5.17.10  Chapter 11 Bankruptcy (Reorganization)

5.17.10.1  (08-01-2010)
Overview

  1. This section of the handbook discusses the basic purpose and procedural workings of a Chapter 11 bankruptcy case, explains the ways in which a Chapter 11 bankruptcy case is different from a bankruptcy case brought under other chapters of the Bankruptcy Code, and highlights issues of particular significance to the IRS in Chapter 11 bankruptcy cases.

  2. For further information, see IRM 5.9.8, Processing Chapter 11 Bankruptcy Cases.

5.17.10.2  (08-01-2010)
Purpose of Chapter 11 Bankruptcy

  1. Chapter 11 is the primary reorganization chapter of the Bankruptcy Code for business debtors.

  2. Individuals are also eligible to file Chapter 11. See IRM 5.17.10.11 for further discussion on individuals in Chapter 11.

    1. An Individual who wishes to pay creditors over time through a plan and not liquidate in a Chapter 7 case generally files a Chapter 13 case rather than a Chapter 11 case.

    2. For individuals, Chapter 13 has the following advantages over Chapter 11: proceedings are less expensive for a debtor, and more of an individual debtor’s debts (including tax debts) may be discharged in Chapter 13 without payment.

    3. To be eligible for Chapter 13, an individual must have regular income and meet certain debt limitations. Currently, an individual must have less than $360,475 of unsecured debts and less than $1,081,000 of secured debts to file a Chapter 13 case. These debt amounts are adjusted every three years based upon the Consumer Price Index. The next adjustment will be effective April 1, 2013.

    4. Also, changes to the Bankruptcy Code made by the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA) have made Chapter 11 cases filed by individuals similar to Chapter 13 cases. As in Chapter 13, individual Chapter 11 debtors must now complete payments under the plan before they can receive a discharge. 11 USC § 1141(d)(5).

  3. The general goal of a Chapter 11 case is for the financially distressed business debtor to restructure and negotiate its debts and ownership interests with its creditors and owners and then obtain court approval (confirmation) of a plan of reorganization that allows the debtor to continue operating its business after the commencement of the bankruptcy case.

    1. Ideally, a Chapter 11 plan of reorganization is acceptable to most of the debtor’s creditors because creditors are more likely (over time) to receive a greater distribution from the plan as payment of the debtor’s pre-bankruptcy debts than through liquidation of the debtor’s business.

    2. In addition, a Chapter 11 plan often gives the debtor’s creditors some form of new ownership interest in the debtor.

  4. However, a large percentage of Chapter 11 debtors actually fail to reorganize their businesses successfully, either before or after confirming a plan.

    1. In these circumstances, the Chapter 11 case may still enable a business debtor to sell its business assets for a higher price (e.g., as a going concern) than a Chapter 7 trustee would be able to obtain for the assets in a Chapter 7 liquidation, resulting in a greater return for creditors.

    2. On the other hand, while a Chapter 11 debtor is in the process of deciding whether to sell its assets, the debtor may incur new significant debts, or it may dissipate its assets trying to keep the business going. As a result, Chapter 11 cases are ordinarily much more labor intensive for the IRS and other creditors to monitor and evaluate than bankruptcies filed under other chapters of the Bankruptcy Code.

5.17.10.3  (08-01-2010)
Initiating a Chapter 11 Case

  1. A Chapter 11 case is commenced with the filing of a voluntary bankruptcy petition by a debtor or with the filing of an involuntary bankruptcy petition by creditors.

  2. A debtor need not be insolvent or even unable to pay its debts when due in order to file a voluntary Chapter 11 case. A debtor’s inability to pay debts as they become due may be relevant if a debtor contests an involuntary petition filed against it. 11 USC § 303(h).

  3. In a Chapter 11 case, whether or not the IRS is listed on the debtor’s schedules as a creditor, the IRS should be served with copies of all voluntary Chapter 11 petitions, notices of any cases converted from another chapter to Chapter 11, and orders for relief entered for any involuntary Chapter 11 cases. Bankruptcy Rule 2002(f) and (j)(3). Bankruptcy Rule 2002(j)(3) provides that copies of notices that are required to be mailed to all creditors must be mailed, in a Chapter 11 case, to the IRS at the address set out in the register maintained by the clerk of the bankruptcy court under Rule 5003(e). Thus, for the duration of the Chapter 11 case, the IRS should continue to be served with bankruptcy pleadings, orders, and other documents in the Chapter 11 case that are required to be served on "all creditors," whether or not the IRS has filed a claim in the case. Bankruptcy Rule 2002(a), (b), (f), and (j)(3).

5.17.10.3.1  (08-01-2010)
Documents Required When Chapter 11 Case Is Initiated

  1. Within 15 days of filing a voluntary petition or the entry of an order for relief (in an involuntary case), a Chapter 11 debtor must file a number of standardized schedules, statements, and other specified documents with the court. Bankruptcy Rule 1007(b) and (c). These documents tend to be more voluminous and more widely available to creditors (including the IRS) in Chapter 11 cases than in bankruptcy cases under other chapters.

  2. In a voluntary case involving an individual Chapter 11 debtor, the debtor must file the following documents with the petition:

    1. a certificate indicating that the debtor has received credit counseling during the 180-day period before the filing of the petition, as required by 11 USC § 109(h);

    2. the debt repayment plan developed during that credit counseling, if any; or

    3. a court determination excusing the debtor from the required credit counseling.

      Note:

      See Bankruptcy Rule 1007(b)(3) and (c). Failure to file these documents can be grounds for dismissing the debtor’s bankruptcy case.

  3. With a voluntary petition, a Chapter 11 debtor should file a mailing matrix indicating the names and addresses of each of its creditors, plus a list of creditors holding the 20 largest unsecured claims against the debtor. Bankruptcy Rule 1007(a)(1) and (d). In the case of an involuntary petition, the debtor must file the mailing matrix within 15 days after the entry of the order for relief and file the list of creditors holding the 20 largest unsecured claims within two days after the order for relief. Bankruptcy Rule 1007(a)(2) and (d). This list of creditors may assist the United States Trustee in appointing members of the Unsecured Creditors’ Committee for the debtor’s case.

  4. The debtor’s required schedules and Statement of Financial Affairs may help the IRS identify some of its potential tax claims against the debtor, as well as the IRS’s setoff rights, and evaluate its security for Notices of Federal Tax Liens (NFTLs) filed against the debtor.

5.17.10.3.2  (08-01-2010)
Prepackaged Chapter 11 Cases

  1. In recent years many large Chapter 11 debtors have been able to file their proposed disclosure statements and plans on or immediately following the date they file for bankruptcy. Before even filing for bankruptcy, these large debtors may negotiate a restructuring of their debt and ownership structures with their major secured and general unsecured creditors and stockholders. They hope to obtain enough votes for confirmation of their plans before going into bankruptcy and to remain under bankruptcy court supervision for the shortest possible time. Cases of this type are called "prepackaged" and are now commonly filed in Delaware and the Southern District of New York pursuant to 11 USC 1126(b) and Bankruptcy Rule 3018(b).

  2. In a prepackaged Chapter 11 case, the debtor may seek consideration of its proposed disclosure statement and confirmation of its proposed plan at the same time, and request that hearings on these matters be held in a very short time frame — sometimes as little as 45 days after filing the petition. Prepackaged cases can be a problem for the IRS because the IRS is ordinarily one of the debtor’s few major creditors that is not aware of the debtor’s plans to file a prepackaged bankruptcy. Because the IRS may have ongoing audits of the debtor, confirmation of the proposed plan may occur before the bar date for the IRS and other governmental units to evaluate and file their claims.

  3. Prepackaged plans that propose a sale or transfer of substantially all of the debtor’s assets are a particular problem for the IRS because the principal purpose of the transaction may be tax avoidance. See In re Scott Cable Communications. Inc., 227 B.R.596 (Bankr. D. Conn. 1998). Refer to the Chief Counsel Directives Manual (CCDM) at IRM 34.3.1.3 for procedures regarding the referral to Counsel of Chapter 11 cases involving major tax liabilities or significant or sensitive issues for the IRS.

