5 Reasons Why it Takes So Long for Payout Recovery in Chapter 11 Bankruptcy

5 Reasons Why it Takes So Long for Payout Recovery in Chapter 11 Bankruptcy

The Chapter 11 Bankruptcy process case can be broken down into two phases: the pre-confirmation phase and the post-confirmation phase. The marker that separates the two is a mandatory step in any successful Chapter 11 Bankruptcy case, which is the court-approval of the Plan of Reorganization.  

The vast majority of the court deliberations, proceedings, and litigation take place in the first pre-confirmation phase leading up to the formation and approval of the Plan of Reorganization; and therefore, consumes much of the Ch.11 case timeline. Once the Plan of Reorganization is court-confirmed, the Debtor in the post-confirmation phase must implement the Plan in its restructuring efforts and resolve claims with Creditors, prior to exiting Chapter 11.    

Overall, the timing of each phase varies from case to case and is dependent on the legal and capital structure of the Debtor, the Plan proposed, the litigiousness of the proceedings, negotiations with Creditors’ Committees, and the Creditors’ acceptance of the Plan.

While understanding the general bankruptcy process is helpful, the intricacies of certain steps in its legal procedures will help shed light on why the bankruptcy claims timeframe to resolve a Creditor’s claim is so uncertain.

What Factors Impact Creditor Recovery Timing?

While the average length of a Chapter 11 Bankruptcy case can last 17 months, larger and more complex cases can take up to five years. And following the conclusion of the bankruptcy case, it can still take months for Debtors to begin distributing payouts to the highest priority class of Creditors.

Unfortunately, there is no definitive answer to the question of when claim payouts will be issued to a particular Creditor. The concise answer is—it depends. Each Chapter 11 case, Creditor situation, and individual bankruptcy claim is unique and subject to many variables that can impact the recovery timeline. Certain Creditors will receive fast payouts and full recovery on their claim’s value, while other Creditors will not be as fortunate.

The 5 most critical factors within the Chapter 11 process that impact the timing of Creditor recovery outcomes are:

  • Claims Reconciliation
  • Creditor Prioritization
  • Debtor’s Plan of Reorganization
  • Court Confirmation on the Plan of Reorganization
  • Claims Resolution

Below, we will review each of these key factors and how they each can play a role in affecting the bankruptcy claims timeframe for Creditor payout.

Timeline of Chapter 11 Bankruptcy Process

Claims Reconciliation

Under Chapter 11, a distressed business will attempt to shed assets and liabilities through court monitored reorganization efforts with the objective of resuming financial stability and future sustainability. The filing of the bankruptcy petition marks the official start of the Chapter 11 process. Within 14 days of filing for bankruptcy protection, the Debtor is required to submit a Schedules of Assets and Liabilities that outlines the details of the company’s assets, liabilities, expenses, obligations, and debts owed to Creditors and parties of interest. Providing this information begins the proceedings of the reconciliation process with Creditors.

Allowance of Claims

Creditors are typically first alerted of the Debtor’s bankruptcy case when they receive a Notice of Bankruptcy. As a result, Creditors are given the opportunity to assess how their bankruptcy claim is listed in the Debtor’s Schedules. If their claim is not listed in the Schedule, appears inaccurate, or the claim is marked as ‘disputed’, ‘contingent’, or ‘unliquidated’; Creditors can assert their legal rights by filing an official Proof of Claim with the court before the bar date (the court’s deadline). Otherwise, claims that are listed on the Schedule are presumed to be accurate.  

The Debtor must review all of the filed bankruptcy claims, by comparing the submitted details against their own financial records. Under this reconciliation process, submitted claims that are fraudulent or invalid are rejected by the court. While Creditor claims that are valid are deemed allowed if a Proof of Claim has been filed or the Debtor does not object to the claim. Court-allowed claims therefore preserve a right to eventual repayment under the Debtor’s bankruptcy estate.  

