The most common corporate insolvency procedure is Chapter 11 of the United States Bankruptcy Code, pursuant to which a corporate debtor can reorganize, sell its business, or liquidate. Companies that intend to wind down may instead choose to liquidate under Chapter 7 of the Bankruptcy Code. Small business debtors (with liabilities under the statutory threshold (currently USD 3,024,725)) can file under Subchapter V of the Bankruptcy Code, which provides simplified procedures intended to facilitate a timely reorganization.

Three less commonly used state law alternatives are a court-appointed receivership, an assignment for the benefit of creditors (under which all of the debtor’s assets are transferred to a trustee to be sold for the benefit of creditors), or a state law Article 9 foreclosure proceeding.

Prior to commencing an in-court restructuring process, a debtor may negotiate an out-of-court restructuring with its creditors and key constituents by mutual agreement among all of the parties. These mutual agreements may incorporate elements of a standstill, forbearance, waiver of a default, or other amendment to existing contractual arrangements, subject to complying with the requisite lender thresholds under the particular documents.

The filing of a petition for relief under the United States Bankruptcy Code automatically, and without further order of the court, stays all creditor enforcement actions against the debtor and its estate/property. Certain tax proceedings and government actions under its police and regulatory power are exempt from the automatic stay. While the automatic stay applies to both domestic and foreign creditors and all of a debtor’s assets, debtors may encounter issues enforcing the stay in foreign jurisdictions and, therefore, may seek recognition of the U.S. bankruptcy case in those jurisdictions. Creditors may seek relief from the automatic stay pursuant to section 362(d) of the Bankruptcy Code in limited circumstances, including for cause. While cause has not been defined, bankruptcy courts generally look to the totality of the circumstances. The court generally looks to 12 so-called “Sonnax” factors that include whether the relief will:

• result in partial or complete resolution of the issues;
• interfere with the administration of the bankruptcy case; or
• result in prejudice to the debtor’s other creditors.

The party seeking to lift the stay has the burden of establishing a prima facie entitlement to the relief requested.

3.1 What are the conditions to entry?

A company is eligible to file for relief under Chapter 11 (the reorganization provision of the Bankruptcy Code) so long as it:

• has a domicile, principal place of business, or property in the United States;
• files the required petitions for relief; and
• pays the filing fee.

Although insolvency is not a prerequisite for filing for Chapter 11 relief, in rare circumstances the court may dismiss a filing for being in bad faith (including if the debtor does not exhibit financial distress). See In re LTL Mgmt., LLC, No. 22-2003, 2023 WL 1098189 (3d Cir. Jan. 30, 2023).

An involuntary insolvency case may also be commenced by three or more creditors holding the minimum statutory amount (currently USD 18,600) in non-contingent, undisputed, unsecured claims against the company. The company can contest the involuntary filing.

3.2 Can creditor claims be compromised “within a class”?

Yes, creditor claims can be compromised within a class. All claims within a class must be treated equally unless a holder of a claim agrees to different treatment. A class of claims is deemed to accept a plan of reorganization if the class votes two thirds in amount and more than one half in number, only counting those voting. If the plan of reorganization is approved by the class and confirmed by the court, the applicable treatment will apply to all holders of claims within a class whether or not individual creditors voted to approve or reject the plan.

3.3 Is there a “cross-class cramdown”?

Yes, cross-class cramdown (i.e., where a plan is enforceable against a class of creditors that votes to reject the plan) is possible if: (i) at least one class of impaired claims votes to accept the plan of reorganization; and (ii) the requirements of section 1129(b) of the Bankruptcy Code are met, including that, with respect to each class of claims that is impaired under, and has not voted to accept the plan of reorganization (x) the plan does not discriminate unfairly in its treatment of classes of similar priorities (meaning classes must receive the relative value equal to the value given to all similarly situated classes and cannot bear disproportionate risk as compared to similarly situated classes) and (y) is fair and equitable with respect to each class of claim or interest that is impaired under, and has not voted to accept the plan of reorganization. The “fair and equitable” standard incorporates a number of factors, including that the no-party junior to the dissenting class can receive a recovery under the plan unless the rejecting class is paid in full (also known as the “absolute priority rule”).

3.4 Can shareholder claims be compromised?

Yes, shareholder claims (called “interests”) can be, and are often, compromised under a plan. There is no numerosity voting requirement for equity interests as there is with claims; a class of equity interests accepts a plan by voting two-thirds in amount (i.e., value). Because equity interests rank behind unsecured claims and, by virtue of the absolute priority rule, cannot receive a recovery until senior claims are paid in full, equity interests are often cancelled under a plan. If equity interests are cancelled, no vote of the shareholders is required and they are deemed by the Bankruptcy Code to have rejected the plan.