5.17.10.4  (08-01-2010)
The Debtor in Possession (DIP)

  1. In a Chapter 11 case, the debtor (i.e., the debtor’s management team) usually remains in control of its business and assets as the "debtor in possession" (DIP), unless the court orders the appointment of a trustee to replace the DIP. 11 USC §§ 1101, 1104(a).

  2. A DIP is given the rights and powers of a bankruptcy trustee. 11 USC § 1107(a).

5.17.10.4.1  (08-01-2010)
Appointing a Chapter 11 Trustee

  1. At any time from the petition date until the confirmation of a Chapter 11 plan, any interested party in the case (e.g., the Creditors’ Committee or individual creditors) or the United States Trustee (UST) may make a motion with the bankruptcy court for the appointment of a trustee to replace the debtor in possession in the management of the debtor’s business and assets. 11 USC § 1104(a); Bankruptcy Rule 2007.1(a).

  2. The appointment of a trustee is rare because the change in management disrupts the debtor’s business. A trustee is usually appointed in cases where there is fraud, dishonesty, incompetence, or gross mismanagement of the affairs of the debtor by its current management. 11 USC §§ 1104(a) and (e).

  3. If the bankruptcy court does not order the appointment of a Chapter 11 trustee, then at any time before a plan is confirmed, an interested party or the UST may make a motion for the appointment of an examiner to investigate the debtor for matters such as allegations of fraud, dishonesty, misconduct, or irregularity in managing the affairs of the debtor either by current or former management of the debtor. 11 USC § 1104(c); Bankruptcy Rule 2007.1(a) and (c). The examiner does not replace the debtor in possession in the management of the debtor’s affairs or deprive the debtor in possession of its rights to propose a plan for the debtor.

  4. If grounds exist for the dismissal or conversion of the case, the court may instead appoint a trustee or examiner if it determines that doing so is in the best interests of creditors and the bankruptcy estate. 11 USC § 1104(a)(3).

5.17.10.4.2  (08-01-2010)
Chapter 11 Committees

  1. The Bankruptcy Code provides a mechanism that allows unsecured creditors to oversee the debtor’s operations and voice their concerns throughout the Chapter 11 case. As soon as practicable after a voluntary Chapter 11 petition is filed, or an order for relief is entered in an involuntary case, the UST appoints a committee of unsecured creditors.

  2. The powers of the Unsecured Creditors’ Committee in a Chapter 11 case are very significant and extensive. 11 USC §§ 1102 and 1103. Its views are also important to the bankruptcy court.

  3. The Unsecured Creditors’ Committee ordinarily consists of the creditors, willing to serve, that hold the seven largest unsecured claims against the debtor. 11 USC § 1102(b).

  4. With the court’s approval, the Unsecured Creditors’ Committee may hire one or more attorneys, accountants, or other agents to represent or perform services for the committee. 11 USC § 1103.

  5. The IRS and most governmental units are not eligible to serve as members of the Unsecured Creditors’ Committee. 11 USC § 101(41).

5.17.10.5  (08-01-2010)
Early Events in a Chapter 11 Case

  1. In a typical Chapter 11 case, the debtor seeks bankruptcy court approval for a number of "first day" orders, including an order allowing the debtor to continue using its cash collateral. The court will grant the debtor the use of its cash only if the debtor can show that a creditor that has a security interest in the cash is adequately protected, i.e., the creditor will not lose the value of its security.

    1. When the IRS has filed NFTLs which attach to such cash collateral, the IRS should become involved in the case as soon as possible to protect its interests.

    2. Early in a Chapter 11 case, a debtor may also seek to compel turnover to it of property which the IRS levied upon or seized before the petition date.

  2. The IRS and other creditors may take advantage of their opportunity to question a debtor at the first meeting of creditors under 11 USC § 341.

5.17.10.5.1  (08-01-2010)
Mandatory Referrals to Counsel

  1. Soon after a Chapter 11 case is filed, IRS employees in SB/SE, LMSB, Appeals, and TEGE should identify and refer cases meeting certain criteria to Field Insolvency. Field Insolvency will then refer the case to the appropriate SB/SE Area Counsel office for handling. See IRM 5.9.4.13.3 . These include cases in which the debtor has major tax liabilities, there is significant audit impact to items claimed on returns, or which may involve significant or sensitive issues for the IRS. If certain other criteria are met, these cases may also be referred by Area Counsel to the Associate Chief Counsel, Procedure and Administration, as part of the Significant Bankruptcy Case Program.

5.17.10.5.2  (08-01-2010)
Limitations on a Debtor’s Right to Use Cash Collateral

  1. In a Chapter 11 case, the debtor in possession (DIP) typically wants to continue running the business until the business can either be reorganized or sold as a going concern.

    1. The DIP may automatically continue its routine ("ordinary course" ) use, sale, or lease of most of its prepetition property (other than cash collateral) without obtaining the approval of the court. 11 USC § 363(c)(1). However, the DIP must obtain court approval to use, sale, or lease property of the estate other than in the ordinary course of business. 11 USC § 363(b).

    2. Whether the DIP’s proposed use of its cash collateral is routine or otherwise, the DIP must obtain the consent of each creditor with an interest in such cash collateral, or bankruptcy court authorization, prior to the use of the cash collateral. In evaluating the DIP’s request for authorization to use cash collateral, the court may authorize such use only if the creditor’s interest in the property is adequately protected against loss. 11 USC §§ 363(a), (c)(2), and (e).

    3. The DIP’s unauthorized use of cash collateral which causes substantial harm to one or more creditors is grounds for dismissal or conversion of the bankruptcy case. 11 USC § 1112(b)(4)(D).

  2. A DIP often negotiates agreed first day orders for the use of its cash collateral with its significant prepetition lenders before entering bankruptcy. However, the DIP may neglect to consider the secured position of the IRS in cash collateral after the IRS has filed NFTLs against the debtor.

    1. Accordingly, when the IRS is a secured creditor, the IRS must frequently take the initiative of seeking relief from the DIP or from the court by pointing out that the DIP is using cash collateral that is subject to an IRS lien.

    2. As soon as possible after a Chapter 11 bankruptcy filing, the IRS should identify any secured claims it has against the debtor, contact the debtor’s counsel, and begin negotiations for adequate protection for the IRS as a condition for the debtor’s continued use of cash collateral.

  3. Adequate protection to the IRS for a DIP’s use of its cash collateral usually includes periodic cash payments (beginning immediately) on the secured claim or the provision of replacement liens to the IRS on property the DIP acquires after the petition date. 11 USC § 361. See also the discussion on adequate protection in IRM 5.17.10.5.3, below, and IRM 5.9.8.5, Adequate Protection.

5.17.10.5.3  (08-01-2010)
Turnover and Adequate Protection

  1. A voluntary Chapter 11 filing by a debtor is often preceded by the IRS levying upon or seizing certain assets of the debtor. After filing bankruptcy the debtor may then immediately file a motion with the bankruptcy court requesting an order for the IRS to turn over the seized property to the debtor or to release the levy. 11 USC § 542.

  2. In U.S. v. Whiting Pools, Inc., 462 U.S. 198 (1983), the Supreme Court affirmed a debtor’s right under 11 USC § 542 to the return of tangible property seized by the IRS, subject to the requirement of 11 USC § 363(e) that the debtor provide the IRS with adequate protection for the use of property to be turned over in which the IRS has a secured interest.

  3. The protection that is adequate to a creditor for turnover of property to the debtor depends on the factual circumstances of the case, including the type of property involved.

    1. The IRS seldom expects to receive periodic cash payments as adequate protection for its turnover of the debtor’s seized real property because such property does not usually depreciate rapidly.

