The Aggressive Unsecured Creditor in Chapter 11

If you are a creditor in a Chapter 11 bankruptcy, make no mistake about it. Much can be done to maximize your return.

Indeed, much was done before the bankruptcy was filed to minimize your recovery and to fund the bankruptcy with money that would have been paid to you or to others--or even to take money back from you to fund the bankruptcy of the entity that owes you money!

In spite of the apparent injurious impact of this bankruptcy, the Chapter 11 law was written to protect the interests of unsecured creditors. The concept is that by reorganizing the business, the business can be saved and give a divident to the unsecured creditors instead of the banks or the government taking everything.

When a debtor files a Chapter 11, he trades his freedom of action for protection from lawsuits and foreclosures. Outwardly the business continues to operate without interruption, but in reality the owners no longer own the business. The business is now a bankruptcy estate and the owners are fiduciaries subject to removal. If the owners want to keep the business, they have to buy it back by paying something to the unsecured creditors. And the unsecured creditors get to vote for or against the owners' proposal. The bottom line is that the debtor has traded his freedom for bankruptcy protection and he is vulnerable.

Therefore, the threshold issue for the unsecured creditor in this arena is how much he stands to gain by striking at that vulnerability. If he has a small claim or if there is little value in the business, he has little to gain and probably should do little. If he has a large claim and there is value in the debtor, the unsecured creditor may wish to become aggressive.

The most aggressive posture that a creditor can take in a Chapter 11 is to file his own plan of reorganization. This is called a competing plan because it competes with the debtor's plan.

In order to justify the expense of a competing plan and the expense of the fight that it produces, the aggressive creditor should fall into at least one of three scenarios. He should 1) have a large claim in a bankruptcy of a business that has real present or future value and the management refuses to treat him fairly, or 2) he should become active in the unsecured creditors' committee and have the committee file a plan or 3) he should find sufficient cash to propose a competing plan, preferably a plan that purchases assets and value from the debtor (a buy-out). This buy-out can be a sale free and clear of all liens and interests.

The first two alternatives are conventional aggressive Chapter 11 creditor attacks and they are often yield more benefit than expense. But it is the third alternative that carries the greatest return.

The third alternative works like this. If the creditor or the investors can offer a competing plan that offers significant cash to purchase assets, the unsecured creditors will vote for that plan rather than for a debtor's plan that offers a pay-out to the unsecured creditors for less that what is owed to them.

The bottom line is that as long as the secured creditors end up with their collateral (or its value), the unsecured creditors may be able to sell the debtor to the highest bidder. In most cases there are only two bidders - and one of them is a bankrupt.

There are many possibilities.

We consider contingency fees for selected cases.

Charles Chesnutt, Sr.