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Chapter 11 Issues A. General Corporate Reorganizations Filing a Chapter 11 Bankruptcy Chapter 11 generally involves a reorganization of a debtor's business affairs and assets, and is generally filed by corporations which require time to restructure their debts. As a Chapter 11 reorganization is the most complex of all bankruptcy cases and generally the most expensive, it should be considered only after careful analysis and consideration of all other alternatives. 1. Filing the Petition and Schedules: The Chapter 11 is commenced by the filing of a voluntary petition by the debtor. An involuntary petition may even be filed by creditors who meet certain statutory requirements set forth in the Bankruptcy Code. The petition provides a thumb nail sketch of the dollar volume of the assets and liabilities of the debtor, as well as identifies the debtor's twenty largest unsecured creditors. From the latter list will usually be chosen by the Office of the United States Trustee, an arm of the Department of Justice, those creditors who will serve on the creditors committee in the case. Shortly after the filing of the petition, the debtor will be required to file its schedules and statement of financial affairs. In the schedules and statements, the debtor will be required to identify all of its assets, liabilities and creditors. Essentially, as a result of filing for bankruptcy protection, the debtor's financial affairs become an open book. The need for accurate and up to date financial information is crucial. A debtor is required to fully and completely list all of its assets. Failure to do so can expose the debtor and its representatives to sanctions or possible conversion or dismissal of the case. 2. Operating in Chapter 11: During the Chapter 11, the debtor will usually be permitted to operate as a debtor-in-possession. This term refers to a debtor that continues to control, possess and administer its assets and business affairs during the bankruptcy. In rare cases a court may appoint a chapter 11 trustee, who is a third party appointed by the Office of the United States Trustee to administer the debtor. The debtor-in-possession's duties include accounting for property, examining and objecting to claims, and filing monthly operating reports (Debtor-in-Possession Reports) which identify, among other information, all revenue and expenses of the debtor on a monthly basis. The debtor may, with the court's approval, employ attorneys, accountants, appraisers, auctioneers and other professionals. The accountants will usually assist the debtor in the preparation of its Debtor-in- Possession Reports. 3. Benefits of Chapter 11: A debtor has usually chosen to file for protection under Chapter 11 of the Bankruptcy Code because of pressures from creditors that the debtor is unable to cope with. Immediately upon filing, a stay of creditor actions against the debtor automatically goes into effect. This stay, referred to as the "automatic stay" provides the debtor a breathing spell during which the debtor can attempt to resolve its financial problems and put together a plan of reorganization. The automatic stay will stay pending court actions against the debtor, non-judicial collection efforts and the imposition or enforcement of liens or other encumbrances against the debtor's property. The automatic stay will not apply to stop actions or proceedings by a governmental unit to enforce such unit's police or regulatory powers. Another important feature of Chapter 11 is that once a plan of reorganization is approved by the bankruptcy court, such plan will bind all creditors of the debtor and discharge the debtor from any claims arising prior to the bankruptcy. This "discharge" feature of bankruptcy gives the Chapter 11 debtor a fresh start, subject to the debtor's fulfillment of its obligations under its plan of reorganization. Creditors are permanently enjoined or stopped from seeking to enforce any pre-petition claims or rights against the debtor. 4. The Plan Process: During the first one hundred twenty days of a case, only the debtor-in-possession may file a plan. This period may be extended by the court for cause. The plan process involves a number of parties to the bankruptcy. While the plan will usually be prepared by the debtor, it will usually reflect substantial input from the creditors committee in the case. Acceptance or rejection of a plan cannot be solicited without approval of what is called a disclosure statement by the court. The disclosure statement is intended to provide creditors with sufficient information to allow them to make an informed decision on whether to accept or reject a plan. The statement usually explains the background of the debtor, why the debtor was forced to file for bankruptcy protection in the first place, classification of the different claims filed against the debtor 's estate and how such claims will be treated, and why the plan proposed by the debtor is a more desirable alternative to converting the case to Chapter 7 liquidation. Once the disclosure statement is approved, the disclosure statement, plan and voting ballot is then sent to the creditors, holders of stock interests and other interested parties in the bankruptcy. 5. Treatment of Claims: The plan of reorganization will classify the various different claims filed against the debtor's estate and set forth the manner in which such claims will be treated in the reorganization process. Because different claimants possess different rights, the Bankruptcy Code sets forth certain limitations on the manner in which such claimants can be treated. The Bankruptcy Code also imposes restrictions on the ability of a debtor to satisfy the claims of one class of claimants prior to satisfying the claims of another class of claimants. Secured creditors are those creditors whose indebtedness is secured or collateralized by certain assets of the debtor. Such creditors are usually and should be separately classified in a plan. Since these creditors, but for bankruptcy, would be entitled to foreclose upon or recover the collateral which secures their debt, these creditors' liens or security interests cannot be prejudiced by a plan. In certain cases, their liens can be transferred, as part of the plan, to other collateral or assets having the same value as the original assets upon which their liens attached. This special treatment and protection applies, however, only to the extent the value of the assets securing the secured creditors' debt is greater than the amount of such debt. In many cases, a secured creditor is undersecured, meaning that the amount of debt is greater than the value of the assets. In such case, the creditor is unsecured to the extent of this deficiency, which deficiency claim will be treated in the plan as an unsecured claim. An administrative claim in a bankruptcy is a claim arising from goods or services provided to the debtor after bankruptcy and which benefitted the bankruptcy estate. Such a claim will be entitled to payment in full before payment to unsecured creditors in a case. Finally, an unsecured claim is one that arises prior to the bankruptcy. These claims are further bifurcated as priority (including certain tax and wage claims) and non-priority. An unsecured non-priority claim has the lowest priority for distribution purposes. A debtor will usually treat and except in rare cases is required to treat all unsecured non-priority claims in a single class and creditors holding such claims will receive the same percentage distribution on their claims as all other creditors in such class. In rare situations, when a debtor can show a compelling reason, an unsecured creditor may be separately classified. 