If you are a business owner and you were doing business with a company who later files for Chapter 11 reorganization, and you are owed money by that company, there are many safeguards in place that can be utilized to make sure that you, as a creditor, recover as much money as possible through the reorganization process. This article will discuss one example of this.
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Typically, in a Chapter 11 bankruptcy case, a debtor proposes a plan to pay creditors over time, which may include a sale of assets, and the court scrutinizes the proposed sale to determine which creditors are to be paid from the sale, how much the creditors will receive from the sale, and whether the sale is fair and equitable to all creditors. If a Chapter 11 debtor proposes to sell its assets to a third party purchaser, but the actual amount to be paid is only enough to pay some creditors and not others, then the question arises as to whether such a sale is fair and equitable, and whether it should be approved.
For example, if a debtor proposes to sell its assets for $200,000, but the potential purchaser would only actually be paying $25,000 and the remainder of the purchase price consists of liabilities that the potential purchaser would be assuming, then the court would need to review the facts and determine whether or not to approve such a sale. First, the court would need to assess what creditors would benefit from the sale. If the proceeds from the sale would satisfy the debtor’s secured creditor, but no money would be paid to unsecured creditors from the sale, and only select unsecured creditors would have their liabilities assumed by the potential purchaser, then it is very likely that the court would deny such a sale.
Generally speaking, courts consider a number of factors in determining whether or not to approve a sale, including but not limited to: the amount of money actually being paid by the proposed purchaser (if the proposed purchaser is merely assuming liabilities then no money is actually being paid), and the sale must not violate the best interest of creditors test because, in order for a sale to be approved in bankruptcy court, creditors must receive no less than they would receive in a Chapter 7 liquidation. In the above example, several unsecured creditors would not receive a penny from the sale. Therefore, it is arguable that the best interest of creditors test would be violated by such a proposed sale. Further, in making its determination, the court would likely consider the payment terms set forth in the proposed asset purchase agreement. If the proposed asset purchase agreement does not provide specific payment terms setting forth who is getting paid what amount and when, then it is not clear when, or if, the potential purchaser would be making any additional payments to creditors. Thus, if the proposed sale is too illusory to approve, then the sale will usually be denied.
In conclusion, debtors cannot cherry pick among creditors in their bankruptcy cases, proposing to pay some creditors and not others. If a debtor wants the benefit of a bankruptcy case, then creditors must be treated fairly.
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