 11 case, the plan must:
- Have at least one impaired class of creditors vote in favor of confirmation
- Be proposed in good faith
- Be feasible
- Not unfairly discriminate against any impaired non-consenting class
- Provide that all priority unsecured claims are paid in full over the 3-5 year plan term (e.g. recent taxes, domestic support obligations, administrative claims, etc.)
- Satisfy the “Best Interest Test” by providing that general unsecured claims are to be paid at least what they would receive in a hypothetical chapter 7 liquidation
- Satisfy the “Best Efforts Test” by providing that general unsecured claims are to be paid at least all of the debtor’s projected disposable income over the 3-5 year plan term
- Satisfy the “Absolute Priority Rule” where equity interests are not retained unless general unsecured creditors are paid in full.
**Note – There is a split of authority as to whether the absolute priority rule applies in individual Chapter 11 cases. Currently, there is no binding authority in the Third Circuit on the issue.
And, finally, a business debtor will generally receive a discharge upon confirmation. Whereas, an individual debtor will generally receive a discharge after the debtor completes all payments under the plan.
Importantly though, there are certain specific types of chapter 11 debtors that get special/different treatment under the bankruptcy law. They are: (1) the “single asset real estate” debtor; and (2) the “small business debtor;” and (3) the “subchapter 5” debtor.
Single Asset Real Estate Debtor (SARE)
A chapter 11 debtor is a “single asset real estate” debtor (SARE) if: (1) their primary business is the operation of a single piece of income-producting property (other than residential real property with fewer than 4 residential units or a family farmer); and (2) substantially all of the debtor’s income is derived from that property.
Creditors of a single asset real estate debtor, particularly those foreclosing on the real property, can obtain relief from the automatic stay in circumstances not available to creditors in traditional chapter 11 cases. Specifically, upon a creditor’s request, the court will grant relief from the automatic stay if the debtor has not, within 90 days from the petition date, either: (1) filed a feasible plan; or (2) begins making interest payments to the creditor in an amount equal to the non-default contract interest rate on the value of the creditor’s interest in the real estate. If a SARE debtor fails to satisfy these requirements, the court is likely to grant a secured creditor relief from the automatic stay, which will permit the creditor to commence or continue with a foreclosure of the real property.
Small Business Debtor
A Chapter 11 debtor is a “small business debtor” if the debtor: (1) is engaged in commercial or business activities (excluding SARE); (2) has liquidated debts of not more than $2,725,625, of which at least 50% arose from those business activities; and (3) did not elect to be a subchapter 5 debtor.
A small business debtor has 180 days exclusivity to file a plan, and must do so by the drop dead deadline of 300 days from the petition date.
Subchapter 5 Debtor
On February 19, 2020, the Small Business Reorganization Act (SBRA) went into effect. The SBRA created a new type of Chapter 11 debtor that gets special/different treatment under the bankruptcy law – a “subchapter 5” debtor. Subchapter 5 was enacted for purposes of creating a new streamlined and less costly Chapter 11 option for those engaged in a small business activities, both individuals and businesses alike.
Subchapter 5 enables debtors, both individuals and businesses alike, to, among other things, save real property from foreclosure by curing delinquent mortgage and property tax payments over time, avoid eviction, assume or reject contracts, modify secured claims, including sometimes mortgage liens encumbering a principal residence, and to discharge most types of pre-petition debts, including, but not limited to, credit cards, utilities, medical bills, old income taxes, deficiencies, lines of credit, rejected contract obligations, personal loans, personal guarantees, condo/HOA dues, mortgages and car loans.
For a Chapter 11 debtor to be a subchapter 5 debtor, the debtor must: (1) elect to be a subchapter 5 debtor; (2) be engaged in commercial or business activities (excluding a single asset real estate business); and (3) have liquidated debts of not more than $7,500,000, of which at least 50% arose from the debtor’s business activities.
While the case is pending, the debtor remains in exclusive possession and control of all property of the estate, and is empowered to use, sell or lease such property, even outside the ordinary course of business upon Court approval. A trustee is automatically appointed to all subchapter 12 cases. The trustee is charged with, among other things, investigating the debtor’s financial affairs, facilitating plan confirmation and, in certain circumstances, act as disbursing agent for certain of the debtor’s plan payments. There is no automatic appointment of an unsecured creditor committee in subchapter 5, no quarterly fees due to the United States Trustee, and no absolute priority rule. Also, within 60 days of the filing, a status conference will be held to help facilitate an expeditious and economical resolution of the case. And, at least 14 days in advance of the status conference, the debtor must file a status report detailing its efforts to attain a consensual plan of reorganization.
A subchapter 5 debtor has perpetual exclusivity to file a plan, and must do so within 90 days of the petition date. Creditors vote on confirmation of the plan. But, a plan can still be confirmed even when all classes of creditors vote against it. Generally, to achieve court approval (confirmation), the plan must:
- Be proposed in good faith
- Be feasible
- Not unfairly discriminate against any impaired non-consenting class
- Provide that all priority unsecured claims are paid in full over a 3-5 year plan term (e.g. recent taxes, domestic support obligations, administrative claims, etc.)
- Satisfy the “Best Interest Test” by providing that general unsecured claims are to be paid at least what they would receive in a hypothetical Chapter 7 liquidation
- Satisfy the “Best Efforts Test” by providing that general unsecured claims are to be paid at least all of the debtor’s projected disposable income over a 3-5 year plan term
If the plan is consensual, the debtor will receive a discharge immediately upon confirmation. If the plan is non-consensual, then a discharge is entered after completion of all payments required in the commitment period.