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Published Articles by David Balovich

Title: Rehabilitation and Restructuring in Chapter 11
Published in: Creditworthy News
Date: 4/3/02

Chapter 11
is constructed so that neither the debtor nor creditor has a clear advantage. It encourages negotiated settlements of disputes, as well as negotiated reorganization plans. Good bankruptcy attorneys know that litigation often leads to the worst possible results for both parties. Therefore, it is important to recognize that during a Chapter 11 proceeding there will be negotiation and compromise by both sides.

The overall benefit of Chapter 11 is that it enables debtor businesses to be saved, and even cured of their financial ills. This approach is unique to the American justice system. In the majority of countries, creditor relief, not debtor protection is of major importance.

In Chapter 11 there are two primary issues; rehabilitation and restructuring.

Without doubt, the single most important benefit of Chapter 11 is the automatic stay. Like an injunction, the automatic stay restrains creditors from any act against the debtor or their property, such as repossession, foreclosure or litigation. The stay is automatically invoked upon the filing of the Chapter 11 petition. The court may punish creditors violating the stay by having a contempt charge filed against them. While in Chapter 11 the debtor is allowed to put all debts on hold. The company, with few exceptions, may not pay any of its pre-petition debts. The combination of the automatic stay and the moratorium on debt payment provides the debtor a chance to preserve and, if necessary, to recreate a valuable going concern that can operate profitably.

The filing of a Chapter 11 petition often restores a company’s ability to borrow money or obtain credit. The reason is that post-petition borrowing must be paid back before any payment can be made to pre-petition creditors. In fact, under appropriate circumstances, a bankrupt firm can secure a borrowing with a lien on assets that is senior to existing liens. In legal jargon this is referred to as “priming the lien.” If the company can show lenders that it can operate profitably, if it does not have to pay its pre-petition debt, chances are very good that it will be able to borrow needed operating capital. This is why so often we read about bankrupt companies obtaining large sums from financial institutions shortly after they have filed Chapter 11. Often times, even trade creditors are persuaded to extend credit terms.

After a period of business stabilization, which can last a few months or many years, a company restructures its financial affairs by proposing a plan that can be confirmed by the court. The bankrupt as a proponent of the plan, has several options available to restructure its affairs.

Installment obligations, such as leases or promissory notes that have been accelerated because of nonpayment can be reinstated, over creditors objections. All that is required is that the obligation be brought and kept current.

Leases can be assigned to others or rejected. Debts can be paid in installments or discharged by paying only a portion of the debt. Taxes must be paid in full but can be pain in installments over a seventy-two month period.

The fact that creditors do not agree with the plan of reorganization proposed by the debtor does not mean the court will reject the debtor’s plan. There is a term in bankruptcy parlance known as “cram down”. This means that a dissenting class of creditor, such as unsecured, can be forced to accept the plan.

I wish you well.

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