The Bankruptcy Code (Title 11 of the United States Code) gives the force of
law to several national policies or values. First is the value of allowing a Texas debtor a breathing spell and a fresh start, the chance for a productive future
unburdened by past debts and mistakes. Second is the value of a fair
distribution of a Texas debtor's property among creditors. The federal bankruptcy
system is designed to achieve an orderly, equitable distribution of the debtor's
assets under court supervision and compulsion. By contrast, state law on
creditors' rights has been called "grab law." Each creditor grabs what it can,
and the Texas debtor is dismembered. The swift creditor is rewarded. The slow creditor
gets nothing.
TWO TYPES OF BANKRUPTCIES: CHAPTER 7 AND CHAPTER 11
Under Chapter 7, the debtor's assets are simply liquidated. Upon filing a
Chapter 7 petition, the debtor turns its keys over to a private trustee and
walks out of business. The trustee is appointed by the Office of the U.S.
Trustee (a part of the Justice Department that generally monitors bankruptcy
proceedings). The filing of the Chapter 7 petition creates a "bankruptcy estate"
that the trustee administers for the benefit of creditors. The trustee locates
and liquidates everything of value that the debtor had.
Under Chapter 11, the debtor stays in possession of its assets. Its business
continues. It proposes a plan of reorganization. The plan usually proposes a
restructuring of debts and can affect equity. A committee of creditors may arise
as a counterweight to the debtor, monitoring the Texas debtor's handling of the
business, particularly the handling of cash and equivalents, called "cash
collateral." The creditors' committee may urge and participate in the debtors'
development of a plan. After 120 days, during which the debtor has the exclusive
right to propose a plan, the creditors' committee or an equity security holders'
committee may propose a plan. The creditors' committee, viewed mainly as an
interference by debtor, can nevertheless benefit the debtor. The tension created
by the committee's monitoring can help debtor obtain approval for rehabilitative
steps if and when debtor can show the court that the committee approves.
Ultimately, in a typical Chapter 11, debtor proposes a plan and a disclosure
statement. Creditors may vote against the plan, but the Texas court may approve a plan
it deems fair ("cramdown"). Bankruptcy Code Section 1129(b). If debtor does not
propose a plan, the case may be converted to a Chapter 7 liquidation or
dismissed. An alternative to the plan process may be a sale of assets, then a
liquidation.
