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A Chapter 11 bankruptcy offers debt relief protection for businesses. Though the bankruptcy process, a business may restructure using a reorganization plan to consolidate debt to pay back creditors. However, such a plan must meet the requirements of the law, and one of the most basic requirements is that the plan is presented in good faith. The case of In Re Texas Star Refreshments provides an example.

Bankruptcy, following a lawsuit

A limited liability company engaged in the vending business filed for Chapter 11 bankruptcy protection.

The major secured creditor--a bank who had a security interest on essentially all of the LLC's assets--held a secured claim at the time of filing for more than $600,000. The LLC was one payment in arrears to the bank at the time of filing, and had, since the filing, made regular monthly payments. The LLC's bankruptcy plan provided for payment of the bank's claim with interest, through 84 monthly payments.

A competitor to the LLC was an unsecured creditor, and was owed over $900,000 as a result of winning a lawsuit against the LLC for misappropriation of trade secrets. The owners of the LLC had previously been employed by the competitor, and the lawsuit had resulted in the LLC's bankruptcy filing. However, the LLC was not prohibited or enjoined from continuing its business operations by that prior lawsuit.

The plan provided that the competitor's claim would be paid in full at interest of five percent per year, through a series of more than 80 monthly payments, followed by a final "balloon payment" at the end of more than $350,000. The plan further provided that the competitor's claim would be secured by a senior security interest in the LLC's stock and equity interest.

Other unsecured creditors would likewise be paid in full, but without a balloon payment. These other unsecured creditors were major trade suppliers of product, and the LLC's survival was dependent on maintaining good business relations with them.

The competitor objected to this plan alleging, among other grounds, that the plan had not been proposed in good faith as a result of the lawsuit, and that the bank was receiving preferential treatment due to its good relations with the LLC.

Repayment in full

The United States Bankruptcy Court noted that, under the law, a plan proposed in good faith must have reorganization as its honest and legitimate purpose. The court considers the circumstances surrounding a plan to assess the subjective motive of the debtors.

In particular, a bankruptcy filing in response to an adverse lawsuit judgment does raise good-faith concerns, but the plan here proposed to repay in full the competitor's judgment, with interest at the rate provided for in the judgment. Although the competitor complained of the plan treating the bank creditor more favorably, the bank was a secured creditor, while the competitor was an unsecured creditor.

The LLC was not enjoined from continuing its business by the prior lawsuit, and it had submitted a plan that assumed its continued operations while paying all creditors. Neither the LLC's bankruptcy filing nor its plan was proposed in bad faith.

Debt relief protection under the law

A Chapter 11 bankruptcy plan must be well-structured and meet all the requirements under the law, whether it arises from a lawsuit or from normal business operations. If you are considering filing for bankruptcy, it is crucial you seek an experienced attorney who can help you maintain your livelihood and business, without losing everything to creditors.