    2. However, the IRS does want the DIP to be required to maintain adequate insurance coverage for its buildings and other improvements to real property.

    3. On the other hand, levied upon cash, accounts receivable, and inventory may quickly be dissipated by a DIP if turned over to the DIP by the IRS. In these situations the IRS is interested in adequate protection along the lines of retaining a portion of the cash received, receiving future periodic payments (with post-petition interest) before a plan is devised or confirmed, obtaining replacement liens on after-acquired assets such as the DIP’s inventory and accounts receivable, and providing for the DIP’s post-petition compliance with its continuing federal tax obligations.

5.17.10.5.4  (08-01-2010)
The First Meeting of Creditors

  1. The section 341 meeting in a Chapter 11 case is an opportunity for creditors (including the IRS) to question the debtor under oath about a wide range of relevant matters concerning the debtor’s past behavior, its present finances, and the likely future of the bankruptcy case. 11 USC § 341; Bankruptcy Rule 2003.

  2. In some areas Insolvency asks selected revenue officers for their assistance and expertise in listening to and questioning the debtor’s witnesses at section 341 meetings.

  3. If the debtor provides inadequate information or documentation for IRS purposes at the section 341 meeting, Insolvency may ask Area Counsel to arrange a more thorough examination of the debtor or other witnesses under Bankruptcy Rule 2004.

5.17.10.6  (08-01-2010)
Claim Bar Dates in Chapter 11

  1. The time for filing claims in a Chapter 11 case is not determined by statute or rule. The bankruptcy court fixes (by an order) the date by which creditors are to file their prepetition claims in a Chapter 11 case. Bankruptcy Rule 3003(c)(3).

  2. The IRS and other governmental units are allowed no fewer than 180 days after the order for relief (e.g., the petition date in a voluntary case) to file a timely claim for a prepetition period. 11 USC § 502(b)(9). In "prepackaged cases," however, it may be in the IRS’s interest to file a claim as soon as possible where confirmation of the plan will occur before the 180-day filing period expires.

  3. A proof of claim is deemed to have been filed on behalf of the IRS if a Chapter 11 debtor lists, on the debtor’s bankruptcy schedules, a prepetition tax debt owed to the IRS which is liquidated, undisputed, and not contingent. 11 USC § 1111(a); Bankruptcy Rule 3003(b)(1) and (c)(2).

  4. As a result of BAPCPA’s amendments to 11 USC § 503(b)(1)(D), for cases commencing on or after October 17, 2005, the IRS may file, but is not required to file a request for payment of its administrative claim. Nevertheless, the IRS should file an administrative claim to put the debtor and creditors on notice of the liability and of the amount due. See IRM 5.9.8.11(8).

5.17.10.6.1  (08-01-2010)
Setoffs

  1. In the course of many Chapter 11 cases, the IRS discovers that its prepetition tax debts are secured, even though it did not file an NFTL, due to setoff rights the IRS holds against carryback tax refunds for prepetition years or against amounts owed the debtor by other federal agencies. All federal agencies are generally considered one creditor (the United States) for setoff purposes under the Bankruptcy Code. See In re HAL, 122 F.3d 851 (9th Cir. 1997); Turner v. SBA, 84 F.3d 1294 (10th Cir. 1996).

  2. Be aware that corporate Chapter 11 debtors often request carryback tax refunds from the IRS immediately through tentative carryback (quickie refund) procedures, rather than through ordinary refund procedures.

  3. The IRS has the right to offset the quickie refund against federal tax liabilities of the taxpayer. This right of setoff becomes particularly important when the taxpayer is in bankruptcy because dollar amounts of quickie refunds can be large, and setoff may be the only assured way of collecting liabilities owing from the taxpayer. Difficult mutuality issues are raised, however, when losses from post-petition periods are carried back to prepetition years; consult Area Counsel in such cases. See IRM 5.9.8.8 for further discussion.

  4. The automatic stay, 11 USC § 362(a)(7), prevents the actual making of a setoff, but prepetition setoff rights are nevertheless preserved in bankruptcy. 11 USC § 553. If a refund is owed to the debtor that could be credited against a liability owed by the debtor, the Service should freeze the refund until the stay can be lifted. See Citizens Bank of Maryland v. Strumpf, 516 U.S. 16 (1995) (temporary freeze of a debt owed to the debtor and request for relief from stay to allow setoff did not violate the automatic stay against setoffs). The Service's setoff rights extend to unassessed liabilities identified on a proof of claim. Rev. Rul. 2007-52.

    Note:

    For cases filed on or after October 17, 2005, the effective date of BAPCPA, the automatic stay does not prohibit setting off prepetition income tax refunds against prepetition income tax liabilities.

  5. When the FDIC has taken over a bank, the bank's parent holding company often files for bankruptcy protection. The FDIC as well as the parent holding company may file a claim for refund if proper procedures are followed. Treas. Reg. § 301.6402-7. The FDIC's claim for refund does not affect the Service's setoff rights.

5.17.10.6.2  (08-01-2010)
Straddle-Year Claims

  1. Because Chapter 11 debtors ordinarily continue to operate their businesses after filing for bankruptcy and seldom file bankruptcy on the first day of a new tax reporting period, there are frequently federal tax liabilities owed by Chapter 11 debtors for taxes arising in the year in which the bankruptcy petition was filed.

    1. For divisible/transactional taxes (e.g., employment and most excise taxes), the IRS splits the taxes due for the straddle period between priority tax debts incurred prepetition and administrative period tax debts incurred post-petition.

    2. However, income taxes are incurred on the last day of the income tax year. 11 USC § 507(a)(8)(A), as amended by BAPCPA, clarifies that only income taxes for tax years ending on or before the petition date will receive priority treatment in the bankruptcy case. Thus, income taxes that accrue in the year for which the bankruptcy petition is filed are entirely administrative expense taxes.

      Note:

      Section 507(a)(8)(A) was clarified by BAPCPA to provide that income taxes will be considered prepetition (priority) claims only when the tax year ended before the bankruptcy petition was filed, overturning pre-BAPCPA case law that relied on that section to hold that the petition-year liability should be split into prepetition and postpetition portions. See In re Pacific-Atlantic Trading Co., 64 F.3d 1292 (9th Cir. 1995).

5.17.10.6.3  (08-01-2010)
Pensions and Penalties

  1. Although pension underfunding taxes arising under IRC § 4971 are considered a "tax" under the Internal Revenue Code, the Supreme Court has determined that the tax under IRC § 4971 is a penalty (hence a general unsecured claim) for Bankruptcy Code claim classification purposes. See U.S. v. Reorganized CF&I Fabricators of Utah, Inc., 518 U.S. 213 (1996).

  2. However, in appropriate cases where the Chapter 11 debtor has incurred IRC § 4971 underfunding taxes post-petition, the IRS may assert before the bankruptcy court that these taxes are entitled to administrative expense priority as part of the actual and necessary costs and expenses of preserving the bankruptcy estate under 11 USC § 503(b)(1)(A). Contact Area Counsel in cases where the debtor owes IRC § 4971 liabilities.

5.17.10.6.4  (08-01-2010)
Post-Petition Tax Compliance

  1. Debtors in possession (DIPs) are required to file periodic reports with the bankruptcy court, the U.S. Trustee, and the IRS describing payments made to employees, the amount of taxes required to be withheld or paid for and on behalf of employees, and the place where these amounts are deposited. 11 USC §§ 704(8) and 1106(a)(1); Bankruptcy Rule 2015(a).

  2. Chapter 11 cases require monitoring by Insolvency even if the IRS has not found any prepetition taxes owed by the debtor because the DIP often becomes delinquent in paying withholding tax, FICA, and other taxes while operating the business after the petition date. Large dollar or chronically noncompliant taxpayers may merit manual monitoring by Insolvency, including putting the DIP on monthly filing and deposit verification regimes.

