Chapter 11 Bankruptcy Basics for Unsecured Creditors

Chapter 11 is the section of the United States bankruptcy code that specifically deals with the reorganization of corporations and also partnerships.

Chapter 11 is the section of the United States bankruptcy code that specifically deals with the reorganization of corporations and partnerships. Entities filing under Chapter 11 are trying to preserve the existence of their businesses and maintain an ownership interest. Their goal is to continue day-to-day operations while working out acceptable repayment plans with creditors who could otherwise force the sale of assets. Unsecured creditors, such as suppliers and bondholders, however, take the backseat.

Claim Verification

When entities file a Chapter 11 petition, creditors--both secured and unsecured--must verify that the debtors listed their claims appropriately in the petition schedules. Since tangible assets guaranteeing their claims don't exist, unsecured creditors must double-check the filing; and disputing an inaccurate listing is of paramount importance at this stage. The burden of proof falls on creditors, who also must exercise due diligence to ensure that their claims are listed. Failure to do so means these claims won't be considered during the reorganization of the business.

Committee Membership

The trustee overseeing the Chapter 11 petition appoints a creditors' committee. Membership is open to the unsecured creditors who can prove they hold the seven largest claims against the corporation or partnership. Members of the creditors' committee act as watchdogs during the reorganization to ensure that changes in management practices do not adversely affect the interests of the creditors.

Fiduciary Duty

Unsecured creditors with sufficiently large claims to warrant a seat on the creditors' committee have a fiduciary duty to act in the interest of creditors with only small claims. As they help formulate the reorganization plan, these unsecured creditors may petition the trustee to hire their own legal counsel or other professionals that will help them with such duties. Since a thorough investigation of the corporation's (or partnership's) business practices involves operational aspects, unsecured creditors typically involve independent accountants, management consultants or human resources professionals.

If the debtor fails to file a reorganization plan within 120 days of petitioning the bankruptcy court and does not request an extension of time, the creditors' committee may file its own proposed plan instead. Members of the committee must act quickly, since other creditors may beat them to the punch by floating a liquidation plan, for example. In this latter case, unsecured creditors once again take a backseat to their secured counterparts.

Adversary Proceedings

The creditors' committee may petition the presiding bankruptcy judge to authorize starting adversary proceedings against the corporation or partnership, or against a debtor in possession of assets. This step protects all creditors against losing out, due to disputed lien priorities or issues with the subordination of claims. Such proceedings may also challenge the details of a proposed plan of reorganization or liquidation.

References

• United States Courts: Chapter 11 Reorganization Under the Bankruptcy Code
• U.S. Securities and Exchange Commission: Corporate Bankruptcy