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Chapter 11 Bankruptcy

Posted by attorney Keith Carr

CHAPTER 11 OVERVIEW Chapter 11 allows a business to propose a plan of repayment for part or all debts owed to its creditors over an extended period of time. In the alternative, the plan may propose liquidation whereby the business sells all of its assets to repay creditors. In Chapter 11, creditors must vote and approve the plan, and the court must approve the plan. The primary benefit of a Chapter 11 for a business is that the business may continue to operate during the course of the Chapter 11 pending approval of the Chapter 11 Plan. In addition, the debtor in a Chapter 11 bankruptcy serves as its own trustee or "debtor-in-possession" or "DIP."

The debtor as DIP has all the duties of a conventional trustee, i.e. preserving bankruptcy assets, obtaining financing to continue operations, gaining approval of business leases (see below), etc. The debtor must propose, and has the exclusive right to so propose, a Chapter 11 Plan within the first four months of entering bankruptcy. Thereafter, both the creditors and court must approve the Chapter 11 plan. Federal and State Employment Taxes Employment taxes are normally withheld from an employee's payroll and paid accordingly to the IRS or state. The problem is when the business fails to turn over sums to the IRS or state for one or more quarters. Unlike income taxes, payroll taxes are held "in trust" for the IRS. Therefore, the IRS is aggressive in collecting delinquent employment taxes.

Employment taxes may not be discharged in bankruptcy. However, a business owing Federal and State Employment Taxes may propse a Chapter 11 plan for the repayment of those past due employment taxes in full. If the government has a tax lien for unpaid employment taxes (the usual case), the lien will extend to the business' operating cash. This is called "cash collateral." The business will necessarily have to gain the government's consent to continue in business using cash from the business on which the lien exists or the business will have to obtain a court order to operate using cash from the business. Upon entering bankruptcy (on the first day), the business must obtain a temporary order in this situation allowing use of cash on which exists a government lien for unpaid employment taxes.

Thereafter, either the court will grant further use of cash on a permanent basis or the government will consent to the same. Business Leases One of a business owner's most important asset will be the lease in which the business operates. Unexpired business leases for a term (usually for at least a year) must be "assumed" in the Chapter 11 within the first 120 days of filing the bankruptcy in order to keep the lease. If the business does not assume the unexpired lease by that time, then the lease is deemed rejected and must be surrendered. A business owner must show the court that it can timely perform all obligations under the lease before the court will allow assumption. Special Requirements for Chapter 11

If a business is organized as a corporation or partnership, it must file for Chapter 11 bankruptcy in order to rehabilitate itself. A business may also file for Chapter 7 if it does not wish to continue and merely wants to submit assets for liquidation.

Investment Property

Many debtors must file Chapter 11 to reorganize their secured debts (such as mortgages) because they cannot file for Chapter 13. The Chapter 13 guidelines are codified in 11 U.S.C. Section 109(e) ( As of this writing, a debtor with more than $360,475 of unsecured debts and secured debts totaling more than $1,081,400.00 must file for Chapter 11. (A competent bankruptcy attorney should be consulted as to which Chapter the debtor should file.) ( process of a Chapter 13 Bankruptcy is less complicated and geared toward consumer debtors. However, debtors in Chapter 11 with investment property can realize the same benefits. Investment real estate is real estate that is not the debtor’s principal residence.

In Chapter 11, debtors may “strip" or have the mortgage on investment property lowered to the value of the property in question if the property is underwater (the value of the property is less than that of the mortgage). The Chapter 11 plan will then modify the mortgage on investment property to reflect a new, lower principal and monthly payments. However, creditors must vote for acceptance of the Chapter 11 plan. At one class of impaired claims (with the modified mortgage as one of these claims) must vote to accept the plan. 11 U.S.C. 1129(a)(10) ( In addition, if debtor is an individual, the debtor must complete the Chapter 11 plan.

As to debtor’s principal residence, the second or higher mortgage may be stripped in Chapter 11 (in California - In re Zimmer ( so long as the value of the residence is less than the balance of the first mortgage. However, because the residential second mortgage is stripped and will be impaired in the Chapter 11 plan, at least one class of impaired claims must vote to accept the plan. Also, if the debtor is an individual, the debtor must complete the Chapter 11 plan.

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