The disclosure statement appears in the closing stages of a Chapter 11 case and has a distinct character from the schedules and statement of financial affairs. While the preceding documents are intended to be objective, black-and-white manifestations of facts, a disclosure statement frequently provides the debtor's perspective on how it entered bankruptcy and why its creditors should approve its exit plan for reorganization.
The submission of a plan of reorganization represents a significant turning point in a Chapter 11 case. The business (or individual with a complex or sophisticated financial situation) provides creditors with their first look at the amount and duration of repayment. The debtor may propose to restructure secured debt and pay a substantial amount less than the nominal value of unsecured claims. A reorganization plan may also include provisions for non-economic measures, such as an injunction against the enforcement of creditors' rights against third parties, such as officers or other guarantors.
If a reorganization plan proposes to harm a class of creditors, those creditors have the right to vote on whether or not to approve the plan. The Bankruptcy Code does not anticipate that these creditors will have to make this decision in the dark; the debtor is required to provide these creditors with information about the debtor's past, present, and future. This information must be compiled within a disclosure statement by the debtor.
The disclosure statement must contain sufficient information for a typical voting creditor to accept or reject a plan of reorganization with knowledge. In a Chapter 11 case, it is essential for the bankruptcy court to determine whether the debtor's proposed disclosure statement meets this threshold. In general, the minimum requirements will be:
A income statement
An income statement
A history of the debtor's pre-bankruptcy operations
Reasons for filing Chapter 11 Post-bankruptcy occurrences, such as litigation
A description of the officers and management of the debtor, along with their compensation.
Predicted post-Chapter 11 performance of the debtor.
Alternatives to the proposed course of action
Consequently, a disclosure statement is a significantly more dynamic document than the debtor's schedules and statement of financial affairs. The disclosure statement provides the debtor with the opportunity to explain why the business failed and why creditors should have faith in the debtor's management to rectify the situation. Additionally, the disclosure statement permits the debtor to explain, to some extent, any significant litigation that may have occurred during the Chapter 11 case.
Most significantly, the disclosure statement describes the debtor's perspective on plan alternatives. Typically, the principal alternatives are bankruptcy dismissal and conversion to Chapter 7. In most instances, the debtor can make a convincing case that both of these options are disastrous for creditors.
Certainly, the debtor will clarify that dismissal of the Chapter 11 case will permit creditors to dismember the debtor through foreclosure on secured claims or execution on obtained (or anticipated) judgments. While this outcome may be appealing to the creditors whose enforcement actions may have prompted the Chapter 11 filing, the majority of the debtor's creditors will likely be concerned that there will be insufficient funds to satisfy the majority of the debtor's existing claims.
In contrast, comparing the plan to a Chapter 7 liquidation may prove more difficult for the debtor. For this alternative, the debtor must persuade creditors that the value of the debtor's pledge to make post-Chapter 11 payments is greater than the value of the debtor's liquidated assets. When these assets are fully encumbered by a secured bank or finance company (or the Internal Revenue Service), this task is relatively simple: in a Chapter 7 bankruptcy, the lender will almost undoubtedly be able to obtain relief from the stay and foreclose on its collateral, leaving unsecured creditors with nothing. Under these conditions, unsecured creditors should support the debtor's plan in full.
However, when there is no such secured debt and the assets are freely available to unsecured creditors, the task of the debtor becomes more difficult. In that instance, the debtor will need to increase its proposed stream of payments and pay a premium in order to effectively repurchase from the creditors the equity in its assets. This premium is required because the debtor is essentially wagering that its post-Chapter 11 performance will be more valuable to creditors than a straightforward liquidation.
Creditors, however, are truly at risk, as they may experience a decline in the value of the debtor's asset base as the debtor strives to satisfy a stream of payments that frequently extends over a number of years. In this situation, the debtor must explain in the disclosure statement that it is likely to be able to continue making payments and that the payments are significantly more valuable than the debtor's assets.
The bankruptcy court will closely monitor these disclosure statement components.The approval standard is reasonably stringent. Creditors may have written off the debts by the time the debtor files a plan of reorganization and disclosure statement, which could be many months or even years after the Chapter 11 case has been initiated. In such a scenario, a creditor may assume that any recovery is preferable to no recovery and, as a result, vote for the plan without much consideration. Courts will require debtors to include substantial financial information in the disclosure statement in order to ensure that creditors are adequately informed when voting.
Once a disclosure statement has been approved by the court, the debtor will send each creditor a packet containing the plan of reorganization, the disclosure statement, a ballot, notice of the hearing to consider confirmation of the plan, and deadlines for submitting ballots or filing objections to the plan. This is an exciting time for the debtor as it attempts to emerge successfully from Chapter 11, a feat only made possible by the time and effort required to compile its information-rich disclosure statement.
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