Dorsey U.S. Bankruptcy Law Q&A Series Six

Dorsey & Whitney LLP

We hope that you found the five previous Q&A series regarding what to do when a U.S. customer files for Chapter 11 bankruptcy protection helpful. You can check them out here: One, Two, Three, Four, and Five. This Series Six will address questions relating to the plan process, including the disclosure and solicitation process, what happens if a plan is or is not confirmed, and how that impacts your right to a distribution.

1. Question: What is a Chapter 11 plan and are there different types?

A Chapter 11 plan, once approved by the bankruptcy court, governs the debtor’s exit from bankruptcy and the treatment of claims against and interests in the debtor’s estate. A Chapter 11 plan may either provide for reorganization or liquidation of the debtor. Whereas reorganization will involve the debtor itself continuing operations, liquidation will often involve the sale of substantially all of the debtor’s assets to a new company. A debtor may accomplish a number of other transactions through a plan, including a merger, the creation of a liquidating trust, modification of liens, or issuance of new debt or equity.

2. Question: How can I learn more about a proposed plan and its effects?

A debtor is required to file and serve upon all creditors a disclosure statement containing adequate information regarding the proposed plan to enable a creditor to make an informed judgment regarding whether or not to vote in favor of the plan. The disclosure statement will include information regarding, among other things, the treatment of different types of claims and estimated recoveries, what led to the bankruptcy filing, and what has taken place during the bankruptcy case. Both the proposed plan and disclosure statement tend to be lengthy, detailed documents and it would be worthwhile to retain U.S. bankruptcy counsel to review them on your behalf, to determine how your rights will be affected and to guide you through the confirmation process.

3. Question: What is the proposal, solicitation, and confirmation process like and what role do suppliers play?

Chapter 11 debtors are given the exclusive right to file a plan during the early months of the case, and are often the only party to do so even after the exclusive period comes to an end. The plan proponent will first request approval of a disclosure statement and solicitation and notice procedures with respect to the proposed plan. Once approved, the plan proponent solicits acceptance of the plan in accordance with the approved procedures. The solicitation materials will include copies of the plan and disclosure statement, a ballot, directions and deadlines for submitting the ballot and objecting to confirmation, and notice of the confirmation hearing. When solicitation is complete, a confirmation hearing will be held before the bankruptcy court.

To the extent a supplier’s pre-bankruptcy claim against a debtor does not qualify as a reclamation claim or for “critical vendor” treatment (see Series Two), its claim will typically be classified as general unsecured. General unsecured claims are placed near the back of the line for distribution, behind several other typical classes of claims, e.g. secured and administrative. As a result, suppliers’ pre-bankruptcy, non-reclamation, non-critical vendor claims are often impaired, meaning they will not receive a full recovery.

Holders of impaired claims are entitled to vote on a plan unless they are not entitled to any distribution, in which case they are typically deemed to reject the plan. A plan may be confirmed over the objection of a dissenting impaired class if the plan satisfies certain requirements, including that at least one impaired class has accepted the plan and the plan is fair, equitable, and does not unfairly discriminate as to classes of claims and interests.

4. Question: What happens if the bankruptcy court confirms a proposed plan?

If the bankruptcy court confirms a proposed plan, the debtor consummates the transactions contemplated by the plan on an effective date. This will likely include distributions to creditors, such as administrative expense creditors that provided goods and services to the debtor during the bankruptcy case. To the extent such suppliers are not paid in the ordinary course during the bankruptcy case, they must be paid in full on the effective date in order for the plan to be confirmed. General unsecured creditors may receive a distribution of cash or securities on the effective date, but often plans provide for the creation of a liquidating trust out of which distributions to general unsecured creditors are made depending on the extent to which the trust successfully liquidates assets and prosecutes claims on behalf of the post-confirmation estate.

Confirmation of the plan will result in the discharge of all pre-bankruptcy liabilities of the debtor, meaning creditors cannot pursue their pre-bankruptcy claims against the debtor even if the confirmed plan does not pay such claims in full. Indeed, the plan substitutes a debtor’s pre-bankruptcy obligations to its creditors with those obligations set forth in the plan.

5. Question: What happens if the bankruptcy court denies confirmation of a proposed plan?

If a bankruptcy court denies confirmation of a proposed plan, the debtor may amend its plan and seek confirmation of the amended plan, or the debtor or another party in interest may propose an alternative plan. If the estate lacks liquidity to continue reorganization proceedings, the bankruptcy court may convert the case to a liquidation under Chapter 7 of the Bankruptcy Code or dismiss it entirely. If the case is converted to Chapter 7, the debtor’s business operations will cease and a trustee will be appointed to marshal and liquidate the debtor’s assets for the benefit of creditors. In that event, the costs of administering the Chapter 7 case will take first priority, meaning general unsecured creditors are one step farther back in the line for distributions.

6. Question: What is the likelihood that a Chapter 11 case will be successful?

Chapter 11 is open to businesses of all sizes and to individuals. As a result, a considerable proportion of Chapter 11 cases filed in the United States are unsuccessful and result in dismissal or conversion to liquidation under Chapter 7. However, in our experience, larger cases (meaning those where the debtor has over $10 million in assets or liabilities) are dramatically more likely to succeed, particularly because they are more likely to have the resources needed to complete a successful reorganization under Chapter 11. Often, larger cases will involve the sale of substantially all of the debtor’s assets to a new company, the proceeds of which are used to pay creditors.

While a successful Chapter 11 case may result in some creditors receiving less than they are due, the ultimate result is usually that a business is able to continue operating which benefits the nation’s economy as a whole. As such, reorganization in the U.S. is appropriately viewed as an essential element of our capitalist system.

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We do hope that you enjoyed these series and now have a fuller understanding of the Chapter 11 process, at least as it may impact the rights of foreign suppliers of bankrupt U.S. companies. From the outset of the bankruptcy case, a creditor’s rights are directly impacted – whether through imposition of the automatic stay which prohibits further collection efforts or through the imposition of a 20-day deadline to file reclamation claims measured from the filing date. As such, as soon as you learn of a customer’s bankruptcy filing, you should contact your trusted U.S. bankruptcy counsel to guide you through the process, ensure you do not miss any key dates or deadlines, and obtain the greatest recovery possible.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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