Disallowance of Claims

The Debtor or trustee maintains the legal right to file objections against Creditor claims. Oftentimes, the Debtor may pursue filing objections on claims in order to invalidate or disallow them, and thereby reduce their own liabilities for ease of restructuring. This is often one of the variables that can prolong the first few months of bankruptcy proceedings. A Proof of Claim is often objected due to the following reasons:

  • The claim lists an incorrect amount due
  • The claim lists false interest or penalty charges
  • The claim lists an incorrect category, falsely stating it is a priority or secured
  • The claim has been filed for unethical reasons
  • There is a lack of supporting documentation with the claim

If a Debtor chooses to object to a Creditor’s Proof of Claim for any of the reasons listed above, they are required to file a written objection with the Bankruptcy Court. A copy must also be served to the Creditor, as well as the notice of hearing at least 30 days prior to the scheduled hearing date. Court hearings will attempt to resolve objections to claims. If the Debtor’s objection is successful, the claim is disallowed by the court, and the Creditor is unable to share in the repayment distribution from the Debtor’s bankruptcy estate. Most often, disallowed claims will be discharged at the end of the bankruptcy case unless a Creditor takes further legal action to dispute the court decision.

Allowance and disallowance of claims in the reconciliation process determines if the Creditor’s lawful right to repayment is upheld in the bankruptcy case. However, disputes on claims through Debtor’s objections and court hearings can greatly lengthen the time it takes for an allowance ruling on a Creditor’s claim, thus delaying recovery.



Creditor Prioritization

After the claim reconciliation process, the Debtor will seek to formulate a restructuring plan. The Debtor’s Plan of Reorganization must include a Disclosure Statement that categorizes Creditors into different classes based on the characteristics of their allowed bankruptcy claims. Within the Disclosure Statement, it also proposes how each class of Creditor will be treated under the Plan according to a similarity in repayment rights. The classification of Creditors is significant because it will determine the priority of each claim, which then affects the sequential order and timing in which a Creditor receives remediation from the bankruptcy estate.

Classification of claims will depend on the following factors:

  • Obligor (whether the bankruptcy claim is against the Debtor as a parent entity or its subsidiaries)
  • Collateral interests (whether the claim is secured or unsecured)
  • Debt position (whether the debt is senior or subordinated)
  • Post-petition or pre-petition (whether the debt was incurred before or after petition date)
  • Priorities (whether the type of claim is entitled to special treatment)

Taking these into account, bankruptcy claims are then categorized into the following Creditor classes, ranked from highest priority to lowest:

  • Secured Creditor
  • Unsecured Creditor, Priority Claim
  • Unsecured Creditor, Non-Priority Claim (General Unsecured)
  • Unsecured Equity Security Holders (Stockholders)

If a Creditor holds multiple claims, each with different rights, the individual claims can be classified into different Creditor classes based on their similarity of rights against the Debtor. This means that a Creditor can exist in different classes simultaneously, with each claim having different rights and priority to repayment distribution.

Secured Claims vs. Unsecured Claims

Determining whether a Creditor’s bankruptcy claim is secured or unsecured can offer a little insight into how long it will take to recover.

A bankruptcy claim that is classified as secured is guaranteed by collateral or a lien on property owned by the Debtor, such as specified through a contract. Secured creditors may be the holder of a real estate mortgage, a financial institution with a lien on all assets, a receivables lender, an equipment lessor, the holder of a statutory lien or a number of other entities. Because the claim is guaranteed against the value of collateral or a lien, a secured creditor will receive payment first and in full from the available funds of the bankruptcy estate before the next tier of unsecured Creditors.

On the contrary, an unsecured claim is one that is not guaranteed by collateral or a lien. Classes of unsecured Creditors will only receive recovery from the Debtor’s bankruptcy estate after distributions are made first to secured Creditors. Creditors with unsecured claims, however, are not guaranteed payment unless they have a priority claim.

Priority Claims vs. Non-Priority Claims

Unsecured Creditors with a priority claim are not secured by collateral, however they are treated with higher priority over other claims by Federal law. A priority claim is debt that is entitled to special treatment in the bankruptcy process and will get paid ahead of non-priority claims.

These might include bank lenders, employees, the government if any taxes are due, suppliers, and investors who have unsecured bonds. This class of bankruptcy claims are dependent on unrestrained assets of a bankruptcy estate for payment. This class of claims typically carry priority for public policy reasons, and thus under law are required to be paid out as a matter of priority to fulfill their special obligations. For instance, priority claims may include: employee compensation owed, unpaid tax obligations, and accounting and legal costs for administering the bankruptcy case.

