Chapter 11 – is it right for you?

Chapter 11 cases are rare.  In 2014 and 2015, the average number of Chapter 7 cases filed in the Eastern District of Wisconsin has been about 9,000.  The average number of Chapter 13 cases has been over 3,000.  The number of Chapter 11 cases – only about 20.
Chapter 11 cases are wildly different from their Chapter 7 and Chapter 13 counterparts.  So much so that only a handful of attorneys do Chapter 11 work and are qualified to really discuss Chapter 11 cases.  I am not one of those attorneys.
But – for the benefit of people who want to know whether they should consider consulting with a Chapter 11 attorney, or for people who just want the peace of mind of knowing what Chapter 11 is before ruling it out and proceeding under Chapter 7 or Chapter 13 – here’s a quick summary of the pros and cons of Chapter 11 as articulated by Atty. David Krekeler.
Why might someone consider filing Chapter 11?
  1. Debtor is a corporate entity that wishes to remain in business.  (Corporations may file Chapter 7, but they have the effect of killing the business.  Corporations cannot be debtors in Chapter 13.)
  2. An individual does not qualify for Chapter 7 (because of a prior bankruptcy discharge or because they fail the Means Test) and the individual does not qualify for Chapter 13 (because their debts exceed the maximum limits imposed by statutes).
  3. An individual wants to avoid liquidation in Chapter 7, but has no regular income to fund a Chapter 13.

What are some of the drawbacks to Chapter 11?
  1. They’re expensive.  On the low end, a “simple” individual consumer case will typically cost over $10,000 in attorney fees.  Small-to-medium size corporate cases can easily transit from 5 figures to 6 figures.  Extremely large corporate cases, like the Lehman Bros. bankruptcy case, can run up a legal bill of hundreds of millions of dollars.  The court filing fee alone is $1,717, which is more than 5 times the price of a Chapter 7 court filing fee.  Additionally, the court charges a quarterly fee that is dependent on how much money is disbursed, and that fee can range anywhere from $325 to $30,000.
  2. Chapter 11s are a lot more work.  There are more meetings to attend and more forms to complete and maintain throughout the life of the bankruptcy case.
  3. There is no absolute right to have your case dismissed, so if you get into a Chapter 11, plan on being locked into it for a while.
  4. Because there is usually no trustee, you – the Debtor – assume many of the responsibilities of the trustee.  And while that may sound like a good thing, it also means that you have a legal fiduciary duty to your creditors.

What are some of the benefits to Chapter 11?
  1. Generally speaking, you have more time.  You’re not bound by the 5 year limitation of a Chapter 13, nor many of the other fast-paced deadlines in an ordinary Chapter 7 or Chapter 13 case.
  2. You can be extremely creative when you propose a Chapter 11 plan.  Although the plan must be voted on by creditors, you can propose modifications and settlements and payment plans with greater flexibility than you can in Chapter 13.

Exemption Planning and the Conversion of Non-Exempt Assets to Exempt Assets

Hypothetical:
John Doe has $50,000 locked up in stocks.  John Doe needs to file for bankruptcy, but given his available exemptions, the stocks are wholly non-exempt.  John Doe’s attorney advises John Doe to sell his stocks and use the cash to pay down his mortgage, because even with the increase in equity, John Doe would still have enough exemptions to protect his home.
This sort of “exemption planning” and conversion of assets from one form to another happens all the time.  The question is whether such conversions are permissible under the bankruptcy code.
11 U.S.C. § 522(o) / Relevant Parts:

[…] The value of an interest in […] real or personal property that the debtor or a dependent of the debtor claims as a homestead shall be reduced to the extent that such value is attributable to any portion of any property that the debtor disposed of in the 10-year period ending on the date of the filing of the petition with the intent to hinder, delay, or defraud a creditor and that the debtor could not exempt, or that portion that the debtor could not exempt […] if on such date the debtor had held the property so disposed of.

