 Hello and welcome to the session in which we would look at chapter 11 bankruptcy. Chapter 11 bankruptcy is different than chapter 7. In chapter 7 in the prior session in chapter 7 we had the liquidation. We sell all assets and go out of business or we sell all the goods, all what we own and we pay the creditors. Basically we start from zero. In contrast, in chapter 11 reorg cases, the debtor typically continues to control and manage the assets, a concept known as debtor impossession. So they don't they don't sell everything because they need to stay afloat. And when we say chapter 11, usually chapter 11 is for businesses. The assumption here is this, that the debtor is best suited to operate their own business. Therefore, we try to avoid even having a trustee and managing its asset during the bankruptcy process. So what we are saying here is, you know what, as the debtor keep the asset, we're going to try to work a deal with you, keep the asset, keep running the business. We believe you're in the best position to run this business. Therefore, you're going to stay in control. Unlike, unlike in some other type of bankruptcy cases, a trustee is not usually appointed. It could be appointed. When is it appointed? When we find out that the owner of that business, the debtor, is incompetent. And this is what we will discuss in this session. What happens under chapter 11? So the first thing is to know trustees are usually not involved, usually not involved. So what is involved? Let's see what's involved. Committees, chapter 11 bankruptcy, instead of a trustee, usually we have committees are formed to assist and advise the debtor. These committees would include the committee of unsecured creditors, usually the seven largest creditors, and potentially some equity security holders committee stockholders to provide an oversight and consultation. And this starts shortly after the order of relief is in place, the bankruptcy start. We have these committees and what do they do? They try to help the debtor, advise the debtor, negotiate with the debtor, talk to them. They work with the debtor to ensure that the reorganization process is conducted fairly, because they want to be paid and efficiently, but they don't take over management of the company, because they're not managing the role of advising. They play a major role, but they don't run the business, because the rationale here is the debtor remained in possession of the management of the asset, and they're in the best position to run the business because they have the expertise. Well, if they're going out of business, they should not have the expertise, but we have to make this assumption that they still in the best people to run the business, to run more effectively than external trustees. We want to maximize the value of the debtor's estate, doing what? Keep the debtor and increase the likelihood of a successful reorganization. Now, do you need those committees? For small businesses, as a small business in this context is defined as a business that's not primarily involved in real estate, and has that below 2.6 million. Again, those numbers will change. If a debtor qualifies as a small business under this definition, they have the option to elect special treatment as a small business debtor. One significant aspect of this is you can request a credit committee not to be appointed. Simply put, this means if that motion is granted, there wouldn't be a committee of unsecured creditor involved in the bankruptcy process. The reason behind this is to simplify and expedite the proceeding for small business debtor, rather than having creditors consulting with creditors constantly. If you have a lot of that, the creditors wants to be involved. We also would have an equity security holders committee. Equity is stocks, people with stocks. In cases where the debtor is a corporation undergoing a chapter 11 bankruptcy, means they have shareholders, the committee might be formed to represent the interests of the equity security holders known as stockholders, usually the common shareholders. This committee is typically composed, again, of seven of the largest holders of the corporation equity securities. What is the purpose of this? Is to make sure the right and interests of the equity holders are represented during the bankruptcy process. If I'm an owner, I want to make sure I might be able to get some of that equity, some of that proceeds out for myself at the end of the day I invested in this company. What is the role of the equity security holders committee? It's quite extensive. They have the authority to consult with the debtor, which means they can engage in discussion and negotiation directly with the corporation that's undergoing bankruptcy. They are empowered to conduct a thorough investigation into the debtor's financial position to know exactly what happened. And this investigation would help them understand the financial situation, enable them to make informed decision and provide meaningful input. The reason the committee there is to help you get out of this problem. The equity committee also plays a vital role by drafting the reorganization plan. We're going to talk about this plan. The reorganization plan is the roadmap to get out of this situation, to go back, be solvent, be able to pay your bill and stay in business. This plan details how the debtor will restructure that in business operation to exit the bankruptcy, get out back to normal. The commitment involvement ensures that their interests are protected, which is critical as the plan's outcome directly impact the value of their stocks, the value of their equity. Let's talk about reorganization plan. Remember, the reorganization plan is the roadmap. It's what's proposed. Usually it's proposed by the debtor. The debtor will have a chance to present the plan. Under chapter 11, the debtor has the opportunity to propose a reorg plan at any point during the case. The plan is