  3. On request of an interested party, the court is required to convert a Chapter 11 case to a Chapter 7 case or dismiss the bankruptcy case entirely under 11 USC § 1112(b) if the debtor fails to file the required periodic reports or comply with its post-petition tax obligations.

  4. Corporate Chapter 11 debtors frequently report net operating losses (NOLs) for their recent prepetition income tax years or their post-petition income tax years and then carryback these NOLs to earlier income tax years in order to obtain refunds of the taxes they paid in the earlier tax years.

    1. Corporate Chapter 11 debtors, which often need large cash infusions to keep their businesses operating, also frequently request carryback tax refunds from the IRS immediately (usually within 45 days of filing a Form 1139, Corporation Application for Tentative Refund) through tentative carryback (quickie refund) procedures, rather than through ordinary refund procedures.

    2. If the IRS pays a quickie refund to the DIP after the petition date and the quickie refund turns out to be excessive after the loss year return is audited, then the IRS is entitled to file an administrative expense claim in the Chapter 11 case for the excessive amount of the quickie refund. 11 USC § 503(b)(1)(B)(ii).

    3. For cases commencing on or after October 17, 2005, the IRS may file, but is not required to file, a request for payment of its administrative expenses. Nevertheless, the IRS should file an administrative claim to put the debtor and creditors on notice of the liability and of the amount due.

  5. Corporate Chapter 11 debtors sometimes use a Chapter 11 case to liquidate substantially all of their assets, either through mid-stream asset sales that are approved by the bankruptcy court under 11 USC § 363 or by seeking confirmation of a liquidating plan which may provide either for the sale of the debtor’s assets to a third party or for the transfer of substantially all of the debtor’s assets to a Liquidating Trust. In liquidating cases of this type, the sale or taxable transfer of the debtor’s property to a third party may sometimes cause the debtor’s bankruptcy estate to realize substantial capital gains income (after considering the debtor’s adjusted basis in the property sold) and a federal income tax liability (after considering the debtor’s other taxable events in the year and the debtor’s available NOL carryovers from prior tax years).

5.17.10.7  (08-01-2010)
The Plan Process

  1. The plan process begins with the debtor’s filing of a plan of reorganization and disclosure statement. The disclosure statement should contain information about the debtor and the proposed plan which would enable creditors to make an informed decision on whether or not to vote for the plan. The bankruptcy court must approve the disclosure statement before the debtor may solicit creditors' votes on the plan. As discussed below, the bankruptcy court may determine that the plan itself provides sufficient information in small business cases.

  2. For purposes of determining how creditors are to be treated under the plan and voting, the Bankruptcy Code requires that a plan group claims into classes. Generally, claims may only be put in the same class if they are similar. Creditors within a class vote together. Claims within a particular class are treated the same under the plan.

  3. Once the necessary votes for acceptance of the plan are obtained and the court determines that it meets the requirements of the Bankruptcy Code, the plan will be confirmed. A plan can be confirmed through the cram down process over the dissension of classes of creditors as long as one impaired class votes to accept the plan. 11 USC § 1129(b). For a definition of an "impaired class" , see IRM 5.17.10.9.2 , Impairment of Claims in a Chapter 11 Plan, below. The debtor and all creditors are bound by the terms of a confirmed plan.

5.17.10.7.1  (08-01-2010)
The Debtor’s Control of Plan Development (Exclusivity)

  1. Ordinarily, Chapter 11 debtors enjoy the exclusive right to propose their Chapter 11 plans for the first 120 days after the petition date. On the request of any interested party (e.g., the debtor, creditors, or U.S. Trustee), the bankruptcy court may extend or reduce the debtor’s 120-day exclusivity period if cause is shown. 11 USC § 1121(d)(1). The court may not extend the debtor’s exclusivity period to a date that is more than 18 months after the petition date.

  2. "Small business" Chapter 11 debtors, discussed in IRM 5.17.10.7.2, below, have the exclusive right to file a Chapter 11 plan during the first 180 days following the date of the petition. 11 USC § 1121(e)(1).

5.17.10.7.2  (08-01-2010)
Mandatory Small Business Debtor Treatment

  1. Prior to BAPCPA, the small business provisions and their shorter timeframes regarding the plan were optional. For cases commencing on or after October 17, 2005, small business treatment is now mandatory for all debtors that fall within the small business debtor definition in 11 USC §§ 101(51C) and (51D). See Bankruptcy Rule 1020 (requires debtor in voluntary Chapter 11 case to state in the petition whether the debtor is a small business debtor). Under BAPCPA, the small business provisions are designed to prevent abuses of the bankruptcy system in small business cases, as well as make these cases less costly and move more quickly toward confirmation.

  2. A small business debtor is defined as one that engages in business activities with total, noncontingent debts of less than $2,343,300, but only in a case where the U.S. Trustee has not appointed a committee of unsecured creditors or the court has determined that the committee is not sufficiently active and representative to provide effective oversight of the debtor.

  3. The small business debtor has the exclusive right to file a plan during the 180 days after the petition date, while other Chapter 11 debtors are only guaranteed a 120-day exclusivity period. 11 USC § 1121(e).

    1. However, the small business debtor must file its plan and disclosure statement within 300 days after the petition date. 11 USC § 1121(e).

    2. The 180-day and 300-day periods may only be extended if the debtor demonstrates that it is more likely than not that the court will confirm a plan within a reasonable period of time. Failure to timely file or confirm a plan or file a disclosure statement is a basis for conversion or dismissal of a Chapter 11 case under 11 USC § 1112.

    3. In a small business case, the court must confirm a plan that complies with the Bankruptcy Code no later than 45 days after the plan was filed. 11 USC § 1129(e).

  4. IRS employees should be aware that the automatic stay will not apply in a small business case in the following situations:

    1. the debtor already has a small business case pending at the time the current petition is filed;

    2. the debtor was in a prior small business case that was dismissed for any reason, by a court order, within the two-year period ending on the petition date;

    3. the debtor was in a prior small business case in which a plan was confirmed in the two-year period ending on the date of petition; or

    4. the debtor is an entity that has acquired substantially all of the assets or business of a small business debtor described in a), b), and c) above, unless the debtor demonstrates that it acquired the assets or business of such small business debtor in good faith and not for the purpose of avoiding the application of 11 USC § 362(n).

  5. Section 1116, 11 USC, lists a number of duties required of small business debtors, including the duty to file a copy of the most recent Federal tax return with a voluntary petition or seven days after the order for relief in an involuntary case. Small business debtors must also timely file and pay post-petition taxes. Failure to comply with any of these requirements is a basis for conversion or dismissal of the case. 11 USC § 1112(b)(4)(I).

5.17.10.8  (08-01-2010)
The Disclosure Statement

  1. Chapter 11 requires a debtor to file a disclosure statement along with a proposed plan of reorganization. Bankruptcy Rule 3016(b).

  2. The disclosure statement must be provided to all creditors, and the bankruptcy court must approve it before the debtor may solicit the creditors' votes for the acceptance or rejection of the proposed plan.

  3. The disclosure statement should generally provide creditors and other interested parties with "adequate information" about the debtor and the proposed plan so that they may decide whether to vote for or against the plan.

  4. The bankruptcy court determines, during a hearing, whether the disclosure statement contains adequate information and should be approved. In determining whether there is adequate information, the court is required to consider the cost and benefit of additional information and the complexity of the case. 11 USC § 1125(a)(1). Once the disclosure statement is approved, a proposed plan may move to confirmation in a relatively short time frame.

  5. In small business debtor cases, the court may determine that the plan itself provides adequate information and that a separate disclosure statement is not necessary. The court may also approve a disclosure statement submitted on standard forms. 11 USC § 1125(f)

5.17.10.8.1  (08-01-2010)
The Content of a Disclosure Statement

  1. The Bankruptcy Code does not specify all of the information that needs to be included in the disclosure statement, but does provide that it must discuss the potential, significant federal tax consequences of the plan to the debtor, any successor of the debtor, and creditors. 11 USC § 1125(a).

