Chapter 11 Reorganization
For a business, the goal of a Chapter 7 bankruptcy is euthanasia—putting it out of its misery by
shutting it down and distributing its assets to creditors. Chapter 11 has a much more complicated and
ambitious goal—resuscitating a business so that it can ultimately emerge as a viable economic concern
Keeping a business in operation benefits virtually all company stakeholders: employees, customers,
creditors, shareholders, and the community.
Both individuals and businesses can use Chapter 11. Businesses usually prefer Chapter 11 to Chapter 7
because Chapter 11 does not require them to dissolve at the end, as Chapter 7 does.
Debtor in Possession
Chapter 11 does not require a trustee. The bankrupt is called the debtor in possession and, in essence,
serves as trustee. The debtor in possession has two jobs: to operate the business and to develop a plan
of reorganization.
Creditors’ Committee
The creditors’ committee usually consists of the seven largest unsecured creditors. In a Chapter 11
case, the creditors’ committee is important because typically, there is no neutral trustee to watch over
their interests. The committee generally protects the interests of its constituency, and the Bankruptcy
Code requires the committee to communicate diligently with all creditors.
Plan of Reorganization and Conrmation of the Plan
A plan of reorganization provides for the payment of debts and the continuation of the business.
Anyone who proposes a plan of reorganization must also prepare a disclosure statement to be mailed
out with the plan. The purpose of this statement is to provide creditors and shareholders with enough
information to make an informed judgment.
All the creditors and shareholders have the right to vote on the plan of reorganization. Even if creditors
vote against the plan of reorganization, the court can still confirm it under what is called a cramdown
(as in “the plan is crammed down the creditors’ throats”).
Case: In re Fox1
Facts: Unable to pay a $2 million fraud judgment owed to United Phosphorus, Ltd., Donald Fox filed a
voluntary petition under Chapter 11 of the Bankruptcy Code. His plan of reorganization envisioned that
he would use revenues from his company, Midland Fumigant, Inc., to pay off his creditors in full over
five years, with interest. CPA Kirk W. Wiesner testified that the plan’s projections were conservative
and could easily be met.
Midland had six classes of creditors. All of the classes accepted the plan, except the two classes in
which United was a member. The bankruptcy judge noted that United had an incentive to oppose
Midland’s reorganization because this business was highly competitive and, if Midland were to cease
operations, United would be able to raise its prices substantially.
Issues: Was Fox’s plan of reorganization feasible and fair? Should the court impose a cramdown?
Excerpts from Judge Robinson’s Decision: Debtor has proposed a plan which pays all creditors in
full, with interest. United, the only objecting creditor, will be paid in full [within 16 months]. Debtor
has provided a reasonable and orderly repayment of his debts. Debtor’s desire and intent to provide a
1 2000 Bankr. LEXIS 1713 United States Bankruptcy Court, District of Kansas, 2000.
mechanism for him to retain his business interests and assets is consistent with the purposes of the
Bankruptcy Code. The plan may satisfy [the Code] even though the plan may not be one which the
creditors would themselves design.
United contends that the Plan is not feasible because the projections of Midland’s income and
expenses are unreliable. The purpose [of the Bankruptcy Code] is to prevent confirmation of visionary
schemes that promise creditors and equity security holders more than the debtor can possibly attain
after confirmation.
Will the reorganized debtor emerge from bankruptcy solvent and with a reasonable prospect of
success? Debtor’s expert, Kirk Wiesner, analyzed Midland’s financial statements, and determined that
Midland would have sufficient income and cash flow during the life of Debtor’s Plan, to make the
anticipated distributions and loans that will fund Debtor’s Plan. Based on Wiesner’s Projections, which
proved conservative in [the past], when Midland’s actual income doubled the projected income, the
Court concludes that Midland will have a continuing ability to distribute and loan funds to the Debtor
as contemplated.
The Plan has a reasonable assurance of success and is not likely to be followed by liquidation, or
the need for further financial reorganization. As such, the Debtor’s Plan meets the feasibility
requirement. The Court further notes that the United States Trustee has filed a statement in support of
confirmation of the Plan.
[T]he Court finds that the Debtor’s Plan is fair and equitable and, as a result, the fact that [two]
Classes did not accept the Plan does not preclude confirmation.
The Debtor’s Plan is confirmed over the objection of United and over the dissenting votes of [two]
Classes for the reasons stated.