Here again, whether such conversions will be permitted is going to depend on the facts of the case and the court where such an objection to exemptions is brought.
In re Lacounte, 342 B.R. 809 (Bankr. D. Mont. 2005) – involved a conversion of $42,500 and the exemption was partially denied.
In re Anderson, 386 B.R. 315 (Bankr. D. Kan. 2008) – involved a conversion of $240,000 and the exemption was permitted.  The court noted that this was a “close case”, but pointed out that it was unable to find that the debtor acted with intent to hinder, delay, or defraud his creditors, and that he apparently “did nothing more than take advantage of an exemption to which he is entitled.”

Undisclosed Claims and Pending Litigation

I’ve written in the past about the concept of “judicial estoppel” and how – if you fail to mention that you have pending litigation or a claim against someone on your bankruptcy schedules, you could be barred from litigating the claim in the future.
In plain English, this is how it works…  John Doe goes to Mal-Wart to do some shopping, and while he’s there, he slips and falls on a sidewalk that hasn’t been cleared of ice.  John Doe has a potential personal injury claim against Mal-Wart (whether he can win and how much he could potentially win – both of these are irrelevant).  After the accident, he files for bankruptcy and does not list his potential claim against Mal-Wart.  After his bankruptcy case is discharged, he then brings a lawsuit against Mal-Wart.  Mal-Wart brings a motion to have the lawsuit dismissed on the grounds that on a previous legal document that was signed under the penalty of perjury, John Doe asserted – by his omission – that he had no legal claim against Mal-Wart.
That’s judicial estoppel in a nutshell, and many courts would grant Mal-Wart’s motion and dismiss the case on those grounds.  But sometimes a court will allow the lawsuit to proceed.  The law is not uniform on this subject (yet), but there are two questions to consider.  (1) Whether the lawsuit will be permitted to continue and (2) if the lawsuit continues and the debtor-plaintiff prevails, who gets the money?
The answer to both questions may depend on two factors.  (1) What court is the lawsuit being brought in, and what existing case law on these questions is that particular court bound by?  (2) Has the debtor-plaintiff taken steps to demonstrate that the omission was inadvertent?
Sometimes, despite being grilled by their bankruptcy attorney, debtors simply forget about a potential claim that they have or – more frequently – they don’t realize that they even have a cause of action.  If they later file a motion to reopen the case and disclose the asset, that goes a long way to demonstrating that the debtor did not intend to deceive or hinder creditors – especially if the claim would have been exempt all along.
If a lawsuit is permitted despite judicial estoppel, it is generally accepted that the Trustee will always have a right to pursue those funds.  Whether the debtor has any right to the funds will again depend on the court and a demonstration of intent.
Moral of the story?  Unchanged.  Make sure that you list any potential claims (such as personal injury cases, breach of contract cases, class action suits, etc.) immediately when you file for bankruptcy.

Unlisted Creditors

I have written several times about how important it is to disclose all debts on your bankruptcy schedules

  • regardless of whether the debt can be discharged
  • regardless of your intention to repay the debt, and
  • regardless of your relationship to the creditor

as a matter of due process requirements.
Nevertheless, cases like Guseck pretty much nullify any need to worry about unlisted schedules for no-asset Chapter 7 cases.  11 U.S.C. § 523(a)(3) limits the non-dischargeability of unlisted debts to cases involving distributions where a creditor must file a claim, such as Chapter 7 cases with non-exempt assets or voidable preferences or Chapter 13 cases.
In any case where a creditor must file a claim to be paid out of the bankruptcy estate, the creditor must file a claim before a particular deadline, and the bankruptcy rules (Fed. R. Bankr. P. 9006(b)(3)) prohibit the deadlines from being expanded except under specific circumstances.  Therefore, it is usually the case that by the time an omitted creditor finally learns about the bankruptcy, it is too late for them to file a proof of claim.
The good news for the creditor is that their debt is non-dischargeable.  The bad news is that, despite being barred from filing a claim, they are still bound by the automatic stay while the bankruptcy is pending.
Or are they?
Speaking at the Annual Bankruptcy Update in Milwaukee last month – Judge Halfenger suggested that such a creditor might also have grounds to obtain relief from the automatic stay under 11 U.S.C. § 362(d).
One more thing to keep in mind when you’re checking your schedules to make sure all creditors have been listed…