  2. Generally, the disclosure statement will set forth the recent history of the debtor, the reasons why the debtor filed a bankruptcy petition, and the measures the debtor has undertaken to reverse financial setbacks. The disclosure statement should also provide a summary of the plan and the treatment given to the various creditors.

  3. Bankruptcy courts have required that a disclosure statement contain a discussion of the following matters:

    1. the debtor’s available assets and their value;

    2. claims made against the estate;

    3. a liquidation analysis, setting forth the estimated return that creditors would receive if the debtor was in a Chapter 7 case;

    4. the future management of the debtor;

    5. the risks being taken by creditors and interest holders under the proposed plan; and

    6. the existence, likelihood, and possible success of litigation involving the debtor.

    Note:

    For Chapter 11 cases filed on or after October 17, 2005, the Code clarifies that the disclosure statement should discuss the tax consequences of the plan. 11 USC § 1125(a)(1).

  4. A careful review of the proposed disclosure statement may lead Insolvency to conclude that a referral to Area Counsel for assistance is appropriate under Significant Bankruptcy Case handling procedures. See Chief Counsel Directives Manual (CCDM) at IRM 34.3.1.3. For instance, the proposed disclosure statement may indicate that the plan will create a Liquidating Trust to pay creditors’ claims or that the plan will effect a sale of substantially all of the debtor’s assets to a third party. Insolvency may conclude that Area Counsel’s assistance is required to evaluate the potential tax consequences of the plan and to devise appropriate procedures to protect IRS interests under the proposed plan.

5.17.10.8.2  (08-01-2010)
The Disclosure Statement Approval Process

  1. After a plan proponent files a proposed disclosure statement with the bankruptcy court, the court typically enters an order giving notice to the debtor, all creditors, and other interested parties that a hearing will be held. Bankruptcy Rule 3017(a).

  2. When the disclosure statement notice order is served on the IRS, Insolvency uses the event as an opportunity to fine tune and amend the amount of any IRS claims, to reevaluate the security for any claims the IRS has filed as secured and amend the characterization of its secured claim (to priority or general unsecured status) if appropriate, and to conduct updated post-petition tax compliance reviews for the debtor to see if any further administrative expense claims should be filed.

  3. Ultimately because the purpose of the disclosure statement approval process is informational and because the Government has limited resources for litigating in bankruptcy court, the IRS usually objects to a proposed disclosure statement only if it is grossly deficient, and the IRS is also considering significant objections to the proposed plan. However, an objection to a proposed disclosure statement should be filed if it incorrectly describes the Service's claim, since this will affect other creditors.

5.17.10.9  (08-01-2010)
Plans in Chapter 11

  1. The ultimate form of a Chapter 11 plan in a particular case is ordinarily a matter for intense negotiations between a debtor, its significant creditors, and other interested parties (e.g., the debtor’s stockholders).

5.17.10.9.1  (08-01-2010)
Classification In Chapter 11 Plans

  1. For the purpose of determining the treatment of creditors in a Chapter 11 plan, the Bankruptcy Code generally requires that claims be "classified" (placed in Class 1, Class 2, etc.) based on the nature of the claims. 11 USC § 1123(a)(1). Claims or interests may be included in a particular class only if such claims or interests are substantially similar to the others in that class. 11 USC § 1122(a).

  2. In practice, each secured claim is commonly placed in its own class or subclass, due to a secured creditor’s often unique interest in certain property of the debtor’s bankruptcy estate, based upon the extent and priority of the creditor’s lien or the specific mutual debt subject to offset.

  3. Administrative expense claims, gap period claims, and priority tax claims should not be classified by a Chapter 11 plan.

5.17.10.9.2  (08-01-2010)
Impairment of Claims in a Chapter 11 Plan

  1. A Chapter 11 plan must specify any class of claims or interests that is not impaired under the plan. 11 USC § 1123(a)(2).

    1. A class of claim or interest holders is impaired by a Chapter 11 plan unless the plan leaves the claim or interest holders’ non-bankruptcy legal, equitable, and contractual rights unaltered. 11 USC § 1124(1).

    2. In general the IRS’s secured claims and general unsecured claims are almost always impaired by a Chapter 11 plan.

  2. A Chapter 11 plan must provide the same treatment for each claim or interest in a particular class, unless the holder of a particular claim or interest agrees to a less favorable treatment of the holder’s particular claim or interest. 11 USC § 1123(a)(4). This is one reason why general unsecured creditors may be placed in several different classes in a complex Chapter 11 case.

  3. It is improper for a debtor or other plan proponent to attempt to limit or reduce the amount of a disputed IRS tax claim by providing in the plan that the IRS claim is for a specific amount that the IRS does not agree with; the amount and classification of disputed tax claims should be challenged in a contested proceeding apart from the plan confirmation process. See In re Taylor, 132 F.3d 256 (5th Cir. 1998).

5.17.10.9.3  (08-01-2010)
Acceptance and Voting on a Chapter 11 Plan

  1. In Chapter 11 cases, most of a debtor’s creditors and interest holders may "vote" to accept or reject a proposed plan, as well as file an objection to the proposed plan. In the Bankruptcy Code, voting on acceptance or rejection of a plan only occurs in Chapter 11 cases.

  2. Classes of creditors and interest holders who are unimpaired are deemed to have accepted the plan. 11 USC § 1126(f). A class is deemed not to accept if it receives no property under the plan. 11 USC § 1126(g).

  3. An impaired class of creditors is considered to have accepted the plan if it is accepted by creditors holding at least two-thirds of the amount of the combined claims and more than one-half in number of the allowed claims of those in the class who vote. 11 USC § 1126(c).

  4. Because administrative expense claims, gap period claims, and priority tax claims should not be classified by a Chapter 11 plan, the IRS ordinarily may not vote with respect to these types of claims.

  5. However, IRS claims that are secured or general unsecured should be classified and are almost always impaired by the plan, so the IRS should have an opportunity to vote to accept or reject a plan with respect to these types of claims.

    1. When the IRS or other agencies of the United States are creditors, 11 USC § 1126(a) provides the Secretary of the Treasury with authority to accept or reject a Chapter 11 plan on behalf of the United States.

    2. Pursuant to General Counsel Order No. 4 (Jan. 19, 2001), the authority to accept or reject plans where the United States is a creditor has been delegated to the Chief Counsel. See CCDM 30.2.2, Exhibit 30.2.2-6. This delegation covers proceedings where the United States possesses only a tax claim, as well as proceedings in which there are other claims of the United States in addition to the claim of the IRS.

  6. When there are claims of the United States for taxes owed to the IRS and for debts owed to other agencies, the different agencies must coordinate their votes; disagreements on how to vote may be referred to the General Counsel of the Treasury Department for resolution. See Chief Counsel Directives Manual (CCDM) at IRM 30.2.2, Exhibit 30.2.2-6 at ¶10.

5.17.10.9.4  (08-01-2010)
Chapter 11 Plan Confirmation Process

  1. Once eligible creditors have voted on the plan, and any modifications are made to it, a confirmation hearing is held to finalize the plan. 11 USC § 1128.

  2. Under the "cram down" procedures, a plan can be confirmed over the dissenting vote of an impaired class as long as the plan does not "discriminate unfairly," and is "fair and equitable," with respect to each impaired, dissenting class. 11 USC § 1129(b). Thus, a plan can be "crammed down" over the vote of a dissenting class of creditors as long as one impaired class has voted to accept the plan.

  3. However, the Bankruptcy Code describes how each type of claim the IRS may have against a Chapter 11 bankruptcy estate should be treated under a plan in order for the plan to be confirmed. The IRS should ensure that its various claims are properly treated under a plan and object to confirmation of the plan if it fails to provide for such treatment. Failure to object to a plan’s proposed treatment of a claim may be interpreted as consent to that treatment.

