If you are a creditor in a Chapter 11 bankruptcy proceeding in Utah, consult with an experienced Sandy Utah bankruptcy lawyer. The lawyer can represent you as a creditor in the proceedings and protect your rights. Chapter 11 bankruptcy is complex.

The term “estate representative” may be applied to any of the following four situations: (i) a formal Chapter 11 trustee appointed under the Bankruptcy Code; (ii) a trustee picked by the creditors for a liquidating trust; (iii) the debtor or debtor-in-possession; and (iv) the manager of an entirely new business entity, such as a limited liability company, owned or controlled by creditors and created to liquidate the estate.

Chapter 11 Trustee

A Chapter 11 trustee appointed under the Bankruptcy Code has the advantage of having his or her powers and responsibilities more clearly laid out. This type of trustee is appointed during the case, prior to confirmation of the plan. Because this trustee function is created by statute, and because the Bankruptcy Code and case law have clarified the scope of a trustee’s authority, power, and responsibilities, the likelihood of a dispute over the trustee’s role is greatly reduced. Everyone knows where to look for the authority of the Chapter 11 trustee—the Bankruptcy Code.

Additional advantages arise from the fact that the Chapter 11 trustee is appointed while the case is still active in Chapter 11 and prior to the implementation of the liquidating plan. These advantages include continuity and protection from collateral actions. Presumably, a Chapter 11 trustee is also knowledgeable regarding both the assets he or she has been administering and the history of the case. This knowledge facilitates liquidation and, perhaps, accelerates the disposition of assets.

A Chapter 11 trustee has a degree of immunity to attack by creditors, the debtor, and others. This protection should avoid or limit indemnification requirements for the trustee. Clearly, the trustee does not face potential liability for government penalty or forfeiture claims, if he or she is appointed pursuant to the Bankruptcy Code. The fact that the trustee is not susceptible to attack personally for such claims and the clarity with which a statutory trustee’s role is perceived, decreases the need for reserves in connection with distributions to creditors and, therefore, facilitates prompt payout. Finally, bonding a Chapter 11 trustee is typically easier than bonding one appointed pursuant to a plan.

On the other hand, having a Chapter 11 trustee conduct the post-confirmation liquidation of the debtor has several disadvantages. First, the statutory trustee’s cumbersome and often expensive connection with the court is maintained. Employment of professionals must continue to occur only upon order of the court and their payment continues to be governed by normal court procedures. Reporting is required by applicable Bankruptcy Rules. Most importantly, the investment of estate funds is governed by the extremely conservative strictures of the Bankruptcy Code.

A Chapter 11 trustee has an independent fiduciary duty to the estate and its creditors. That independent duty is likely to limit—if not eliminate totally— creditor control of the liquidation process. In addition, the statutory trustee must continue to fulfill disinterested roles even after confirmation of the plan. Because the party liquidating an estate post-confirmation is frequently involved in the control of subsidiaries of the debtor and may even serve as an officer or director of those subsidiaries, remaining disinterested is a problem for a Chapter 11 trustee attempting to wear more than one hat.

In a business liquidation, more than one corporate entity often needs to be liquidated. Most corporations have officers and directors that are common to all the affiliate corporations. This overlap can create a huge problem for a trustee appointed under the provisions of Chapter 11, which require trustees to be totally disinterested. Such a trustee must avoid any hint of impropriety. Functioning as the CEO of several companies in a corporate structure involving intercompany debts and different creditors for each of the separate corporate entities creates that hint. In a liquidating plan with a plan trustee selected by the creditors, these problems can be avoided simply by having the plan state that a liquidating trustee can serve in multiple capacities. A trustee appointed by the court is much more limited.

Plan Trustee

The advantages of utilizing a liquidating trustee, whose position is created by the plan and whose duties and powers are tailored by the plan, are almost a mirror image of the disadvantages of a Chapter 11 trustee. Creditor control of the duties of a plan trustee may be tailored to the unique needs of each case. Because the plan is the instrument creating the role of the liquidating trustee, that role may include whatever opportunities for creditor input and control creditor representatives deem appropriate. While the trustee almost certainly is granted the powers of a Chapter 11 trustee, he or she may receive contractual powers beyond those afforded a Chapter 11 trustee, if deemed appropriate by the creditors. For example, the trustee appointed pursuant to a plan of reorganization may have the power to compromise controversies or sell property on limited notice or on no notice at all, and to invest funds in ways other than those permitted by the Bankruptcy Code or the United States Trustee. These powers, which may be exercised without seeking authority from the court, allow a faster, smoother liquidation. By eliminating the need to go to court at each step of the liquidation, costs are reduced. Additionally, the trustee appointed pursuant to a plan, is not subject to the same disinterestedness requirements of the Bankruptcy Code and can serve in any situations and capacities approved by the creditors. Because of the relative absence of a statutory law basis for the plan trustee role, the plan trustee may require extensive indemnification. Similarly the trustee appointed pursuant to the plan of reorganization may be concerned about his or her potential personal exposure. These factors can cause delays in distribution and maintenance of large reserves to ensure against what are, in fact, remote contingencies.

