Chapter 11: The Burden Of Delivering Adequate Information In A Disclosure Statement

Towards the beginning and towards the end of a Chapter 11 case the debtor must summarize its financial condition for creditors and the court. In the beginning, the debtor files schedules of assets and liabilities and a statement of financial affairs. These documents are often creditors’ first look at the debtor’s inner workings and are designed to give creditors insight into the prospect of, and possible sources for, repayment for their claims.

The disclosure statement appears towards the finale of the Chapter 11 case and has a different flavor than the schedules and statement of financial affairs. While the earlier documents are intended to be objective, black and white expressions of facts, a disclosure statement frequently provides the debtor’s point of view regarding how it fell into bankruptcy and why the creditors should approve the debtor’s exit plan of reorganization.

The filing of a plan of reorganization is an important milestone event in the life of a Chapter 11 case. The business (or the individual with a complex or sophisticated financial situation) is offering creditors the first view of how much the debtor intends to pay and over what period of time. The debtor may propose to restructure secured debt and pay considerably less than the face amount of unsecured claims. A plan of reorganization may also contain provisions for non-economic measures such as providing an injunction against the enforcement of creditor’s rights against third parties, such as officers or other guarantors.

If a plan of reorganization proposes to impair a class of creditors, those creditors have the right to vote to accept or reject the plan. The Bankruptcy Code does not contemplate that these creditors will need to fly blind in making this decision: the debtor is required to furnish those creditors with information concerning the debtor’s past, present and future. The debtor must compile this information within a disclosure statement.

The disclosure statement must contain adequate information to enable a typical voting creditor to make an informed decision whether to accept or reject a plan of reorganization. It is a vital part of a bankruptcy court’s function in a Chapter 11 case to make a determination whether the debtor’s proposed disclosure statement satisfies this threshold. The minimum requirements will generally be:

  • A balance sheet
  • An income statement
  • A pre-bankruptcy history of the debtor’s operations
  • Reasons for filing the Chapter 11
  • Post-bankruptcy events, including litigation
  • A description of the debtor’s officers and management, with their compensation
  • Projections of the debtor’s anticipated post-Chapter 11 performance
  • Alternatives to the plan

A disclosure statement therefore becomes a much more living document than the debtor’s schedules and statement of financial affairs. The disclosure statement offers the debtor the opportunity to explain why the business faltered and why creditors should trust debtor’s management to fix the problems. The disclosure statement also allows the debtor to tell its side of the story, to a point, regarding any significant litigation that may have occurred during the Chapter 11 case.

Most importantly, the disclosure statement explains the debtor’s view of alternatives to the plan. The primary alternatives are typically dismissal of the bankruptcy and conversion of the case to Chapter 7. In most cases, the debtor can make a persuasive case that both of these alternatives will spell disaster for creditors.

Certainly, the debtor will explain that dismissal of the Chapter 11 case will allow creditors unrestricted ability to dismember the debtor by foreclosure on secured claims or execution on judgments obtained (or expected to be obtained). While this result may be appealing to the aggressive creditors who may have motivated the Chapter 11 filing by their enforcement actions the debtor should expect that the majority of its creditors will be concerned that such actions would leave nothing to satisfy the bulk of the debtor’s existing claims.

On the other hand, the debtor’s task in comparing the plan to a Chapter 7 liquidation may prove more complex. For this alternative, the debtor will need to convince creditors that the value of the debtor’s promise to make a stream of post-Chapter 11 payments is more valuable than the liquidation value of its assets. When these assets are fully encumbered by a secured bank or finance company (or the IRS) this task is relatively easy: in a Chapter 7 case the lender will almost certainly be able to obtain relief from the stay in bankruptcy and foreclose on its collateral, leaving unsecured creditors with nothing. Under that circumstance, unsecured creditors should be expected to fully support the debtor’s plan.

However, when no such secured debt exists and the assets are freely available to unsecured creditors, the debtor’s task becomes more challenging. In that case, the debtor will need to bolster its proposed stream of payments to in effect buy back from the creditors the equity in its assets, as well as pay a premium. This premium is necessary because the debtor is, in effect, gambling that its post-Chapter 11 performance is more valuable to creditors than straight liquidation.

The creditors, however, are really the players at risk because they may suffer the decrease in the value of the debtor’s asset base as the debtor labors to satisfy a stream of payments that frequently extends for several years. In this circumstance, the debtor must explain in the disclosure statement that it is likely to be able to maintain the payments, and that the payments are much more valuable than the liquidation value of its assets.

The bankruptcy court will closely monitor these elements of the disclosure statement. The standard for approval is fairly high. The debtor may not file a plan of reorganization and disclosure statement for many months or even years after commencing the Chapter 11 case; creditors may well have written off the debts. In that case, a creditor may be expected to believe that any recovery is better than no recovery, and therefore simply send in its ballot accepting the plan without much analysis. Courts will require that debtors include substantial financial information in the disclosure statement to make sure that the creditors are reasonably informed in casting their ballot.

Once the court approves a disclosure statement the debtor will send each creditor a packet including the plan of reorganization, the disclosure statement, a ballot, notice of the hearing to consider confirmation of the plan and deadlines for submitting their ballots or filing objections to the plan. This is an exciting time for the debtor as it seeks to successfully emerge from Chapter 11, made possible only by expending the time and effort needed to compile its information-rich disclosure statement.


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