  4. Also, the IRS should attempt to include specific default provisions in a Chapter 11 plan. These default provisions specify the manner for the IRS to give the debtor notice of a default and an opportunity to cure the default. The default provisions may also clarify that the IRS may use its administrative collection powers to collect the tax due by the debtor if it fails to timely cure its defaulted plan payments.

  5. Once a plan is confirmed, it is binding on the debtor and all interested parties.

5.17.10.9.4.1  (08-01-2010)
Objection to a Chapter 11 Plan

  1. Objecting to a proposed Chapter 11 plan is a separate process from voting to accept or reject a plan. The IRS votes (accepts or rejects) only when it holds a secured claim or a general unsecured claim and it does not believe confirmation of the plan would be in its best interest. It objects to confirmation when the plan does not meet the legal requirements for confirmation under the Code, as when it holds unsecured priority tax claims that are not provided for as required under section 11 USC § 1129(a)(9). In most cases the IRS holds all three types of claims, so it votes and objects.

5.17.10.9.4.2  (08-01-2010)
Plan Treatment Of Administrative Expense and Gap Period Claims

  1. All administrative expense claims (11 USC § 507(a)(2)) and gap period claims (11 USC § 507(a)(3)), including those of the IRS, must be fully paid in cash on the "effective date" of the plan, except to the extent that a particular claimant agrees otherwise. 11 USC § 1129(a)(9)(A).

    1. The IRS should rarely agree to any different treatment. But see paragraph 4, (IRM 5.17.10.9.4.2(4)), below.

    2. In some Chapter 11 cases, the IRS may even request that the bankruptcy court order the debtor in possession or trustee to deposit the money required to pay these administrative expense and gap period claims on the plan effective date in a special account before the court enters an order confirming the plan. Bankruptcy Rule 3020(a).

  2. The effective date of the plan is ordinarily defined in the plan.

    1. If not, the effective date may be considered to be the date that the plan confirmation order becomes final and plan distributions should begin, ordinarily no sooner than 10 days after the confirmation order is entered.

    2. If the IRS holds significant administrative expense claims against a debtor’s bankruptcy estate and if the proposed plan suggests an effective date for the plan that is too vague or too long after the plan is confirmed, then the IRS should object to the plan. See In re Potomac Iron Works, Inc., 217 B.R. 170 (Bankr. D. Md. 1997).

  3. Administrative expense tax liabilities include penalties and interest on taxes incurred by the bankruptcy estate. See United States v. Friendship College, Inc., 737 F.2d 430 (4th Cir. 1984); In re Preferred Door Company, Inc., 990 F.2d 547 (10th Cir. 1993).

    Note:

    Administrative claims for penalties may not be equitably subordinated (paid less or differently from other administrative expense claims) under 11 USC § 510. See United States v. Noland, 517 U.S. 535 (1996).

  4. If the bankruptcy estate is incurring administrative period taxes, but the administrative expense claim bar date proposed in the plan falls before or shortly after the tax return for the relevant tax year is due, the IRS should seek to extend the proposed administrative expense claim bar date to a specified reasonable period of time after the tax return is due.

    1. In this circumstance the IRS may agree for some of its potential administrative expense claims to be paid in full sometime after the plan effective date, since the bankruptcy estate’s tax return for the administrative tax period will not be due until after the plan becomes effective.

    2. The IRS may also want to be sure that the reorganized debtor or other entity responsible for paying the administrative period taxes later determined to be due has maintained a cash reserve that will be available for paying the potential administrative period taxes.

      Note:

      While 11 USC § 503(b)(1)(D) provides that for cases commencing on or after October 17, 2005, the Service's request for payment of administrative liabilities does not have to be filed with the court for the expenses to be allowed, an administrative expense claim should nevertheless be filed. The filing of an administrative claim puts the debtor and creditors on notice of the liability and of the amount due. It also assists in the referral of the case to Counsel for dismissal or conversion, and helps ensure that the claim will be treated as an allowed administrative claim.

5.17.10.9.4.3  (08-01-2010)
Plan Treatment of Priority Tax Claims in Chapter 11

  1. In order to be confirmed, a Chapter 11 plan must provide for unsecured priority tax claims (11 USC § 507(a)(8)) of the IRS to be paid in full, in cash, either on the plan effective date or in regular installment payments within five years of the date of the petition, including interest on any unpaid claim amounts after the plan becomes effective. 11 USC § 1129(a)(9)(C). The IRS may consent (knowingly or by not objecting) to other treatment of its priority tax claims by a Chapter 11 plan.

  2. While irregular or fluctuating payments may be acceptable to the IRS when the reorganized debtor operates a seasonal business, the IRS should object to any Chapter 11 plan which promises a large balloon payment of IRS priority taxes at the end of a five-year payment period.

  3. The interest rate required for installment payments of priority taxes under a Chapter 11 plan is determined pursuant to IRC § 6621 as of the calendar month in which the plan is confirmed, compounded daily pursuant to IRC § 6622. 11 USC § 511.

5.17.10.9.4.4  (08-01-2010)
Plan Treatment of Secured Tax Claims in Chapter 11

  1. If a confirmed Chapter 11 plan and confirmation order provide for incomplete payment of or fail to address an IRS secured claim, property of the debtor’s estate (except exempt and abandoned property) may be treated as free and clear of the IRS liens that previously secured the IRS claim. 11 USC § 1141(c).

    1. Thus, it is very important for the IRS to ensure that its secured claims are properly classified as "secured" by a proposed Chapter 11 plan, that the plan accurately defines the amount of the IRS secured claims, and that the IRS’s liens will attach to the proceeds arising from the sale of any property to which the liens attached.

    2. Also, the plan should provide for the retention of the IRS’s liens and the provision of deferred cash payments to the IRS for at least the total value of the IRS secured claim, plus interest calculated from the plan’s effective date. 11 USC §§ 1129(b)(2)(A)(i)-(ii).

  2. In addition to security arising from properly filed NFTLs, IRS claims are often secured by IRS rights to set off against prepetition federal tax refunds owed to the debtor and against other amounts payable to the debtor from another agency of the United States.

    1. The case law is split on whether a creditor loses its setoff rights by failing to provide specifically for preservation of these rights in a confirmed Chapter 11 plan or in the confirmation order. Compare In re De Laurentis Entertainment Group, Inc., 963 F.2d 1269 (9th Cir. 1992) (no loss of setoff rights) and In re Deutchman, 192 F.3d 457 (4th Cir. 1999), with In re Continental Airlines, 134 F.3d 536 (3d Cir. 1998) (setoff rights arguably lost, if not preserved in the plan).

    2. Accordingly, when the IRS knows it has setoff rights or is uncertain at plan confirmation whether it has setoff rights (as in a prepackaged plan situation), the IRS should request that the Chapter 11 plan specifically provide that the setoff rights of the IRS, if any, are not impaired by the plan.

  3. Generally, when a reorganized Chapter 11 debtor retains property encumbered by an IRS lien after plan confirmation, the Bankruptcy Code requires that the reorganized debtor make deferred cash payments to the IRS for at least the allowed amount of the IRS secured claim with interest. Interest is determined pursuant to IRC § 6621 as of the calendar month in which the plan is confirmed. 11 USC § 511. However, 11 USC § 1129(b)(2)(A)(i)(ll) does not specify the time period by which full payment of a secured tax claim must be completed.

    1. For cases commencing on or after October 17, 2005, 11 USC § 1129(a)(9)(D) provides that if a secured tax claim would otherwise have had priority tax status under section 507(a)(8), it will be paid in the same manner as unsecured priority tax claims, i.e., by regular installment payments to be made within five years of the date of the petition, including interest on any unpaid claim amounts after the plan becomes effective. See IRM 5.17.10.9.4.3(3) .

