Unlike in Chapter 7 and Chapter 13 bankruptcy, creditors have a vote on what happens in Chapter 11. Chapter 11 bankruptcy is sometimes used by individuals who are over the Chapter 13 debt limits, but most of the time businesses file Chapter 11 to reorganize or to sell their assets. The fact that creditors have a vote in Chapter 11 makes it very different than the other types of bankruptcy. Here’s how it works.
Debts (claims and interests, technically) are divided into classes in Chapter 11. There can be many controversies about which debts are lumped together for reasons we will see, but in a very simple scenario, let’s say, the business in bankruptcy has a secured bank loan and several unsecured vendor debts. The secured debt will occupy Class 1 and the vendor debt will make up Class 2. The voting totals emerging from each class is what will matter.
In a standard reorganization scenario, the business debtor’s lawyer will draft a lengthy document telling the story of the business, how it ended up in bankruptcy, what it’s financial picture is like, what the business intends to do in its bankruptcy plan, and what the alternatives to the plan’s approval is. That document is called a disclosure statement. The court must ensure that the disclosure statement provides adequate information. This is largely a discretionary standard, but it is defined quite intelligently as enough information so that a hypothetical investor in a class of claims being treated under the plan would be able to make an informed judgment about whether to invest in a claim of that class. Anyway, the court will approve this document after one or more amendments and it will then be transmitted to all creditors along with a copy of the plan and a ballot. The voting will begin.
Whether a class of claims accepts the plan or not is based on whether more than half of the creditors in the class holding at least 2/3 of the dollar amount of the class who actually cast a vote do so in favor of the plan. In general, all classes of claims who are “impaired” (basically have their normal rights outside of bankruptcy modified) have a right to vote on the plan and must accept the plan. However, and this is a big however, there is an alternative route to getting a plan confirmed, and that is called “cramdown.” A cramdown plan is possible when not all impaired classes accept the plan (but at least one must) as long as the plan is held to be fair and equitable. The phrase “fair and equitable” is a whole subject matter in itself, and I will plan to get to that in another post. However, if the plan is accepted by all classes of creditors or the cramdown requirements are met, and the plan otherwise complies law and stands a decent chance of working out (is “feasible”), the court will confirm the plan. In a classic reorganization scenario, once that happens the business (a “debtor in possession”) is reorganized and tie up loose ends and emerge from bankruptcy. The business will still be bound to carry out what it promised in its plan (i.e. make certain payments to pre-bankruptcy creditors), but otherwise it will be free to operate unimpeded and unsupervised with a new capital structure and a discharge of pre-bankruptcy debts.