Debtor as Estate Representative

The debtor can serve as estate representative, but this choice is usually ill advised. If the debtor in a Chapter 11 proceeding in which you are a creditor is offering to act as the estate representative, consult an experienced Sandy Utah bankruptcy lawyer. Retaining the debtor as the post-confirmation estate representative has clear drawbacks. While the debtor’s ownership may be altered to reflect creditor control of the equity in the debtor, implementing that control may have practical difficulties. For example, if ownership of the debtor is transferred to creditors, the number of creditor-shareholder entities may be required to report under the Securities Exchange Act. Income may be taxed twice, taxation on income to the corporation as well as taxation on dividends to creditor shareholders. Finally, a Chapter 11 debtor that is a business entity whose assets were acquired pursuant to a plan may not survive in a form suitable to conduct the rest of the liquidation. In practice, the creditors want to choose a liquidator who is answerable to them.

New Business Entity

The remaining alternative available in a post confirmation liquidation is the creation of an entirely new entity to serve as the estate representative and conduct the liquidation. Limited liability companies (LLCs) in particular have been popular post confirmation entities. LLCs are taxed as partnerships for federal tax purposes. On the plus side, partnership classification for tax purposes removes the two tiers of tax (corporate and shareholder). Because it is a flow through entity, only one tier (the beneficial owner) remains. On the minus side, however, LLCs that are taxed as a partnership for federal tax purposes are deemed to be in an active trade or business in some states. Therefore, such entities may be subject to other state business taxes such as franchise taxes and gross receipt taxes. The transfer of the assets to the partnership further removes any lawsuits from the original parties at interest and may impact the tax character of certain recoveries.

Governing the Estate Representative

In formulating a liquidating plan of reorganization the creditors must determine both who will control the estate representative and the extent of that control. While control of the liquidation process is one of the key goals in most liquidating Chapter 11 cases, a variety of concerns contribute to whether and how to exercise that control. Essentially, creditors have three ways to exercise control.

Minimum Oversight

First, creditors may elect to exercise little or no control. Sometimes, particularly if the liquidator is a Chapter 11 trustee or is the continuing debtor, the creditors want the liquidator to be subject to supervision and control by the bankruptcy court. These cases are not the norm. While a liquidator under a creditors’ trust may be made independent, normally creditors want to exercise control post-confirmation.

Creditors typically exercise control through a committee named in the plan. This committee may be the statutory creditors’ committee, or it may be a new committee created pursuant to the plan. The creditors decide. A number of practical problems arise in attempting to control the liquidation process through a committee.

First, the committee does not have the in-depth knowledge that the liquidator has and therefore must defer in large part to the liquidator on various issues, many of which are critical to the liquidation process. If the committee has confidence in the liquidator, this lack of detailed knowledge is no problem. However, a great deal rests on trust.

Second, committee members usually are not compensated for overseeing the liquidation process. A complex liquidation may require numerous decisions and a substantial time commitment. They are likely to receive nothing other than the same pro rata share of the estate that creditors who do not serve on the committee receive.

Finally, members of a creditors’ committee must be extremely cautious not to exercise their powers for their own benefit. They are fiduciaries. Fiduciaries acting for the benefit of the creditor group may be held liable to the creditor group, if they put their own interests first.

The role of a committee that oversees the liquidator should be spelled out clearly. While the plan may define the committee’s role in general terms, the committee should also establish a set of rules of operation covering its powers, duties, and interaction with the liquidator. In general, the control exercised by a creditors’ committee is similar to the control exercised by a board of directors.

The committee should have an operative document (i.e., bylaws, LLC agreement, etc.) that ensures that it (i) approves or rejects major transactions proposed by the liquidator, (ii) oversees the compensation of any professionals, (iii) receives regular reports on the status of the liquidation process and the manner in which funds are being handled, and (iv) meets often enough to provide meaningful supervision to the liquidator. Yet, the liquidation process must be turned over to the liquidator. As a practical matter, the liquidator must have a degree of freedom in areas such as marketing, negotiating, litigation, and the like. The analogy of a board of directors working with a chief executive officer (CEO) is apt.

The appointment of independent directors and officers, a third approach for governance of the liquidator, only makes sense when the entity conducting the liquidation is a corporation. Providing for independent directors and officers has the advantage of reducing the possibility of self-dealing that exists with any committee made up from among the largest creditors in the case. However, finding persons willing to serve as officers or directors of a debtor engaged in a relatively short-term liquidation is difficult, especially if the reorganized debtor is a publicly reporting company. The debtor’s recent time in bankruptcy court increases the difficulty of finding insurance for officers and directors in a liquidation scenario. This creates indemnity problems beyond those that might be expected with a trustee appointed pursuant to a plan of reorganization. The corporate vehicle is usually considered and then dropped for these reasons.

As a creditor in a Chapter 11 bankruptcy, you should seek the assistance of an experienced Sandy Utah bankruptcy lawyer to protect your rights.

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When you need to file for bankruptcy in Utah; whether it is a chapter 7, chapter 12, chapter 13, chapter 11 or chapter 9 bankruptcy, please call Ascent Law LLC (801) 676-5506 for your Free Consultation. We want to help you.

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— Tim Cella (@TimCella2) October 6, 2022