    2. For other secured tax claims, the IRS generally opposes long payout periods in a Chapter 11 case. The IRS has defeated some Chapter 11 plans which have proposed long payout periods for IRS secured claims on grounds of feasibility. See In re Haas, 162 F.3d 1087 (11th Cir. 1998).

  4. When the IRS holds an oversecured claim in a Chapter 11 case, the IRS is entitled to be paid post-petition, pre-effective date interest with respect to its oversecured claim. 11 USC § 506(b).

    Note:

    When the IRS has not been paid this administrative period interest on its oversecured claim before confirmation, the IRS should ensure that the plan specifically recognizes the oversecured status of the IRS claim and provides for the full payment of this administrative period interest under the plan.

  5. Whether an IRS secured claim is oversecured or undersecured, the IRS is also ordinarily entitled to be paid post-effective date interest under the plan on its secured claim if the property encumbered by the tax lien was not sold. The interest is determined pursuant to IRC § 6621 as of the month in which the plan is confirmed. 11 USC § 511.

  6. Some bankruptcy courts allow a Chapter 11 debtor in possession to strip down the value of liens (prohibited in Chapter 7 cases by Dewsnup v. Timm, 502 U.S. 410 (1992)) before confirmation, in a proceeding to challenge the secured claim or to determine the extent of a lien. Courts have no authority, however, to modify secured claims other than through the plan. Section 1123(b)(5) allows the court to confirm a plan that modifies the rights of holders of secured claims, so any lien stripping in Chapter 11 must happen through a provision in a confirmed Chapter 11 plan.

  7. While a Chapter 11 plan may modify the rights of holders of secured claims against property of the estate, individual debtors often have prepetition property which is

    • excluded from their bankruptcy estates (such as ERISA qualified pension interests, as in Patterson v. Shumate, 504 U.S. 753 (1992));

    • exempted from their bankruptcy estates (see 11 USC § 522, Bankruptcy Rule 4003, and Taylor v. Freeland, 503 U.S. 638 (1992)); or

    • abandoned by their bankruptcy estates prior to plan confirmation (11 USC §§ 554(a)-(b)).

  8. An individual debtor’s non-estate property of this type is not generally dealt with by a Chapter 11 plan, so this property is ordinarily not at risk of being stripped of prepetition tax liens by the plan. 11 USC § 1141(c); In re Isom, 901 F.2d 744 (9th Cir. 1990).

5.17.10.9.4.5  (08-01-2010)
Plan Treatment of General Unsecured Tax Claims in Chapter 11

  1. If the IRS has general unsecured claims, it may vote to reject a plan and subsequently file an objection to confirmation of a plan based on the plan’s proposed treatment of those claims.

  2. In general, a Chapter 11 plan may be confirmed despite a vote to reject the plan by a class of creditors holding impaired, general unsecured claims. However, the plan cannot improperly discriminate between general unsecured claims. It must be "fair and equitable" in its treatment of the dissenting class of impaired, general unsecured claims holders in order to be confirmed by the bankruptcy court under "cram down" procedures. 11 USC § 1129(b)(1).

  3. A plan is "fair and equitable" if it provides full payment, with interest, to the holders of claims in a dissenting class of general unsecured creditors or provides that the claims or interests of any "junior" claim or interest holder will not receive or retain any property or interest under the plan. 11 USC § 1129(b)(2)(B)(ii). This latter requirement is commonly referred to as the "absolute priority rule."

    1. The classes of claims or interests that are "junior" to a class of general unsecured creditors under the Bankruptcy Code include any class of subordinated holders of debt (subordinated bondholders, for instance) and the debtor’s owners (e.g., the stockholders or partners).

    2. Thus, if a proposed Chapter 11 plan provides for the stockholders or the parent company of the debtor to retain any part of their ownership interest in the reorganized debtor, then a dissenting class of general unsecured creditors may object to confirmation of the plan by raising the absolute priority rule.

    3. However, some courts recognize a "new value exception" to the absolute priority rule. Under this exception, the owners of the debtor may retain some part of their ownership interests in the debtor in a cram down situation if the owners will be making a new contribution in money (or other capital) to the reorganized debtor.

    4. The Government has argued that there is no new value exception to the absolute priority rule. The Supreme Court has not addressed whether such an exception to the absolute priority rule should be recognized. See Bank of America NT & SA v. 203 North LaSalle Street Partnership, 119 S.Ct. 1411 (1999); U.S. Bancorp Mortgage Co. v. Bonner Mall Partnership, 115 S.Ct. 386 (1994); Norwest Bank Worthington v. Ahlers, 485 U.S. 197 (1988).

  4. In addition to an objection based on the absolute priority argument, the IRS may file an objection to confirmation of a Chapter 11 plan in the following situations:

    1. The plan improperly classifies the IRS’s general unsecured claims apart from other similar, general unsecured claims and then provides for better (earlier or closer to full) payment of these other classes of general unsecured claims. 11 USC §§ 1129(a)(1) and (3), 1123(a)(1), and 1122(a).

    2. The plan attempts to subordinate IRS penalty claims (including taxes for the debtor’s underfunding of a pension plan under IRC § 4971) or other IRS general unsecured claims to the claims of all other classes of general unsecured creditors. See U.S. v. Reorganized CF&I Fabricators of Utah, Inc., 518 U.S. 213 (1996).

    3. The plan provides smaller payments, overall, for the general unsecured claims of the IRS than the IRS would receive for those claims if the debtor was liquidated in a Chapter 7 case. 11 USC § 1129(a)(7)(A)(ii). This is commonly referred to as the "best interests of creditors" test. However, it is usually very difficult for a general unsecured creditor to make a successful argument that the plan fails the best interests of creditors test as to its own claim.

5.17.10.9.5  (08-01-2010)
IRS Feasibility Concerns with Chapter 11 Plans

  1. A Chapter 11 plan should not be confirmed if the plan is likely to be followed by liquidation or the need for further reorganization (in another bankruptcy case, for instance), of the debtor or of any successor to the debtor under the plan, unless the plan proposes such liquidation or further reorganization. 11 USC § 1129(a)(11). This is commonly referred to as the "feasibility" test.

  2. Common Chapter 11 feasibility concerns and objections of the IRS have included the following types of plan proposals:

    1. Balloon payments of IRS priority tax claims.

    2. Delays of the plan effective date (the date to pay IRS administrative expense or gap period claims) for an unreasonable period of time after plan confirmation, while the debtor remains in possession and control of the business.

    3. Extended deferred payment periods for IRS secured claims.

  3. Identifying other IRS feasibility concerns with a proposed Chapter 11 plan may require a closer review of the entire structure of the proposed plan.

    1. A proposed Chapter 11 plan may provide that the reorganized debtor will pay the entire allowed priority tax claims of the IRS in regular even installments within five years of the petition date, but a careful review of other provisions of the plan may show that this promise is empty.

    2. For instance other parts of the proposed plan may provide that the debtor will transfer substantially all of its assets to a new entity (separate from the reorganized debtor), that the debtor’s pre-confirmation debts to be assumed by the new entity will be limited to certain categories (secured debts and unsecured trade creditor debts perhaps) that would not include the tax debts to the IRS, and that the debtor will not be retaining or receiving sufficient cash or other property from the transfer of substantially all of its property to the new entity to ever pay the outstanding IRS tax claims.

5.17.10.9.5.1  (08-01-2010)
IRS Tax Avoidance Concerns with Chapter 11 Plans

  1. If a proposed Chapter 11 plan is otherwise qualified to be confirmed, the bankruptcy court should nevertheless deny confirmation if the principal purpose of the plan is the avoidance of taxes. 11 USC § 1129(d). If the IRS objects on this ground, it has the burden of proof on the issue of showing that tax avoidance is the principal purpose of the proposed Chapter 11 plan. 11 USC § 1129(d).

