When a Chapter 11 plan “impairs” a creditor by paying the creditor less than what it would receive under the original agreement, the creditor gets to vote on whether the Chapter 11 plan should be adopted. Even if the impaired creditor votes against the plan, you still might convince the court to “confirm” or approve it if you can show that you’ve made a reasonable offer.
In this article, you’ll learn about the process of confirming a Chapter 11 reorganization plan over the objection of an impaired creditor. Learn more about business bankruptcies in Frequently Asked Business Bankruptcy Questions.
What Is Chapter 11 Bankruptcy and Who Files It?
Chapter 11 bankruptcy is primarily used by businesses hoping debt relief will help them remain open. However, individuals who owe too much to qualify for Chapter 13 can also file for Chapter 11. The goal of Chapter 11 filers is for the court to approve a manageable plan, which usually consists of balance reductions, lowered payments or interest rates, and modified payment schedules.
Creating a plan begins when you negotiate new agreements with your creditors. However, it doesn’t always go smoothly—especially when asking to pay less than you owe.
What Is an Impaired Creditor in Bankruptcy?
In your Chapter 11 reorganization plan, you must label each of your creditors as “impaired” or “unimpaired.” A creditor’s claim is impaired if you negatively change the original debt terms, such as reducing the interest rate or lengthening the pay-out period.
Unimpaired creditor claims aren’t altered by the plan. Each receives what it would have received had you not filed for bankruptcy.
This distinction is important because impaired creditors vote on your plan, while unimpaired creditors do not. Find out what to expect at a 341 meeting for businesses.
Classification and Treatment of Impaired Claims in a Chapter 11 Plan
Your Chapter 11 plan must group similar debts into distinct classes and propose a payment plan for each class, called a “treatment.” Some classes will contain multiple creditors, while others will contain just one. The class is impaired if your proposed class treatment is less than full payment.
Example. Jane owns a home and a small restaurant on the seashore. Jane’s out-of-season business has been unusually bad for the last few years. As a result, she’s behind on her house payment and restaurant supplier invoices. Jane decides to file a Chapter 11 bankruptcy to manage her bills until the business improves. Jane and her lawyer create a plan that classifies and treats her major creditors like this:
Class 1 – $10,000 in past-due income taxes. Treatment – paid in full upon plan confirmation.
Class 2 – $300,000 home mortgage, with five payments past due. Treatment – the past-due amount paid over three years at 5% interest. Future payments are paid as agreed.
Class 3 – $6,000 claim of restaurant landlord for three months past due rent. Treatment – resume making current monthly payments and pay the past due rent in one lump sum at the end of twelve months when business has improved.
Class 4 - $10,000 in claims of restaurant suppliers. Treatment – pay 100% of claims over two years in monthly payments with 8% interest.
In this example, Class 1 is unimpaired. Classes 2, 3, and 4 are impaired, so they will vote on the plan.
Voting on the Chapter 11 Plan
Once you finalize a plan, you’ll file it with the court and send it to creditors along with a voting ballot. When the creditors return ballots, you’ll count the votes and group them by class.
Under Chapter 11 rules, if at least half the number of creditors and two-thirds of the dollar amount of claims in an impaired class vote yes, then the class has accepted the plan—even if all other class creditors vote no.
So, in the above example, if Class 4 contains ten suppliers with $10,000 in total claims, at least five of the suppliers holding at least $6,667 in total claims must vote yes for the class to accept the plan.
Learn whether filing a business bankruptcy will eliminate a personal guarantee and why filing a personal bankruptcy might be a better option.
Cramdown of Impaired Creditors in Chapter 11 Bankruptcy
Just because a class rejects a claim doesn’t mean the plan won’t be confirmed. If you can show that your proposed treatment of the rejecting class is fair, as defined by Chapter 11 rules, you can “cramdown” the plan. The cramdown rules are complicated, but generally, you must prove to the bankruptcy judge that the dollar value of the proposed future payments is worth at least as much as the current amount of the debt.
Chapter 11 plans can vary widely and are unique to the particular situation. Your plan won’t look like another filer’s, but the basic principles remain the same. You should consult a lawyer about the best way to classify and treat impaired claims.
Learn how to maximize your consultation time in Bankruptcy: Preparing to Meet with a Lawyer.
Questions for Your Lawyer:
- Will I have to impair some creditors under my plan for it to work for me?
- What kind of proposed plan treatment might my impaired creditors vote to accept?
- Do you think the court will confirm my plan even if a class of impaired creditors rejects it?