3.5 Can secured creditors’ claims be compromised? Are deficiency claims treated differently?

Secured creditor claims can be compromised by class vote in accordance with the above voting requirements or crammed down if the class rejects the plan. To cram down a class of secured creditors, the plan of reorganization must provide to holders of secured claims:

• liens equal to the secured amount of such claim; and
• deferred cash payments totaling the present value of such secured claim on the effective date.

Additionally, a secured creditor’s deficiency claim will be separated from the secured portion of the claim (that is, the portion of the claim equal to the value of the collateral) and treated in a class with the debtor’s other unsecured claims.

3.6 Can creditors propose competing plans?

Creditors can propose competing plans, however, the debtor is afforded a 120-day exclusive period following the commencement of the case to file a plan of reorganization, which the debtor may move to extend “for cause” for up to 18 months after filing. Exclusivity may be terminated if a party in interest demonstrates that the debtor is not diligently pursuing a reorganization or there is a lack of confidence in the debtor’s ability to successfully reorganize.

3.7 What level of court or other third-party supervision is there of the process(es)?

After filing for bankruptcy protection, debtors are required to obtain court approval for all activities considered to be outside of the ordinary course of business. Other important third parties involved in the process include the U.S. Trustee for the specific region in which the case is filed (a government agency that has statutory authority under the U.S. Trustee Program to supervise the proceedings), an official creditors’ committee which protects the interest of unsecured creditors and other committees which may be appointed by the court depending on the circumstances of the case (e.g., retiree committee, equity committee).

Yes. Transactions can be voided and clawed back under state and federal law where:

• a creditor received payment or other benefit (i.e., a lien) within the relevant look-back periods discussed below; or
• a transaction was fraudulent, as provided in the relevant statutes.

4.1 What is the applicable law that provides for clawback and/or antecedent transaction claims?

The Bankruptcy Code provides debtors and trustees with the power to void transfers that provide preferential treatment to certain creditors. While there are certain state law equivalents that apply in limited circumstances (e.g., in relation to an assignment for the benefit of creditors), those equivalents are rarely utilized.

4.2 What are the relevant “look-back” periods for claims?

Preferential transfers generally have a 90-day look-back period from the date of the bankruptcy filing, except for transactions involving insiders, where the look-back period is one year from filing.

4.3 Who can pursue claims?

The debtor in possession (a corporate debtor where no Chapter 11 trustee has been appointed), or, if appointed, the trustee of the debtor’s estate, is vested with the power to pursue preference claims. Creditors or the creditors’ committee may also seek standing to pursue these claims if the debtor in possession or trustee does not do so.

4.4 What remedies are available and how do they operate in practice?

Transactions determined to be a preference may be avoided such that the creditor is required to return the property back to the estate. For example, if the property is a payment, the creditor would generally be required to return the payment and the creditor would retain a general unsecured claim against the estate in the amount returned. In the case of a lien being granted or perfected in the preference period, the transaction may be unwound with the security being released.

4.5 What defenses are available?

The debtor in possession or trustee must meet certain criteria to establish a preference claim, including that the transfer was made while the debtor was insolvent (there is a rebuttable presumption of insolvency during the look-back period), and as a result of such transfer, the creditor received more than it would have in a Chapter 7 liquidation of the debtor. A preference defendant may challenge these criteria, including rebutting the presumption of insolvency.

Other common defenses include that the transaction at issue:

• occurred in the ordinary course of business and on ordinary terms, according to either the industry standard or course of business between the parties; or
• provided new value to the debtor in a simultaneous/near simultaneous exchange (e.g., customer purchasing goods at a store).

Other defenses may apply in the case of inventory or purchase money security interests.

4.6 Is there a general right of action in respect of transactions defrauding creditors or Actio Pauliana claims?

State and federal law, including the Bankruptcy Code, provide rights of action for fraudulent transfers. Under nonbankruptcy law, this is primarily through a state’s adoption of the Uniform Voidable Transactions Act (UVTA) or its predecessor. The Bankruptcy Code provides its own right of action for fraudulent transfers and permits those nonbankruptcy rights of action to be pursued under its authority during a bankruptcy proceeding.