Question: Two out of six classes of creditors opposed Midland’s plan yet the court imposed a
cramdown. Is this fair?
Answer: Bankruptcy courts certainly listen to any objections that creditors offer to a plan.
Question: What was United’s conflict of interest?
Question: Under what circumstances will a court accept a creditor’s objections and refuse to
impose a cramdown?
Answer: If the plan seems to be promising creditors and shareholders more than the debtor can
Discharge
A confirmed plan of reorganization is binding on the debtor, creditors, and shareholders. The debtor
now owns the assets in the bankrupt estate, free of all obligations except those listed in the plan.
Small-Business Bankruptcy
In 2005 Congress included provisions designed to speed up the process for businesses with less than $2
million in debt.
Chapter 13 Consumer Reorganizations
The purpose of Chapter 13 is to rehabilitate an individual debtor. It is not available at all to
businesses or to individuals with more than $360,475 in unsecured debts or $1,081,400 in secured
debts. Under Chapter 13, the bankrupt consumer typically keeps most of her assets in exchange for a
promise to repay some of her debts using future income.
Beginning a Chapter 13 Case
To initiate a Chapter 13 case, the debtor must file a voluntary petition. Creditors cannot use an
involuntary petition to force a debtor into Chapter 13.
Plan of Payment
The debtor must file a plan of payment after filing the voluntary petition. Under the plan, the debtor
must (1) commit some future earnings to pay off debts, (2) promise to pay all secured and priority
claims in full, and (3) treat all remaining classes equally.
Discharge
Once confirmed, a plan is binding on all creditors whether they like it or not. The debtor is washed
clean of all pre-petition debts except those provided for in the plan, but, unlike Chapter 7, the debts are
not permanently discharged. The debts become permanently discharged only when the bankrupt fully
complies with the plan.
You Be the Judge: Marrama v. Citizens Bank of Massachusetts2
Facts: Robert Marrama lied on his Chapter 7 bankruptcy petition. Although he disclosed that he was
the sole beneficiary of a trust that owned a house in Maine, he listed its value as zero. Marrama also
denied that he had transferred any property during the prior year. In fact, the Maine property was
valuable, and he had given it for free to the trust seven months prior to filing for bankruptcy protection.
Marrama also lied when he claimed that he was not entitled to a tax refund, when he knew that the IRS
check for $8,700 was in the mail.
Once Marrama found out that the bankruptcy trustees were going after the Maine property, he filed
a notice to convert his Chapter 7 bankruptcy to Chapter 13. The trustees and creditors objected. They
contended that because Marrama had acted in bad faith when he tried to conceal the Maine property, he
should not be permitted to convert. The bankruptcy court agreed. The Supreme Court granted
certiorari.
You Be The Judge: Can a bankruptcy court refuse to allow a debtor to convert from Chapter 7 to
Chapter 13?
Argument for Marrama: Under the Bankruptcy Code, a Chapter 7 debtor may convert a case, with
only two restrictions. First, the bankrupt can convert only once. Second, the debtor must meet the
conditions that would have been required for him to file under the new chapter in the first place.
Nothing in the Code suggests that a bankruptcy judge has the right to prohibit a conversion because of
the debtor’s bad faith.
If a debtor acts in bad faith, the court has other remedies: It can convert the case back to a Chapter
7 liquidation; it can refuse to approve the plan of payment; or it can charge the debtor with perjury.
That is the law, whether the Court likes it or not.
Argument for the Bankruptcy Trustee: A bankruptcy court has the unquestioned right to dismiss a
Chapter 13 petition if the debtor demonstrates bad faith. There seems no logical reason why a court
would have the right to dismiss a case for bad faith, but not the right to prohibit a filing under Chapter
13 to begin with. In both cases, the court is simply saying that the individual does not qualify as a
debtor under Chapter 13. That individual is not a member of the class of honest but unfortunate debtors
whom the bankruptcy laws were enacted to protect.
Holding: The Supreme Court held 5-4 that the bankruptcy court had the right to prohibit the
conversion. The arguments laid out in the book reflect the opinions of Justice Stevens for the majority
and Justice Alito for the dissent (Scalia, Roberts, Thomas).
Question: Why would a debtor be allowed to discharge debts under Chapter 13 that he is not able
to discharge under Chapter 7?