crucial because it's going to outline, it's going to spell out how the debtor intend what's their plan to restructure their debt in business operation to exit the bankruptcy. Initially, the debtor enjoys an exclusive period in which they have to file for this reorganization plan. And this period lasts 120 days from the effective date of the order of relief when the bankruptcy officially starts, which marked the formal starting date of the bankruptcy, not from the petition date from the order of relief. If the debtor is unable or unwilling to propose a feasible plan in a timely manner, other stakeholders can stop in to propose an alternative plan. So first the debtor is given a chance. Go ahead, tell us what you can do. Show us a plan. If you are unable or unwilling, then get out of the way. We need to create a plan. Who we usually, the interested parties like creditors, they want to look, they want to help draft a plan because they want to protect their interests. So if the debtor fails to file within 120 days, other parties have the right to submit a plan. So lack of acceptance of the debtor's plan. Also, if the debtor has submitted a plan within the 180 days, but failed to obtain an agreement of the impaired class, impaired class, the classes that they're going to be losing out, who will be losing out, creditors, shareholders, then other parties might propose an alternative plan. An impaired class referred to creditors whose rights are affected by the plan, by what? By reduced claim or delayed payment. And under certain circumstances, we might have to appoint a trustee. Remember, there is no trustee for Chapter 11. If a trustee is appointed to oversee the bankruptcy case, then other parties may propose a plan. So again, we might have a trustee, but in normal circumstances, we will not have a trustee. So what does the plan include? It should be a blueprint, a roadmap to exit. It should show few things. One is the classification of claims. The plan must categorize all claims against the debtor into various classes. They can include secured claim. Those are backed by collateral, first priority claims, second priority claims, so on and so forth. Also claims may be classified as either impaired or unimpaired. Impaired means they're going to lose out. Unimpaired means they're going to be in good shape, depending whether the plan altered the rights of the claimant, because sometimes because you're going to have a plan and some will, some of their interests will be impaired. It means they're going to lose out and some will not. You have to show us who will and who will not. Treatment of each impaired class. The plan must specifically detail how it will address each class of impaired claims. Impaired claims are those where the plan modifies the right of the claimant. This could involve what? Again, changing the terms of the repayment, usually lower, reducing the amount owed taken out part of the principle, extending the payment timeline. The plan must clearly state how they will be treated. And you should have equal treatment within classes. Within each classified group, the plan must ensure identical treatment, no favoritism. This means all claimant with a specific group must receive the same treatment under the terms of the plan. For example, all creditors in the secured claim class must receive a similar approach in terms of the repayment or settlement. Also, you need to show implementation mechanism. It's not only you have a plan. How are you going to execute the plan? The plan must also establish the methods and procedures for implementing and carrying out this rework plan. And this includes specific steps that we'll be taking to make sure the plan provisions are executed, such as sources of funding for repayment, how are you going to get the money, the payment structure during the reorganization and any necessary business operation adjustment. So now we have a plan that's great. We presented the plan. What's next? Voting on the plan. All creditors and equity holders who have claims against the debtor estate are entitled to vote on whether to accept or reject the plan. We vote. The voting process is crucial because you're going to see later the court would look at this for determining the plan's approval. The rules for accepting the plan depending whether the claimant are debt or equity interests. For impaired claims, debt, if we're talking about debt holders, a class of impaired claims, those claims that are affected, is considered to have accepted the plan if two conditions are met. So for the debt holders, you have to have two conditions. One, the plan is approved by creditors holding two-thirds of the total value. Value is a dollar amount. So the creditors have to represent two-thirds, 66% of the debt value will have to be represented. And notice it's also accepted by half of the number of creditors. So the number of creditors, let's assume you could have 10 creditors and only one of them lend you 66%. Well, it will not be approved because only one. You need to have five, half of the creditors will have to be involved. Two-thirds of the money and half of the creditors will have to agree to the plan. Let's look at a number. Let's look at an example with numbers. In a class with total claims of a million, the approval of the creditors, the amount that all the creditors should approve is $666,667. And if we have 100 creditors involved with this $1 million, 51 of these creditors will have to be part of the $666,667. More than half in two-thirds, two conditions. So if the creditors representing $700,000 out of the million and 55 of the 100, then the plan is accepted by this class. How about the shareholders when they vote? A class of impaired interest such as equity interest holders is deemed to have accepted plan if they accepted by holders of at least two-thirds of the total value. Look, in stocks, you vote with your money. So you could have one shareholder that owns