Chapter 11 Bankruptcy- Who are the Players?

If your company (or your client) is considering filing chapter 11 then you need to understand some basics. That is, you need context.

The Debtor

Even though Chapter 11 cases are heard by a bankruptcy judge, sitting in a bankruptcy court, a bankruptcy case is not a lawsuit. There is no plaintiff and there is no defendant. Instead, there is (a) the company that files bankruptcy (or, if an involuntary bankruptcy, the party whose creditors put it in bankruptcy), called the “debtor;” and (b) everyone else. 

The Debtor-in-Possession

In a chapter 7 case, a trustee (commonly referred to as a "chapter 7 trustee") is automatically appointed to take control of the debtor’s bankruptcy estate and liquidate its assets for the benefit of creditors. A chapter 7 debtor but does not retain control of its assets and affairs.

In chapter 11, the debtor does retain possession and control of its assets, unless removed for cause. A chapter 11 debtor is thus also a debtor-in-possession (a “DIP”) unless removed as such. Bankruptcy Code §1107 gives a debtor-in-possession most of the same powers a chapter 11 trustee would have if one were appointed.

Motion to Appoint a Chapter 11 Trustee- an Example of Litigation

I wrote above that a bankruptcy case is not a lawsuit, and it’s not. But lawsuits do get filed in a bankruptcy case. These are called adversary proceedings, and that’s how many disputes are litigated in bankruptcy. The other vehicle for litigating a dispute in front of a bankruptcy court is through a “contested matter.” If a party attempts want the court to appoint a chapter 11 trustee, it files a motion and that begins a contested matter. You can read more about appointing a chapter 11 trustee in The Good, the Bad, and the Ugly of Replacing a Debtor’s Management with a Chapter 11 Trustee.    

The U.S. Trustee

The Office of the United States Trustee ( “UST”) is the division of the U.S. Department of Justice. It is charged with enforcing the Bankruptcy Code. The UST has specific powers and duties under the Bankruptcy Code. Bankruptcy Code §307 authorizes the UUST to raise and be heard on any issue in any bankruptcy case.

Chapter 11 Trustees & Examiners

I mentioned the concept of a Chapter 11 trustee above. The short story is that while the default of chapter 11 is that the debtor gets to remain “in possession,” that default can be overturned. Chapter 11 trustees and examiners are intended to act as independent third parties who either (a) take control of a debtor’s estate in chapter 11 (in the case of a trustee); or (b) independently investigate the debtor’s affairs (in the case of an examiner). When appointed, each is charged with specific statutory duties under Bankruptcy Code § 1106.

Subchapter V Trustees

The Small Business Reorganization Act of 2019 (the “SBRA”) created a new kind of chapter 11: the subchapter V chapter 11 case.

Subchapter V was designed to make chapter 11 easier and cheaper for debtors. If your (or your client’s) company qualifies as a “small business debtor”(currently defined as a chapter 11 business debtor with aggregate noncontingent liquidated debts, excluding debts owed to affiliates or insiders, under $7,500,000) it will a trustee appointed by the U.S. Trustee. You can read more about subchapter V and its trustee in Bankruptcy Code Revised.

Secured Creditors

A secured creditor is a creditor who holds a security interest in specific property owned by a debtor. Stated another way, a secured creditor has a security interest or other lien on some or all of a debtor’s assets. 

Businesses of any significant size typically have a term loan or line of credit (or both) from a bank or other lender, secured by substantially all of the businesses’ assets. Outside of bankruptcy, secured creditors can foreclose on their collateral if their debtor defaults. Inside bankruptcy, the automatic stay prevents (at least temporarily) foreclosure. But bankruptcy also provides certain protections to secured creditors. The dynamic between debtors and their secured creditors is a major consideration in every chapter 11 and smart lawyers will spend a lot of time discussing this dynamic with their client ahead of a bankruptcy filing.

Unsecured Creditors

Any creditor who holds a claim against a debtor but who has no collateral securing that claim is an unsecured creditor. Most trade vendors, contract counterparties, and employees are unsecured.

Official Committees

As I note above, most sizeable chapter 11 debtors have at least one secured creditor who has a lien on all its assets. That secured creditor, and potentially other secured creditors, are commonly owed a great deal of money by the debtor. Most unsecured creditors, on the other hand, are owed far less.

Because of this, and because unsecured creditors are generally paid only after blanket lien creditors are paid in full, the typical unsecured creditor may not want to throw good money after bad in protecting its rights in chapter 11. The Bankruptcy Code recognizes this and provides a solution. It authorizes unsecured creditors to take collective action in chapter 11 by forming an official committee of unsecured creditors.

An official committee of unsecured creditors consists of a small of unsecured creditors with large claims against the debtor, selected by the UST. The Committee hires professionals (attorneys and financial advisors) whose fees and expenses are paid for by the debtor. The Committee has the standing to be heard in the case on any matter. One advantage of a subchapter V chapter 11, from a debtor’s perspective, is that committees are not normally appointed.

Other types of official committees can also be appointed in a chapter 11 case. These include official committees of (a) equity holders; (b) retirees; (c) bondholders; (d) landlords, and others.

DIP Lenders

Many debtors don’t have or generate enough cash to operate their businesses during chapter 11 without borrowing. Such debtors may seek to borrow while in chapter 11, and such a loan is called a  “DIP loan;” a lender who makes a DIP loan is usually referred to as a “DIP Lender.” You can read more about DIP loans in Dealing With Distress for Fun & Profit – Installment #17 – Overview of DIP Financing and Cash Collateral Motions.

Professionals

These players each need an attorney, and some need other advisors. I'll explain what the industry of chapter 11 attorneys and advisors looks like in an upcoming article.

Note: this article is based substantially on one I co-authored, Dealing with Corporate Distress 02: These Are the People in Our Neighborhood: An Overview of Parties in Chapter 11.