2 127 S.Ct. 1105, 2007 LEXIS U.S. 2651, Supreme Court of the United States, 2007.
Multiple Choice Questions
1. CPA QUESTION A voluntary petition filed under the liquidation provisions of Chapter 7 of the
federal Bankruptcy Code:
(a) is not available to a corporation unless it has previously filed a petition under the
reorganization provisions of Chapter 11 of the Code
(b) automatically stays collection actions against the debtor except by secured creditors
(c) will be dismissed unless the debtor has 12 or more unsecured creditors whose claims total at
least $5,000
(d) does not require the debtor to show that the debtor’s liabilities exceed the fair market value of
assets
2. CPA QUESTION Decal Corp. incurred substantial operating losses for the past three years.
Unable to meet its current obligations, Decal filed a petition of reorganization under Chapter 11 of
the federal Bankruptcy Code. Which of the following statements is correct?
(a) A creditors’ committee, if appointed, will consist of unsecured creditors.
(b) The court must appoint a trustee to manage Decal’s affairs.
(c) Decal may continue in business only with the approval of a trustee.
(d) The creditors’ committee must select a trustee to manage Decal’s affairs.
3. CPA QUESTION Unger owes a total of $150,000 to eight unsecured creditors and one fully
secured creditor. Quincy is one of the unsecured creditors and is owed $32,000. Quincy has filed a
petition against Unger under the liquidation provisions of Chapter 7 of the federal Bankruptcy
Code. Unger has been unable to pay debts as they become due. Unger’s liabilities exceed Unger’s
assets. Unger has filed papers opposing the bankruptcy petition. Which of the following statements
regarding Quincy’s petition is correct?
(a) It will be dismissed because the secured creditor failed to join in the filing of the petition.
(b) It will be dismissed because three unsecured creditors must join in the filing of the petition.
(c) It will be granted because Unger’s liabilities exceed Unger’s assets.
(d) It will be granted because Unger is unable to pay Unger’s debts as they become due.
4. Dale is in bankruptcy proceedings under Chapter 13. Which of the following statements is true?
(a) His debtors must have filed an involuntary petition.
(b) His unsecured creditors will be worse off than if he had filed under Chapter 7.
(c) All of his debts are discharged as soon as the court approves his plan.
(d) His creditors have an opportunity to voice objections to his plan.
5. Grass Co. is in bankruptcy proceedings under Chapter 11, _____________ serves as trustee. In the
case of _____________, the court can approve a plan of reorganization over the objections of the
creditors.
(a) the debtor in possession; a cramdown
(b) a person appointed by the U.S. Trustee; fraud
(c) the head of the creditors’ committee; reaffirmation
(d) the U.S. Trustee; voidable preference
Essay Questions
1. James, the owner of an auto parts store, told his employee, Rickey, to clean and paint some tires in
the basement. Highly flammable gasoline fumes accumulated in the poorly ventilated space. James
threw a firecracker into the basement, as a joke, intending only to startle Rickey. Sparks from the
firecracker caused an explosion and fire that severely burned him. He filed a personal injury suit
against James for $1 million. Is this debt dischargeable under Chapter 7?
Answer: Injuries caused by an accident are dischargeable, not those caused intentionally or
2. Mary Price went for a consultation about a surgical procedure to remove abdominal fat. When
Robert Britton met with her, he wore a nametag that identified him as a doctor, and was addressed
as “doctor” by the nurse. Britton then examined Price, touching her stomach and showing her
where the incision would be made. It turned out that Britton was the office manager, not a doctor.
Although a doctor actually performed the surgery on Price, Britton was present. It turned out that
the doctor left a tube in Price’s body at the site of the incision. The area became infected, requiring
corrective surgery. A jury awarded Price $275,000 in damages in a suit against Britton. He
subsequently filed a Chapter 7 bankruptcy petition. Is this judgment dischargeable in bankruptcy
court?
3. You Be the Judge: WRITING PROBLEM Lydia D’Ettore received a degree in
computer programming at the DeVry Institute of Technology, with a grade-point average of 2.51.