more than two-thirds of the stocks. That's good enough. We don't look at the, we don't look at the number of shareholders. We look at the total value because you vote with your money when you are a stockholder. In a bankruptcy case, if a class is impaired, equity like stockholder has total allowed equity of $300,000, the rework plan is accepted if holders of equity were two-thirds, $200,000, agree to it. That's all what we need. After that, we need the court approval. The court must approve. The court must approve. So needs to approve the plan and they will only approve it if it meets certain criteria. One, the plan was accepted by all impaired classes. Ideally, the plan should be accepted by all impaired classes. This means that each class as defined in the plan agree to the term set out. So first, make their job easier is when it's accepted. Also, the court wants to make sure that their full payment for priority claims. Who are the priority claims here? The plan must provide the full payment of priority administrative expenses and gap claims. What are the administrative expenses cost related to the administering the bankruptcy case itself? Filing fees. You could have a trustee, so on and so forth and gap claims. Those are that that arise in the period from filing for the bankruptcy from the petition date when you file until the approval of the rework plan, which is the court approves the rework plan. This is there is a gap and you want to pay those creditors. You have money, you have plan to pay them. Feasibility of the plan. Also, the court must see that the plan must be feasible, meaning it should have a reasonable likelihood of success. The court must be convinced that the plan is realistically capable of achieving the goal, which is what? Getting out of financial distress. More about the court role here. If there are certain situation where the plan can still be confirmed, if not all impaired classes has accepted it. Remember, we have the creditors, we have the shareholders, they might not agree. That's fine. At least one impaired class accepts. That's good enough for the court. If at least one class of impaired claims accepted the plan, the court can still confirm it. They would rather have both, because we don't have to deal with it. But if it's one, that's the case. And there should be no unfair discrimination and everything should be fair and equitable. They force you to accept and they're going to protect your interests. And a cram down the court essentially overrides the rejection of the plan by some impaired classes under justification that the plan meets the criteria of fairness and non-discrimination. And this provision ensure that a single class of creditors cannot unreasonably prevent the reorganization of a financially troubled company provided that the plan is fair and viable. Because again, between the creditors and the shareholders, they might be fighting back and forth. And the court says, no, that's enough. I believe it's fair enough. Let's move on so we can save the company. The final word is for the court. Once the court confirmed the plan, it's binding to old parties. The confirmed plan is legally binding to all creditors, equity holders, debtor, irrespective whether they voted for or against the plan. Now, following confirmation, the debtor is obligated to pay the debtor in accordance with the provisions. So the debtor are required to do what? Follow the plan, work according to the plan. This includes payment to creditors and other arrangement made in the plan regarding the operation of the debtor's business and its financial position. Discharge of pre-confirmation debt. Confirmation of the plan generally results in some discharge of the debtors from all that that existed before the plan. So in other words, some of the debt might go away. This discharge is similar to Chapter 7 bankruptcy. Of course, unless the debt is what is non-dischargeable. Essentially, this discharge gives the creditor a clean slate, freeing them from previous debt and now them to start fresh post bankruptcy under some sort of a reorganization. Also, once we start again, there's a termination of the automatic stay. Remember, the automatic stay is an injunction to stop creditors from collecting debt from the debtor. Once the bankruptcy process begins, this is also terminated upon the plan confirmation because we're starting new, brand new, certain debt was discharged, we reorganize, everybody agrees, all the creditors were starting from fresh. That automatic stay is gone. This simply means that the protection afforded to the debtor under the automatic stay stops and the new terms of the reorganization plan takes effect. The creditors are aware of this, we're starting fresh. Let's take a look at this multiple choice questions from farhatlectures.com. Under what condition can a chapter plan be confirmed by the court, even if not all the impaired classes have accepted it? Well, can the court do that? Accept a plan, although not all impaired classes accepted it? And the answer is yes, they can. If the plan proposes to liquidate the debtor's asset, no, you're not liquidating, it's chapter 11. A is out, easy out. If at least one impaired class has accepted it, and the plan is fair and equitable to the descending class, dissenting class. Yes, if one impaired class accepted it, at least one accepted it, and the court thinks it's fair and equitable to the dissenting class, then they will accept. If the debtor agrees to sell the business, no, we're not into selling or liquidation. All secured creditors accepted the plan. Yes, whereas secured has nothing to do with it. This is the descending creditors. So the answer will be B. What should you do now? You're going to go to farhatlectures, look at additional MCQs where I have AI CPA questions, CPA questions, regular CPA questions, and questions to help you understand the concept. Invest in yourself if you're studying for your CPA exam.