The Bankruptcy Code’s fraudulent transfer look-back period is two years, while state law nonbankruptcy look-back periods are typically longer, ranging from four to six years. Where a look-back period is longer than the Bankruptcy Code provides, the Code utilizes the nonbankruptcy law look back.

4.7 Who can pursue the claims?

Creditors can pursue fraudulent transfer claims under state law prior to a bankruptcy filing. Post-filing, the claims are vested with the debtor in possession or trustee. Similar to preference claims, a creditor or creditors’ committee may seek standing to pursue these claims, or the debtor may assign these claims to a creditor representative.

4.8 What remedies are available and how do they operate in practice?

Transactions proven to be fraudulent can be avoided such that the creditor is required to return the property or its value to the estate, similar to preferences. Defendants may also be required to compensate the debtor for any diminution in value.

4.9 What defenses are available?

Establishing a fraudulent transfer requires showing the transfer meets the criteria to be deemed actual fraud or constructive fraud. Actual fraud requires showing the transferor’s actual intent to hinder, delay or defraud any creditor of the debtor, regardless of the debtor’s solvency at the time. Constructive fraud requires proving the transaction at issue lacked an exchange of reasonably equivalent value at a time the company was insolvent or nearly insolvent. An initial transferee that demonstrates good faith can sometimes retain value equal to the value it provided in the transaction; a subsequent transferee in good faith for value has a complete defense to any fraudulent transfer claim. Additional defenses may exist depending on the jurisdiction of the proceeding.

The duties and potential liability of a debtor’s directors and officers (“D&Os”) are generally established under the applicable state law.

Most U.S. corporations purchase and maintain D&O insurance policies which provide coverage to D&Os for claims arising from breach of fiduciary duties, except in cases of fraud and gross negligence. Debtors ordinarily seek “first day” relief to maintain their insurance programs through a Chapter 11 case.

In Chapter 11, fiduciary duty claims against the D&Os belong to the estate, and the estate fiduciaries can determine whether to bring such claims or release them, often after an investigation. It is customary for a Chapter 11 reorganization plan to provide for the release of all the debtors’ claims against D&Os, including fiduciary duty claims, relating to D&Os’ conduct before the filing and during a case, and for exculpation for all claims arising post-filing, subject to exceptions. Recent rulings of the Supreme Court and Fifth Circuit have narrowed the application of release provisions such that:

• bankruptcy courts can no longer approve non-consensual third-party releases (claims of third parties against D&Os and others); and
• exculpation provisions under a Chapter 11 plan can only apply to the debtor, creditors’ committee and its members, and independent directors of the debtor.

5.1 What are the duties of directors and managers?

D&Os owe fiduciary duties in accordance with state law. The most common fiduciary duties owed are duties of care, loyalty and good faith. Whether the corporation is solvent or insolvent determines to which parties such duties are owed. When solvent, D&Os owe fiduciary duties to the corporation and its shareholders. When insolvent, D&Os owe fiduciary duties to the corporation (at least under Delaware law, which is a common jurisdiction for corporations). Creditors are deemed beneficiaries when an entity is insolvent.

5.2 What claims can be brought against directors and managers arising from breaches of those duties?

In Delaware, breach of fiduciary duty claims can be brought either as direct claims, alleging harm to particular shareholders, or derivative claims, alleging harm to the corporation. The latter is more common. Elements of such claims vary slightly by state, but generally, litigants must prove two elements: (i) that the defendant owed a fiduciary duty to the plaintiff, and (ii) that the defendant breached that duty with their conduct. There are various defenses available to such claims, including the business judgment rule, which is protective of D&Os’ decisions under certain circumstances.

In Delaware — the most common state to have jurisdiction over such claims — the suits are brought in the Court of Chancery, the court with exclusive jurisdiction over matters in equity. In other states, these suits are brought in civil court. When a company is in Chapter 11, the claims are sometimes brought in bankruptcy court.

5.3 Who can pursue the claims?

Prior to a bankruptcy filing, shareholders typically pursue both forms of breach of fiduciary duty claims, although derivative claims also belong to and can be pursued by the entire corporation (and shareholders must make a demand of the corporation before pursuing such derivative claims on behalf of the corporation).

Post-petition, a creditors’ committee (if given standing by the court) or, less commonly, a Chapter 11 trustee, are able to pursue such claims. Following an investigation, debtors may sometimes elect to transfer potential claims into a litigation trust to be pursued following confirmation of the Chapter 11 plan for the benefit of certain creditors (commonly, general unsecured creditors). In practice, claims are often investigated prior to a Chapter 11 filing by a Special Committee of the Board of Directors to determine whether claims are valuable and should be preserved (or transferred in satisfaction of creditor claims) or released under a Chapter 11 plan.

