Impaired Creditors and Your Chapter 11 Plan

Sometimes businesses don't fare too well. A bad economy, poor sales or any number of things can throw any business into a financial tail spin. Chapter 11 bankruptcy may help save the business, though. You may be able to reduce or eliminate debt, keep the company's doors open and hopefully return to making a profit.

The key to this success story is your reorganization plan. This plan does many things, but one of the most important is that it sets out which creditors you plan on repaying, how, how much and when. So, your company's creditors generally have to agree to or approve your plan before the bankruptcy court can confirm it.

There's one type of creditor that can make or break your plan: Impaired creditors.

Not Everyone Votes

As part of your plan, you need to classify your creditors. You put creditors with the same or similar types of claims and interests in the same class. For example, all creditors with security interests in the company's real property may be put into the same class, while unsecured creditors, like vendors and credit card companies, might be put into another class.

Impaired & Unimpaired Creditors

When classifying creditors, you also need to list which creditors are impaired and which are unimpaired:

  • Impaired creditors are those whose legal rights against the company are being changed by the reorganization plan. Usually, this means the plan calls for paying them less, and usually far less, than what they're owed
  • Unimpaired creditors are those whose legal rights against the company aren't changed by the plan

Only impaired creditors vote for or against your plan. That's because only their legal rights are stake.

Creditors who receive nothing in your plan don't get to vote, either. It's presumed they reject plan. That doesn't necessarily mean they'll get nothing, though. Creditors who vote against or reject the plan are usually entitled to recover what they would have recovered if your company had filed a Chapter 7 liquidation bankruptcy.

Voting on the Plan

All impaired creditors who get something under your plan get a vote, but the vote is counted by the whole class (or classes). The vote doesn't have to be unanimous, either. The plan is approved by a class when:

  • A majority (51 percent) of the class members vote in favor of it
  • The class members who voted in favor hold at least the two-thirds of the total value of the claims in that class

As a general rule, before the court can confirm the plan, at least one class of impaired creditors must vote in favor of it.

"No" Votes May Not Kill the Plan

Often, companies have more than one class of impaired creditors. It's also not uncommon for these creditors to disagree when it comes to voting on the plan. Your plan may still be confirmed even if one or more classes of impaired creditors vote against it.

So long as one class of impaired creditors voted in favor of the plan, the cramdown rule may be used to get the plan confirmed. Before a court can confirm the plan, though, you have to show that it's fair to all impaired creditors.

The reorganization plan is the heart of any Chapter 11 bankruptcy. You can't save your business and get relief from your debts without it. By making sure your creditors are treated fairly, you increase your chances of having them approve your plan so you can get back to business.

Questions for Your Attorney

  • If late payments are eliminated from the debt I owe a creditor, is that creditor an impaired creditor?
  • What if a class of creditors that votes in favor the plan includes creditors who also work for my business? Is there a conflict that will cause a problem? 
  • Is it better to propose a plan that is unlikely to be accepted by each class of impaired creditors in hopes of utilizing the cramdown provisions?

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