In this video, I explain chapter 11 bankruptcy reorganization as covered on the CPA exam.
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In a Chapter 11 bankruptcy case, soon after the order for relief (the formal start of the bankruptcy process) takes effect, a special committee is formed. This committee is made up of unsecured creditors, typically those who are willing and hold the seven largest unsecured claims (debts that are not secured by specific assets) against the debtor (the entity filing for bankruptcy).
There's an exception for small businesses in these cases. A small business, in this context, is defined as a business that is not primarily involved in real estate and has debts not exceeding approximately $2.6 million. If a debtor qualifies as a small business under this definition, they have the option to elect special treatment as a small business debtor. One significant aspect of this special treatment is that the small business debtor can request that a creditors' committee not be appointed. This means that, if granted, there wouldn't be a committee of unsecured creditors involved in the bankruptcy process, which can simplify and expedite the proceedings for the small business debtor.
In cases where the debtor is a corporation undergoing a Chapter 11 bankruptcy, a committee may be formed to represent the interests of equity security holders, commonly known as stockholders. This committee is typically composed of the seven largest holders of the corporation's equity securities. The main purpose of this committee is to ensure that the rights and interests of these equity security holders are adequately represented during the bankruptcy process.
The roles and responsibilities of the equity security holders' committee are quite extensive. They have the authority to consult with the debtor, which means they can engage in discussions and negotiations directly with the corporation that's undergoing bankruptcy. Additionally, they are empowered to conduct a thorough investigation into the debtor's financial affairs. This investigation helps them understand the financial situation of the corporation in detail, enabling them to make informed decisions and provide meaningful input.
Another critical role of this committee is its involvement in the preparation of the reorganization plan. The reorganization plan is a key document in Chapter 11 cases, outlining how the debtor intends to restructure its debts and business operations to emerge from bankruptcy. The equity security holders' committee can participate in drafting this plan, ensuring that the interests of the stockholders are considered and protected in the proposed restructuring of the corporation. This involvement is crucial because the outcome of the reorganization plan directly affects the value and future prospects of the equity securities held by the stockholders.
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