Quick Answer
Chapter 11 is the reorganization chapter of the Bankruptcy Code. Filing triggers the automatic stay, which halts all collection actions. The default is the debtor-in-possession (DIP) keeps operational control and assumes most powers of a trustee. The U.S. Trustee supervises the case and appoints an Official Committee of Unsecured Creditors (UCC). A separate Chapter 11 trustee is appointed only in unusual cases of 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.
Filing and the Automatic Stay
Chapter 11 cases begin one of two ways:
- Voluntary petition filed by the debtor itself
- Involuntary petition filed by three or more unsecured creditors holding aggregate claims over a threshold dollar amount (one creditor is sufficient if the debtor has fewer than 12 creditors)
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 contempt and damages, even if they had no actual knowledge of the filing.
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.
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).
Chapter 11 Trustee vs 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.
Fiduciary Duties of Management in 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).