6. Confirmation: Once a plan of reorganization is confirmed, i.e., approved, on the effective date of the plan, the debtor is no longer a debtor-in-possession but rather a reorganized debtor. The automatic stay is no longer applicable. However, creditors are precluded from seeking to claim against the former debtor for any amounts due prior to or during bankruptcy. The former debtor is obligated to pay such amounts required by the plan of reorganization. As the plan acts as a new contract, the creditor can proceed against the former debtor for amounts required to be paid under the plan. B. Real Estate Reorganization Can Bankruptcy Save The Single Asset Real Property Debtor? You are the owner of shopping center or commercial office building. As tenants have moved out, the costs of operating your shopping center or building increase year to year. While you were once able to cover your monthly mortgage payments, with additional proceeds available for profit, you are now four months in arrears on your mortgage. Your lender has just commenced a foreclosure proceeding in state court and has asked the state court to enforce an assignment of rents. Is bankruptcy a viable or beneficial option? The foregoing scenario is all too common in the real estate marketplace. The answer to the last question, however, is both yes and no. While bankruptcy may be a viable and beneficial option to consider when faced with temporary cash flow problems, it is not a cure-all for a bad business investment. When considering whether bankruptcy can save your single asset real estate property, you should consider several questions: (1) is the property worth saving; (2) what is the game plan for fixing the problems which forced you to consider bankruptcy in the first instance; and (3) can you stick to the game plan on a long term basis and fix the problems without thereafter being faced with a second foreclosure or bankruptcy? Many developers or owners of real property, faced with losing their investment to foreclosure, file for bankruptcy without truly considering why they are filing for bankruptcy. Unfortunately, many real estate investments are simply poor business decisions. Bankruptcy simply will not change a shopping center or commercial office building where no tenants want to rent space into a 100% occupied center or building. Accordingly, before you consider bankruptcy to preserve your real property, you should make an honest analysis of whether the property is worth saving. If you are going to be forced to put cash into the property without any hope of receiving a return, you may be better served by allowing your lender to take back the property or negotiating a deed in lieu of foreclosure. This decision should be based upon a case by case analysis of your particular facts. Surrender of the property does not preclude negotiating a cash payment for takeout by the lender. If you have analyzed the continued feasibility of your real property investment, and believe that bankruptcy will provide you both the "breathing room" and ability to restructure debt that will save your property, the next step is to have at the time you file for bankruptcy a basic game plan for operating in and after bankruptcy. Many single asset real property debtors wrongly believe that once they file for bankruptcy, they can simply sit back for months without doing anything except collecting the revenues from such property. This bubble is quickly burst when your lender files an immediate motion to dismiss the bankruptcy as a bad faith filing or seeks relief from the automatic stay to continue with its state court foreclosure action. Bankruptcy courts are especially sensitive to the use of bankruptcy by debtors who are perceived as simply wanting to stop a foreclosure proceeding in state or federal court. Bankruptcy courts have identified factors to be considered in weighing whether a bankruptcy has been filed in bad faith and thus warrants dismissal. These factors include: (a) whether the debtor has only a single asset; (b) whether the debtor has few unsecured creditors whose claims are of insignificant value in relation to the claims of secure creditors; (c) whether the debtor has few employees; (d) whether the property is the subject of a foreclosure action as a result of arrearages on the debt; (e) whether the debtor's financial problems essentially involve a dispute between the debtor and secured creditor which can be resolved in the foreclosure action; and (f) whether the timing of bankruptcy evidences an intent to delay or frustrate the legitimate efforts of a secured creditor to enforce its rights. The debtor who is able to present to the bankruptcy court at the inception of the case a game plan for operating in the bankruptcy and a realistic game plan for emerging from bankruptcy stands a much better chance of defeating a motion to dismiss or motion for stay relief filed by the lender at the inception of the bankruptcy case. During a bankruptcy, the debtor will more likely than not be required to provide its secured creditor some form of what is called "adequate protection," in return for the ability to use income generated by the property for the continued operation of the property. The income has usually been pledged to the secured creditor as additional collateral for its loan. Adequate protection, which is usually in form of monthly cash payments, protects the secured credit from the use and diminution of its collateral, being income from the property, and a diminution in its equity position in the property. In other words, if the secured creditor was not paid anything, monthly interest accruals on its loan would prejudice its ability to be repaid in full on its loan while at the same time allowing its additional collateral, i.e., income from the property, to be used without cost to the debtor. You have now survived or been lucky enough not to have addressed a motion to dismiss or motion for relief from the automatic stay. You have operated successfully during the Chapter 11, made adequate protection payments to the secured creditor and even found additional tenants for your shopping center or office building. The time has come to develop and confirm a plan of reorganization. What kind of plan should you propose? The answer to this question is only limited by your imagination and the dictates of the Bankruptcy Code. With respect to unsecured creditors, you are not required to pay such creditors the full amounts which such creditors are owed. Rather, you may pay such creditors a percentage of the amounts which they are owed. The only limitation is that you are able to demonstrate that payment is greater than what such creditors would receive in a Chapter 7 liquidation. With respect to your secured creditor, your plan must be "fair and equitable," meaning that such creditor must receive payments over the term of the plan that is equal to the value of the creditor's claim as of the effective date of the plan. Thus, debtors have been able to, within the confines of this requirement and based upon the value of the creditor's security interest in the property, extend the maturity date of the loan, readjust the interest rate of the loan and even change an amortizing loan to a balloon payment. You have now emerged from Chapter 11. The future of your real property investment is what you make of it.

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