Quick Answer
Chapter 11 is the Bankruptcy Code's reorganization chapter. Filing triggers the automatic stay, halting all collection actions. By default, the debtor-in-possession (DIP) keeps operational control and most trustee powers. The U.S. Trustee supervises the case and appoints an Official Committee of Unsecured Creditors (UCC). A separate Chapter 11 trustee is appointed only for fraud, dishonesty, or gross mismanagement.
Chapter 11 is the framework that lets a borrower restructure its capital structure while continuing to operate. Knowing who is in charge, who gets stayed, and who can move to dismiss or convert is the foundation for every other Chapter 11 mechanic in this unit.
What Triggers the Automatic Stay When a Chapter 11 Case Is Filed?
Chapter 11 cases begin one of two ways:
- Voluntary petition filed by the debtor itself
- Involuntary petition filed by qualifying creditors of the debtor
The moment a petition is filed, the automatic stay takes effect by operation of law (no court order required). The stay halts:
- All collection actions, lawsuits, and self-help remedies against the debtor
- Foreclosures and lien enforcement
- Setoffs (with limited carve-outs)
- Acts to obtain possession of property of the estate
- Acts to create, perfect, or enforce a lien against property of the estate
The stay gives the debtor a "breathing spell" during reorganization. Creditors that continue collection efforts after filing risk sanctions for violating the stay.
Exam Tip: Gotchas
- The automatic stay is AUTOMATIC. It takes effect the moment the petition is filed, without any court order. A creditor that calls the borrower about a missed payment 30 minutes after filing is in violation of the stay.
- Relief from stay must be sought from the court. Creditors can move for relief from stay for cause, including (i) lack of adequate protection for a secured creditor's interest, or (ii) no equity in property AND the property is not necessary for an effective reorganization.
What Happens to the Debtor's Executory Contracts and Leases?
An executory contract is a contract on which both sides still owe material performance (a supply agreement, an equipment lease, a license). The Bankruptcy Code lets the debtor in possession choose, subject to court approval, to:
- Assume the contract: keep it, but the debtor must cure past defaults and give adequate assurance of future performance
- Reject the contract: walk away, which is treated as a pre-petition breach; the counterparty gets a general unsecured claim for damages
- Assume and assign the contract: assume it and transfer it to a third party, even over an anti-assignment clause, if the assignee gives adequate assurance of future performance
This power is a central restructuring tool: the debtor keeps the contracts that help the reorganized business and sheds the ones that do not.
Exam Tip: Gotchas
- Rejecting an executory contract is a breach, not a free exit. The counterparty holds a general unsecured damages claim, and the debtor must still cure defaults to assume a contract it wants to keep.
Who Are the Key Players in a Chapter 11 Case?
| Player | Role |
|---|---|
| Debtor in Possession (DIP) | The reorganizing company; retains operational control and assumes most powers of a Chapter 7 trustee (avoidance actions, contract assumption / rejection, asset use) |
| Board of Directors / Management | Continue in office; fiduciary duties expand to include creditors as the residual claimants (the "zone of insolvency") |
| U.S. Trustee | Office of the U.S. Department of Justice; supervises bankruptcy administration; appoints official committees; reviews fee applications; does NOT replace management absent fraud or gross mismanagement |
| Chapter 11 Trustee | Appointed only in unusual cases (fraud, dishonesty, gross mismanagement); replaces management; exceptional, not the default |
| Official Committee of Unsecured Creditors (UCC) | Appointed by the U.S. Trustee from holders of the seven largest unsecured claims willing to serve; represents the unsecured class; hires its own counsel and financial advisor at estate expense |
| Ad-hoc Committees | Informal groups of bondholders or term lenders that form to negotiate; pay their own fees (often reimbursed if they make a "substantial contribution") |
| Equity Committee | Rarely appointed; only when residual equity may be in the money |
| Bankruptcy Court | Approves DIP financing, asset sales, plan confirmation, settlements, and fee applications |
Exam Tip: Gotchas
- The U.S. Trustee is NOT the same as a Chapter 11 trustee. The U.S. Trustee is a Department of Justice office that supervises every Chapter 11 case. A Chapter 11 trustee is a private individual appointed in a specific case to replace management; that appointment is exceptional, not routine.
- The UCC is funded by the estate. Its counsel and financial advisor are paid out of the debtor's resources, not by the committee members themselves. Ad-hoc bondholder committees, by contrast, pay their own bills (and may or may not be reimbursed).
How Does a Chapter 11 Trustee Differ from a Debtor in Possession?
The default in Chapter 11 is the debtor REMAINS in possession (no trustee):
- A Chapter 11 trustee is appointed only on motion and a showing of cause
- Common cause grounds: fraud, dishonesty, incompetence, gross mismanagement, or self-dealing by current management
- The high bar reflects the policy that incumbent management has the most knowledge of the business and operational continuity is valuable
- The Chapter 11 trustee, if appointed, replaces the debtor as operator and plan proponent
Think of it this way: Chapter 11 starts with the company's existing executives still in their offices. The U.S. Trustee is checking the paperwork from a different building. A separate Chapter 11 trustee gets parachuted in to take over only if the existing executives have done something seriously wrong.
Exam Tip: Gotchas
- A Chapter 11 trustee is NOT the default. In most Chapter 11 cases, the debtor remains in possession and management continues to run the business under court oversight.
- The DIP exercises trustee powers without being a trustee. The DIP can sue to recover preferences and fraudulent transfers (avoidance actions), assume or reject contracts, and use cash collateral, all without an actual trustee being appointed.
How Do Management's Fiduciary Duties Change in Financial Distress?
When a company is insolvent or operating in the "zone of insolvency," management's fiduciary duties expand:
- Pre-distress, management owes duties primarily to the equity holders
- In distress, management's duties extend to the creditor body because creditors are now the residual claimants on the enterprise
- Self-dealing or preferential treatment of insiders is reviewed closely during the case and can subject directors to personal liability or avoidance of pre-petition transfers
Exam Tip: Gotchas
- The "zone of insolvency" duty shift is a frequent exam concept. Once a company is distressed, directors cannot make decisions that benefit equity at the creditors' expense; the decision framework changes.
- Avoidance powers reach back. The DIP (or trustee) can claw back preferential transfers made within 90 days before filing (one year for insiders) and fraudulent transfers made within longer windows (typically two years under federal law, longer under state law).
What Should You Check on Exam Day?
- Can you state that the automatic stay takes effect the instant the petition is filed, with no court order required, and name the two ways a Chapter 11 case can begin?
- Do you know the U.S. Trustee is a Department of Justice office that supervises the case and appoints the UCC, and that this is distinct from a Chapter 11 trustee, who is a rare, cause-based replacement of management?
- Can you explain why the DIP does not need a trustee to exercise trustee powers (avoidance actions, contract assumption/rejection, cash-collateral use)?
- Do you know the preference clawback window (90 days, one year for insiders) and the fraudulent-transfer window (typically two years federal, longer under state law)?