Bankruptcy in the Time of COVID: An Introduction to Chapter 11 Reorganization

Bankruptcy in the Time of COVID: An Introduction to Chapter 11 Reorganization
Attorney Benoit LetendreAttorney Ben Letendre discusses reorganization options for debtors under Chapter 11 Bankruptcy in light of the COVID-19 pandemic.

2019 Novel Coronavirus (COVID) has caused significant global socio-economic disruption. It is uncertain whether industries such as airlines, retailers and tourism will ever fully recover from the sharp downturn in revenues caused by COVID. This can be seen in the bankruptcy filings of companies such as American Airlines, Hertz Car Rental and JCrew. These financially distressed companies have turned to the bankruptcy code in the hopes of restructuring their debt to reemerge as a leaner and healthier company. What follows is a very brief introduction to a particular type of bankruptcy commonly known as “Chapter 11 Bankruptcy”.

Chapter 11 of the Bankruptcy Code (Title 11, Chapter 11 sections 1101-1195, of the United States Code), entitled “Reorganization”, addresses the readjustment of the rights of both secured and unsecured creditors, and of equity in a distressed company. When a company files for Chapter 11 bankruptcy, that debtor company is generally permitted to remain in control of its business operations and to continue operating its business under supervision of the bankruptcy court. Chapter 11 results in either: a. confirmation of a plan of reorganization in which the debtor’s business is rehabilitated and continued; b. confirmation of a plan that results in the liquidation of the debtor’s business; c. conversion to another chapter of the bankruptcy code (such as Chapter 7); or d. dismissal of the case.

There is no requirement for an insolvent company to file for bankruptcy under U.S. law. When a debtor company does file under Chapter 11, there is no required insolvency test, either on a cash flow basis or balance sheet basis. All that is required is for the debtor company to provide a legitimate business reason for the filing. However as one would expect, most filing debtors, are insolvent. In other instances, foreseeable future events such as costly and protracted litigation (e.g. asbestos and silicone litigation), are reasons companies file for Chapter 11 protection.

The 1978 Bankruptcy Code contains a number of key provisions that facilitate reorganization such as: an automatic stay protecting the debtor company from any and all legal or collection efforts; an exclusive period during which only the debtor can propose a plan of reorganization; the ability to use cash collateral and/ or obtain post-petition financing; the ability to assume or reject leases and other executory contracts; the ability to sell assets free and clear of liens; the ability to retain and compensate key employees; and the ability to reject or renegotiate labor contracts and pension benefits.

These provisions make filing for Chapter 11 bankruptcy protection attractive to many debtor companies as they seek to survive insolvency and reemerge as viable going concerns capable of profitability despite past mistakes and/or a run of misfortune due to circumstances out of the companies’ control (e.g. the impact of COVID on aviation and car rentals).

The U.S. Congress again revised the Bankruptcy Code on April 20, 2005 (the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA)). Significant portions of the Act impact consumer (personal) bankruptcies by making the laws significantly less debtor friendly, however the new Act has many important provisions that affect corporate bankruptcies. Among other changes, BAPCPA amended sections of the Bankruptcy Code dealing with: a. plan exclusivity; b. small business cases; c. assumption or rejection of commercial leases; d. dismissal or conversion of Chapter 11 cases; e. employee retirement benefits; f. composition of creditors’ committees; and g. treatment of vendors. In general, as with consumers, the new Act is viewed as more favorable to creditors.

A central component of Chapter 11 reorganization is to harmonize the collection efforts of many creditors into one joint action. When a debtor company files for Chapter 11 protection, individual creditors are prohibited from taking any legal action that would jeopardize reorganization efforts (the “automatic stay”). This permits the debtor to continue running its business without direct interference from creditors who are instead legally required to file notices of claim through the bankruptcy court.

The automatic stay permits the debtor in the opening stages of a Chapter 11 case to attempt to bring some order out of the chaotic condition which forced the filing of the petition. Without the protection of the automatic stay, unsecured and secured creditors could continue their dismemberment processes, frustrating the attempts to orderly reorganize the debtor company.

Despite the many protections and advantages offered to debtor companies under Chapter 11, most reorganizations fail. At the time of filing, most companies assume (and their accountants and attorneys insist) that the value of the company exceeds its liquidation value. However, all too often the debtor company is mortally wounded, and its value continues to deteriorate to such an extent that reorganization is no longer viable, and liquidation is the only economically sensible outcome. Under these circumstances, a debtor company can confirm a liquidating Chapter 11 plan or convert the case to a straight Chapter 7 (of Title 11 of the Federal Code) liquidation.

If you’re interested in finding out more information about this or other legal issues, please feel free to contact our professionals online. This brief discussion of Chapter 11 bankruptcy is for general, informational purposes only and should not be construed as legal advice.

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