5.4 Do directors have, at any time, a strict obligation to file for insolvency and, if so, when does that arise?

D&Os have no explicit legal obligation to file for bankruptcy at any time but are bound by their fiduciary duties to act in the best interests of the corporation. Depending on the situation, these duties may obligate them to consider contingency plans, engage restructuring advisors and prepare for and authorize filing for bankruptcy.

5.5 Can directors and managers be found liable for the increase in sums owed to creditors after a company becomes insolvent?

Generally, D&Os are not liable for increased sums owed to creditors once a company becomes insolvent. This “deepening insolvency theory” has been tried and subsequently rejected as a theory of damages in the United States.

5.6 In what other circumstances can directors and managers be found liable directly to creditors of the company?

In general, D&Os owe fiduciary duties to the corporation itself, and those duties do not flow automatically by extension to the corporation’s creditors. However, when the corporation is insolvent, creditors as the beneficiary of the corporation’s estate are the beneficiaries of any established breach of duty claims against the directors and officers. While creditors cannot bring direct breach of duty claims against the directors and officers, in certain circumstances creditors may petition a court to pursue a derivative claim on behalf of the corporation. As noted, in a bankruptcy process those claims belong to the estate.

Unless sealed by order of the court, the debtor’s court filings are publicly available and routinely uploaded to a website set up for the case. Creditors should therefore refer to the bankruptcy court’s docket or the debtor’s case website to obtain relevant information regarding a debtor’s bankruptcy case. In connection with filing the petition for relief, a debtor is required to make certain disclosures therein and also files a first day declaration which typically explains, among other things, the relevant details that led to the filing of the petition. Under the Bankruptcy Code, debtors are required to make extensive disclosures during the case including the filing of detailed schedules of assets and liabilities, statements of financial affairs and monthly operating reports.

Throughout the case, a debtor is also required to send notices of certain material filings to their known creditors by registered mail and publish certain notices in select national and industry print outlets. If a creditor is not receiving notice by registered mail, it can contact the debtor’s claims and noticing agent to be added to the debtor’s master service list.

6.1 What information can be obtained by office holders in respect of a debtor’s property, information and affairs?

In a Chapter 11 case, the debtor’s directors, officers and management remain in control of the entity as the debtor in possession unless the court appoints a Chapter 11 trustee. Accordingly, unless a trustee is appointed, there are no external office holders that would need to obtain information.

Pursuant to Bankruptcy Rule 2004, the bankruptcy court may, on motion of a party in interest (which includes the debtor and any other affected party) order an examination of any entity to obtain information relating to the acts, conduct, property or liabilities and financial condition of the debtor, or any other matter which may affect the administration of the debtor’s estate. The bankruptcy court has generally applied this provision broadly and approved expansive requests for discovery. While Rule 2004 may be utilized by any party in interest, it is a tool primarily utilized by a debtor or trustee.

6.2 How is that information obtained in practice?

Information can be obtained directly from the bankruptcy court’s case docket or via the debtor’s case website free of charge.

6.3 Can the court assist in obtaining that information and how does that work in practice?

The bankruptcy court can assist a creditor in obtaining information from a debtor by ruling on a discovery or similar motion, including a discovery request under Bankruptcy Rule 2004.

Practitioners from other jurisdictions can petition for recognition of a foreign bankruptcy proceeding under Chapter 15 of the Bankruptcy Code, which broadly incorporates the UNCITRAL Model Law on Cross-Border Insolvency. Chapter 15 is designed to help foreign debtors administer their U.S.-based assets and enforce their local laws against U.S.-based creditors. In connection with a Chapter 15 filing, a debtor may also seek to stay U.S.-based litigation concerning the debtor’s estate.

7.1 Is the UNCITRAL Model Law on Cross-Border Insolvency adopted?

Yes, the UNCITRAL Model Law was adopted in the United States in 2005. It is codified in Chapter 15 of the Bankruptcy Code, 11 U.S.C. §§ 1501 et seq.

7.2 Is it possible to recognize office holders from other jurisdictions?

Yes, Chapter 15 allows for recognition of a foreign bankruptcy proceeding in other jurisdictions, along with the debtor’s foreign representative.

7.3 What is the process and what are the conditions for recognition?

Chapter 15 cases are commenced by a foreign representative of the debtor filing a petition for recognition of the foreign proceeding in the U.S. bankruptcy court. Foreign proceedings are collective judicial or administrative proceedings in a foreign country in which the assets and affairs of the debtor are subject to control or supervision by a foreign court for the purposes of reorganization or liquidation.