To finance her education, she borrowed $20,516.52 from a federal student loan program. After
graduation, she could not find a job in her field, so she went to work as a clerk at an annual salary
of $12,500. D’Ettore and her daughter lived with her parents free of charge. After setting aside $50
a month in savings and paying bills that included $233 for a new car (a Suzuki Samurai) and $50
for jewelry from Zales, her disposable income was $125 per month. D’Ettore asked the bankruptcy
court to discharge the debts she owed DeVry for her education. Did the debts to the DeVry
Institute impose an undue hardship on D’Ettore? Argument for D’Ettore: Lydia D’Ettore lives at
home with her parents. Even so, her disposable income is a meager $125 a month. She would have
to spend every single penny of her disposable income for nearly 15 years to pay back her $20,500
debt to DeVry. That would be an undue hardship. Argument for the Creditors: The U.S.
government guaranteed D’Ettore’s loan. Therefore, if the court discharges it, the American
taxpayer will have to pay the bill. Why should taxpayers subsidize an irresponsible student?
D’Ettore must also stop buying new cars and jewelry. And why should the government pay her
debts while she saves money every month?
Answer: The court refused to discharge D’Ettore’s debts. It reasoned that anyone who can afford to
4. Dr. Ibrahim Khan caused an automobile accident in which a fellow physician, Dolly Yusufji,
became a quadriplegic. Khan signed a contract for the lifetime support of Yusufji. When he refused
to make payments under the contract, she sued him and obtained a judgment for $1,205,400. Khan
filed a Chapter 11 petition. At the time of the bankruptcy hearing, five years after the accident,
Khan had not paid Yusufji anything. She was dependent on a motorized wheelchair; he drove a
Rolls-Royce. Is Khan’s debt dischargeable under Chapter 11?
5. After filing for bankruptcy, Yvonne Brown sought permission of the court to reaffirm a $6,000 debt
to her credit union. The debt was unsecured and she was under no obligation to pay it. The credit
union had published the following notice in its newsletter:
If you are thinking about filing bankruptcy, THINK about the long-term implications. This action,
filing bankruptcy, closes the door on TOMORROW. Having no credit means no ability to purchase
cars, houses, credit cards. Look into the future—no loans for the education of your children.
Should the court approve Brown’s reaffirmation?
Discussion Questions
1. ETHICS On November 5, Hawes, Inc., a small subcontractor, opened an account with Basic Corp.,
a supplier of construction materials. Hawes promised to pay its bills within 30 days of purchase.
Although Hawes purchased a substantial quantity of goods on credit from Basic, it made few
payments on the accounts until the following March when it paid Basic over $21,000. On May 14,
Hawes filed a voluntary petition under Chapter 7. Does the bankruptcy trustee have a right to
recover this payment? Is it fair to Hawes’s other creditors if Basic is allowed to keep the $21,000
payment?
Answer: The bankruptcy court ruled that this payment was a voidable preference. It was not made
2. Look on the web for your state’s rules on exempt property. Compared with other states and the
federal government, is your state generous or stingy with exemptions? In considering a new
bankruptcy statute, Congress struggled mightily over whether or not to permit state exemptions at
all. Is it fair for exemptions to vary by state? Why should someone in one state fare better than his
her neighbor across the state line?
3. Some states permit debtors an unlimited exemption on their homes. Is it fair for bankrupts to be
allowed to keep multimillion-dollar homes, while their creditors remain unpaid? But other states
allow as little as $5,000. Should bankrupts be thrown out on the street? What amount is fair?
4. What about the rules regarding repeated bankruptcy filings? Debtors cannot obtain a discharge
under Chapter 7 within eight years of a prior filing. Under Chapter 13, no discharge is available
within four years of a prior Chapter 7 or 11 filing and within two years of a prior Chapter 13 filing.
Are these rules too onerous, too lenient or just right?
5. A bankrupt who owns a house has the option of either paying the mortgage or losing his home. The
only advantage of bankruptcy is that his debt to the bank is discharged. The U.S. House of
Representatives passed a bill permitting a bankruptcy judge to adjust the terms of mortgages to aid
debtors in holding on to their houses. Proponents argued that this change in the law would reduce
foreclosures and stabilize the national housing market. Opponents said that it was not fair to
reward homeowners for being irresponsible. How would you vote if you were in the Senate?
6. In the Grisham case, the debtor had virtually no income but owed about $200,000 in debts that
could not be discharged. What kind of fresh start is that? Should limits be placed on the total debt
that cannot be discharged? Is the list of non-dischargeable debts appropriate?