Claims and collections, part 2: understanding chapter 11 bankruptcy in the United States

The business environment today is powered by corporate credit. It’s logical, then, that companies understand the risks of extending credit – and the implications if one of their customers files for bankruptcy. In the US, however, bankruptcy can look a little different than in other countries.

Businesses that file for Chapter 11 of the United States Bankruptcy Code with court approval are able to avoid liquidation and continue to operate. Creditors might think that this means their debts will be paid. But it’s not quite as simple as that. 

A company might file for Chapter 11 bankruptcy because they desire to remain operational and have established that their financial troubles are due to temporary issues, such as cash flow or diminishing demand. Chapter 11 bankruptcy allows these companies to propose a Reorganization Plan that enables them to continue to function and repay creditors. This reorganization is about evaluating strategy, and determining what is needed for that business to thrive.

The proposed Reorganization Plan details how the debtor will turn their business around and reduce the debt load. This could mean borrowing new money, terminating contracts, or restructuring. As with any formal bankruptcy proceeding, the court is involved. The plan will be reviewed and voted on by the creditors as well as being approved by the appointed bankruptcy judge. The judge will only approve the plan if it receives the required votes from creditors and if it meets certain legal requirements.

If resolving outstanding debt prior to the debtor filing bankruptcy is impossible, it’s important for creditors to understand the importance of filing a Proof of Claim. This written statement should include documentation and evidence in support of the claim, and it should be filed as soon as they hear that the debtor has gone bankrupt. This will ensure that their debt is included at the voting stage and, crucially, for the resulting distribution.

The Reorganization Plan is not feasible if the debtor is unable to maintain the value of the business. In this case, they may deem certain creditors “critical” to their day-to-day operations. The debtor, with the agreement of the critical vendor, can file a Critical Vendor Motion that allows debtors, after petitioning for bankruptcy, to be allowed to pay pre-bankruptcy obligations owed only to those suppliers and vendors deemed essential. This incentivizes critical vendors to continue to ship to the debtor during the bankruptcy. Creditors should discuss this option with their bankruptcy attorney.