What Not to Believe About Chapter 11

By Kenneth A. Rosen

Entrepreneurs navigating Chapter 11 often hear, "Don't worry about extending credit to the debtor during Chapter 11. You'll have an administrative claim." While this holds true to a certain extent, the intricacies of administrative claims reveal a more nuanced reality.

Claims stemming from goods or services provided to the debtor during bankruptcy proceedings indeed carry administrative status. However, the landscape shifts when a lender extends crucial financing to the debtor in the form of "DIP" (Debtor-in-Possession) loans. Lenders typically secure a super priority administrative claim, granting them seniority over other administrative claims, including those of vendors.

Professionals engaged in the case often negotiate a "carve out," ensuring that their administrative claims take precedence, even surpassing those of the lending institution. This carve-out provides a measure of protection, mitigating the impact of the super priority administrative claim held by the bank. Notably, professionals tend to receive periodic payments, usually 80% of their invoices monthly, with the remaining 20% settled every 120 days. Even in the face of a debtor grappling with cash flow challenges, professionals often continue to receive payments.

However, it's crucial to dispel any notion of guaranteed payment for administrative claims. Instances of a debtor's estate becoming administratively insolvent are not uncommon. Prominent cases like Toys R Us and Sears serve as stark reminders that even administrative claims may face uncertainty. This reality underscores the importance of a comprehensive understanding of the dynamics at play in Chapter 11 scenarios.

As entrepreneurs engage in Chapter 11 proceedings, it is essential to recognize the complexities surrounding administrative claims, the strategic positioning of lenders, and the nuances involved in safeguarding the interests of professionals amid the intricate financial landscape.