Unsecured creditors with non-priority claims, otherwise known as general unsecured claims, are debts that possess no priority and are not supported by any secured interest or collateral in the Debtor’s bankruptcy estate. These types of bankruptcy claims might include credit card debts, student loans, personal loans, or utility and medical bills. Non-priority unsecured creditors have the lowest position in the priority scheme.

Unsecured priority claims must be paid when the Ch.11 Plan is confirmed or within a few months following the confirmation. Distributions are made to non-priority claims only once all priority claims have been paid. For general unsecured claims (non-priority), it is common that they do not receive a full payout on their claim value as a result of the remaining funds left in the bankruptcy estate after distributions made to higher ranking creditor classes.

Within the unsecured creditor class, there is a specific segment of claims reserved for equity holders—shareholders in the Debtor’s capital structure that can either be holders of preferred stock or common stock. Under the Ch.11 priority scheme, unsecured equity security holders are the last in line in repayment rights.

All in all, a Creditor’s class is determined by the prioritization process that effectively dictates the order in which a bankruptcy claim will receive payout recovery at the consummation of the Debtor’s Ch.11 case. In short, Creditor classes with higher priority (e.g. secured and priority unsecured) will get paid sequentially sooner than those classes with lower priority (e.g. general unsecured and equity).

Debtor’s Plan of Reorganization

Another factor in the bankruptcy timeline is the length of time in which it takes for the Debtor to propose their Plan of Reorganization. The Debtor typically has 120 days from the petition date to formulate and submit a Plan of Reorganization that outlines how it intends to restructure the business.

This exclusive period of 120 days is designated solely for the Debtor in order to grant enough time to prepare a plan to stabilize its operations, explore all available options, negotiate the terms with Creditors, and formulate a proposal that takes into consideration the goals and needs of all the creditor classes involved. In a best case scenario, a Debtor can expeditiously submit a Plan of Reorganization within the designated 120 day exclusive period.

However, Debtors have the option to submit a request with the court to file an additional extension of up to 18 months from the petition date, prolonging the time needed to formulate and submit the mandatory Plan of Reorganization. Extensions that are granted by the court will undoubtedly lengthen the bankruptcy process for the case, delay resolution on claims, and keep Creditors waiting.

In certain cases, the Debtor fails to submit a Plan of Reorganization or obtain acceptance of their Plan within the allowed timeframe. When this happens, a Creditors’ Committee or individual Creditors can submit a Plan of their own. Plans of Reorganization that are submitted by the Creditors’ Committee or an individual Creditor are required to meet the same criteria as that of the Debtor’s Plan regarding disclosure and solicitation requirements. In the event that this takes place, a Creditor submitted Plan will need to undergo further court proceedings—similar to the Debtor’s proposed Plan—prior to votes, approval, and confirmation.

Confirming the Plan of Reorganization

Another procedural factor that affects a Creditor’s path to recovery is the time it takes for the bankruptcy court and each class of creditors to approve the Plan of Reorganization. This step of the process is initiated with a hearing at which point the bankruptcy court will examine the documentation of the Plan of Reorganization and its Disclosures to ensure that it contains all of the necessary information to be approved.

At this point of the process, the court will solicit feedback and objections before it can be put up to vote by the eligible Creditors. If the court or Creditors have objections to any terms of the Plan and Disclosure Statement, the Debtor will have the opportunity to make any necessary modifications and another hearing will be held to review the modified plan.

The Debtor has 180 days after the petition date to obtain acceptances of its Plan from the court. This time period can also be extended by filing a request of up to 20 months from the petition date. If the court grants an extension, the proceedings will only drag on for all parties involved.

The court-accepted Plan of Reorganization, disclosure statement and a voting ballot is then presented to the Creditors that are qualified to vote, so they can either approve or reject the Plan. Each qualified Creditor is given time to review the Plan and cast their vote. In order for the Plan to be accepted, an affirmative vote of at least two-thirds in dollar amount of claim value, or more than half in number of creditors in the class are needed to achieve Plan confirmation.