A bankruptcy court will recognize the foreign proceeding if:

• the foreign proceeding qualifies as “foreign main proceedings” (foreign proceedings pending in the country where the debtor has the center of its main interests) or “foreign non-main proceedings” (foreign proceedings pending in a country where the debtor conducts non-transitory operations);
• the foreign representative applying for recognition is a person or other body authorized to administer the reorganization or liquidator of the debtor; and
• the petition is accompanied by sufficient evidence of the commencement of the foreign proceedings and of the appointment of the foreign representative.

A Chapter 15 petition must include one of the following:

• a certified copy of the decision commencing the foreign proceeding and appointing the foreign representative;
• a court certificate affirming the existence of the foreign proceeding and of the appointment of the foreign representative; or
• other evidence of the existence of the foreign proceeding and the appointment of the foreign representative.

7.4 What information can be obtained by office holders in respect of a debtor’s property, information and affairs?

Under Bankruptcy Rule 2004, a party in interest may move the court for leave to examine the debtor (or any other entity) with respect to the business and affairs of the debtor. Further, under 11 U.S.C. § 1521(a)(4), a foreign representative may request court authorization for the examination of witnesses, taking of evidence, or the delivery of certain information concerning the debtor.

7.5 What steps can a foreign office holder take to recover assets belonging to the debtor?

Once recognition is granted, the proceeding stays:

• the commencement or continuation of any action concerning the debtor’s assets or liabilities; and
• the execution against the debtor’s assets and suspends the right to transfer or encumber any of the debtor’s assets.

It also entrusts the administration of all of the debtor’s assets in U.S. territory to the foreign representative or another person authorized by the court. It can also provide for the examination of witnesses, the taking of evidence, or the delivery of information concerning the debtor’s assets, affairs, rights, obligations, or liabilities. Further, a Chapter 15 proceeding can be helpful in establishing procedures for filing proofs of claim against a foreign debtor, binding creditors in the United States to a restructuring plan approved in a foreign proceeding, and facilitating asset sales approved in a foreign proceeding.

7.6 Is a foreign office holder able to bring clawback claims or fraudulent transaction claims?

A foreign representative is generally prohibited from bringing avoidance actions for preferences, fraudulent transfers, recovery of avoided transfer and the avoidance of a lien securing a claim for a fine, penalty, or forfeiture. The strict language of sections 1521(a)(7) and 1523 of the Bankruptcy Code suggest that a foreign representative can only commence an avoidance action if there is a plenary U.S. bankruptcy case. However some bankruptcy courts have taken a more expansive view and found that a foreign representative may bring foreign law avoidance actions if vested with those rights under foreign law.

The United States does not separately license insolvency practitioners. Debtors and parties in interest are represented in and out of court by attorneys (who must be licensed by the state bar and whose professional duties are established by state law) and are often supported by a financial advisor and investment banker, as applicable. Chief restructuring officers may also be appointed as an officer of the debtor. In a Chapter 7 liquidation proceeding, a trustee is appointed to oversee the liquidation process. To become a panel trustee, an applicant must apply to the U.S. Trustee in the applicable district and demonstrate the requisite skills and experience.

8.1 Can a foreign office holder take appointments?

A foreign office holder, such as a professional liquidator, generally cannot be appointed as a trustee in a U.S. bankruptcy proceeding.

8.2 What are the conditions for becoming an office holder?

In Chapter 11, the debtor retains control of the corporation unless the court orders the appointment of a trustee “for cause”, which is rare. Office holders can be appointed in Chapter 7 filings, or when a Chapter 11 case is converted to Chapter 7. In that case, a trustee is appointed. To be eligible for the panel of trustees maintained by the U.S. Trustee, one must meet certain professional qualifications, including but not limited to: 

• being an attorney at the bar of a state or the District of Columbia;
• being a certified public accountant;
• holding a business-related bachelor’s degree; 
• being a senior law or MBA student under another qualified person’s supervision; or
• having equivalent experience.

A panel member must also have good moral character.

8.3 What are the main rules of professional conduct?

There is no separate ethical regime for bankruptcy trustees. Generally, they must be disinterested in any case in which they are appointed. All attorneys are bound by the applicable rules of professional conduct in their jurisdiction (state law).

The authors would like to thank Felicity Young (Associate) and Michael Creme (Associate) for their assistance with this chapter.