Most debtors, boards and private equity sponsors strongly prefer (and often insist on) a path that allows the company to confirm a liquidating chapter 11 plan. This path is the conventional exit path from chapter 11 and it achieves finality in an “official” sense with the entry of a plan confirmation order. The company, the board, the sponsor and their respective advisors also prefer the plan path because it customarily includes broad releases (at least on a consensual basis) and exculpation provisions providing immunity from suits by disgruntled creditors.
The plan path, however, is expensive. The expense is driven, in large part, by professional fees to prepare and prosecute a disclosure statement and plan of liquidation, the solicitation of votes from creditors and a reconciliation of claims. A plan ong other things, acceptance by an impaired accepting class of creditors (excluding insiders) and payment in full of all administrative claims in cash, including “Section 503(b)(9) claims,” which affords administrative priority status to the claims of pre-petition vendors who shipped goods that were received by the debtors within 20 days before the filing. While the plan path might be the “gold standard,” there are many cases where that path is not feasible or is simply too expensive relative to other options.
The Conversion Path
Conversion is another option. Converting the chapter 11 case to a case under chapter 7 is the least expensive path. The debtor files the case and the board of directors walks away. A chapter 7 trustee is appointed and disposition of the business and ancillary assets is the trustee’s headache. Despite the cost savings, this option is universally recognized by debtors, boards, sponsors and credit bidding buyers as the least desirable because it creates uncertainty stemming from the chapter 7 trustee. Chapter 7 trustees are compensated only when they create a pool of unencumbered assets to be distributed to creditors.