Once the voting ballots have been received and tallied, a hearing is held to determine the official outcome. If the votes approve the Plan, the bankruptcy court then proceeds to officially confirm the Plan. If the Plan is rejected by the Creditors, the court allows the Debtor to further modify the Plan, which sets the timeline back again. There is also the possibility of the bankruptcy case being dismissed altogether or converted to a Chapter 7 liquidation bankruptcy if Plan approval ultimately cannot be achieved.

It should also be noted that during the bankruptcy case and before substantial consummation of the Plan of Reorganization, the Debtor can make modifications to the Plan at any time. Changes made can thus significantly lengthen the amount of time needed to achieve Plan confirmation as a result of the required disclosure hearings, solicitation, and voting processes.

For a Debtor to develop and submit a cohesive restructuring Plan in a Ch.11 case is one issue, but to obtain Plan confirmation is an entirely different challenge. Both of which can require significant time and result in timeline delays due to filing extensions, Creditor objections, Plan modifications and the court’s procedural steps associated with each. A smooth path towards Plan confirmation can be achieved, however, there are also many possibilities for disagreement and delay.

Claims Resolution

At long last, when a Plan of Reorganization is finally confirmed by the court, the post-confirmation phase of the Ch.11 bankruptcy process can be ushered in. At this time, the Debtor can move forward with implementing its approved Plan to restructure its business and to begin claim repayment with Creditors. This includes making payment or equity distribution, implementing new loan repayment terms, or administering other equitable solutions as agreed upon in the Plan of Reorganization with each class of Creditors on their bankruptcy claims. This is known as the Claims Resolution process.  

As mentioned above under Creditor Prioritization section, the order and timing of payment distribution is dictated by Creditor class and their seniority level. Claims of the highest priority and seniority level will receive payment in full from the bankruptcy estate prior to those of the lower priority classes. By Federal law, the Debtor must issue payout to Secured Creditors first, Priority Unsecured Creditors next, then to General Unsecured (Non-Priority) Creditors, and finally to Creditors with Equity Interests (i.e shareholders).


Payout Ramifications

Each of the five reasons described above illustrate how nuanced each factor can be, and the variables that can play a role in causing procedural complications and timing delays to the Ch.11 case. Not surprisingly, Creditors only receive repayment at the conclusion of the bankruptcy case when the Debtor reemerges from restructuring, and so any delays to the case directly postpones payout on Creditor claims.

Creditors typically do not receive recovery until 30 to 90 days from the court’s confirmation of the Plan of Reorganization. Unfortunately, not every Creditor with a valid, allowed claim is guaranteed to receive payment from the bankruptcy process. While some Creditors will receive payment of their full claim value—such as the majority of Secured Creditors—other Unsecured Creditor classes (especially non-priority claims such as General Unsecured) may receive payouts that are only partial claim value.

If there is nothing remaining from the bankruptcy estate after the top tier creditors and higher priority claims have been paid, lower tier Creditors will receive partial or even no recovery for their claims. Alternatively, a Debtor may in lieu of cash payment, provide repayment in the form of promissory notes or equity in the reorganized company—both of these options would delay liquidity for Creditors hoping to recover cash receivables. Furthermore, it is also not uncommon for Debtors to negotiate and establish installment payment plans with Creditors to repay claims over a set multi-year time period.

As evidenced by these varying possibilities, the long-awaited good news of a Debtor finally obtaining Plan confirmation in the Chapter 11 process does not necessarily indicate an immediate repayment on a Creditor’s claim. Recovery for Creditors can take many forms, payouts can be spaced out over long durations, or result in less than full claim value, or not even occur at all.

In Conclusion

The complexities of the Chapter 11 Bankruptcy process can make it nearly impossible for Creditors to predict when claim value recovery will arrive when they reach the case conclusion. There are several factors throughout the Ch.11 court procedures that can come into play at any point that would prolong the process or overturn a Creditor’s expectations.

With so much uncertainty surrounding the process of Chapter 11 Bankruptcy and clouding the path to recovery, it is prudent and even beneficial for Creditors to explore other options for recuperating their owed claim value. As a Creditor, fortunately you can choose to sell your bankruptcy claim through Claims Trading, allowing you to recover cash payouts on your claim in weeks, not years.