  2. One situation where it may be appropriate for the IRS to object that the principal purpose of a Chapter 11 plan is tax avoidance is when a sale or transfer or substantially all of the debtor’s assets after confirmation is expected to produce a sizeable federal income tax liability for the debtor’s bankruptcy estate, and the plan does not provide a mechanism for paying this federal tax liability to the IRS. See In re Scott Cable Communications, Inc., 227 B.R. 596 (Bankr. D. Conn. 1998).

  3. If the taxpayer suspected of attempting to avoid a future federal income tax liability is not liquidating under a proposed Chapter 11 plan, the IRS may still be able to conduct a meaningful review of the facts and legal implications of the transactions after the plan is confirmed through a regular audit pursuant to IRC § 269. In a post-confirmation year audit of a taxpayer with a confirmed Chapter 11 plan, the IRS takes the position that confirmation of the bankruptcy plan does not stop the IRS from challenging the transactions effected by the plan for purposes of IRC § 269. See Treas. Reg. § 1.269-3(e); In re Hartman Material Handling Systems, Inc., 141 B.R. 802 (Bankr. S.D. N.Y. 1992).

5.17.10.9.5.2  (08-01-2010)
Designation of Payments in Chapter 11 Plans

  1. In Chapter 11 cases where a corporate debtor is liable to the IRS for a significant amount of unpaid prepetition trust fund taxes, the debtor in possession often seeks in its plan to designate IRS application of the earliest payments required under the plan to satisfy the corporation’s outstanding trust fund taxes first.

    1. The debtor in possession is often still controlled by the managers whom the IRS has already found or may still find liable as responsible persons for the debtor’s previously unpaid trust fund taxes under IRC § 6672.

    2. The IRS generally views the corporate debtor’s request to designate plan payments to trust fund taxes first as a means of shifting the risk of a Chapter 11 plan failing before completion from the debtor’s managers to the IRS, while the debtor in possession typically argues that it is attempting to relieve its managers of the potential distraction of worrying about whether the IRS will collect the taxes owed from them before the debtor’s plan is completed.

  2. In U.S. v. Energy Resources, 495 U.S. 545 (1990), the Supreme Court decided that bankruptcy courts do have the authority to approve Chapter 11 plans which order the IRS to apply a Chapter 11 debtor’s plan payments to trust fund taxes first if the court concludes that the designation of payments in this manner is necessary for the success of the reorganization plan.

  3. The courts are split on whether a bankruptcy court may designate the application of payments made under a Chapter 11 plan to trust fund taxes when the plan provides for the debtor’s liquidation rather than the debtor’s continuation as a reorganized business. In re Kare Kemical, Inc., 935 F.2d 243 (11th Cir. 1991) (no designation allowed); In re Deer Park, Inc., 10 F.3d 1478 (9th Cir. 1993) (designation allowable).

  4. Energy Resources does not provide that bankruptcy courts have the jurisdiction to determine the tax liability of non-debtors. See In re Prescription Home Health Care, Inc., 316 F.3d 542, 549 (5th Cir. 2002). For this reason, the IRS maintains that a bankruptcy court lacks the proper authority or jurisdiction to enjoin the IRS from investigating a corporate debtor’s potentially responsible persons for their liability for the trust fund recovery penalty (TFRP), from assessing the TFRP against the debtor’s responsible persons, and from attempting to collect the TFRP from the debtor’s responsible persons while the debtor’s trust fund tax liabilities remain unpaid. See generally In re Prescription Home Health Care, Inc., 316 F.3d 542 (5th Cir. 2002); U.S. v. Huckabee Auto Co., 783 F.2d 1546 (11th Cir. 1986); In re LaSalle Rolling Mills, Inc., 832 F.2d 390 (7th Cir. 1987); A to Z Welding & Mfg. Co., Inc. v. U.S., 803 F.2d 932 (8th Cir. 1986); In re American Bicycle Assoc., 895 F.2d 1277 (9th Cir. 1990).

  5. However, absent statute of limitation period considerations, it is the general policy of the IRS to refrain from asserting the TFRP against non-debtor responsible persons in cases where the corporate debtor has already approved a Chapter 11 plan that provides for full payment of priority taxes for so long as the plan is not in default. See IRS Policy Statement 5-14 (formerly P-5-60), at IRM 1.2.14.1.3.

5.17.10.10  (08-01-2010)
The Effects of Confirmed Chapter 11 Plans

  1. When a confirmed Chapter 11 plan becomes effective, the extent to which tax liabilities (whether or not a proof of claim was actually filed) are discharged depends on a number of factors. These factors include whether the debtor is an individual or a non-individual (e.g., corporations, partnerships, limited liability companies, etc.), whether a non-individual debtor is liquidating or reorganizing, and what the specific terms of the plan provide.

  2. Once a confirmed Chapter 11 plan becomes effective, the automatic stay (11 USC § 362), which went into effect on the petition date, is generally lifted. However, the discharge injunction that arises upon confirmation of the plan generally continues to prohibit the IRS from collecting a tax debt that is either discharged or fully provided for by the plan (unless and until the plan falls into substantial default).

  3. For Chapter 11 cases of individuals filed on or after October 17, 2005, the debtor generally does not receive a discharge until after completion of payments under the plan. Under section 362(c), the automatic stay generally terminates upon the earlier of three events, the grant or denial of discharge, the closing of the case, or the dismissal of the case. However, the automatic stay prohibiting acts against property of the estate remains in effect until the property is no longer property of the estate. A Chapter 11 plan typically provides for the revesting of property of the estate in the debtor or some other entity, but it may not. 11 USC § 1141(b). Further, for Chapter 11 cases of individuals filed on or after October 17, 2005, the estate includes post-petition wages and property, as in Chapter 13 cases. 11 USC § 1115.

  4. To the extent a tax debt is fully provided for by an effective Chapter 11 plan that is not in substantial default, the IRS collection limitation period with respect to that tax debt is automatically suspended pursuant to IRC § 6503(h).

5.17.10.10.1  (08-01-2010)
The Chapter 11 Discharge

  1. The overwhelming majority of debtors with confirmed and effective Chapter 11 plans are non-individual debtors (e.g., corporations, partnerships, limited liability companies, etc.). The discharge granted a non-individual debtor in a Chapter 11 case is substantially different from the discharge granted an individual debtor. See IRM 5.17.10.11 for a discussion on the Chapter 11 discharge for individual debtors. When the Chapter 11 debtor is an individual, the exceptions to discharge in 11 USC § 523(a) apply. The provisions of a confirmed plan cannot affect the dischargeability of tax liabilities of individuals when the liabilities are excepted from discharge under 11 USC § 523(a)(1).

    Note:

    For bankruptcy cases filed on or after October 17, 2005, Chapter 11 debtors who are individuals are generally not entitled to receive a discharge until after completion of all payments under the plan, as in Chapter 13 cases. 11 USC § 1141(d)(5). However, a debtor who cannot complete all payments under the plan, but has paid more to creditors than they would have received in a Chapter 7 case, may be entitled to a hardship discharge.

  2. Unless otherwise provided for in the plan or confirmation order, non-individual Chapter 11 debtors generally receive a "superdischarge" of all of their pre-confirmation debts. 11 USC § 1141(d)(1)(A). However, for Chapter 11 cases filed on or after October 17, 2005, tax debts for which the debtor filed a fraudulent return or willfully attempted to evade are not discharged even if the debtor is not an individual. 11 USC § 1141(d)(6)(B).

  3. A debtor’s Chapter 11 plan is required to provide for full payment in cash of the allowed claims the IRS has filed for administrative expense and gap period taxes, priority taxes, and secured taxes. Therefore, a Chapter 11 plan for a non-individual debtor is required to "provide otherwise" for discharge of these types of taxes, as long as the IRS has filed proofs of claim for these taxes, and the IRS claims are allowed. If the IRS does not file proofs of claims for pre-confirmation taxes owed by a non-individual Chapter 11 debtor, the plan generally will provide for discharge of these tax debts.

  4. With respect to the IRS’s secured claims, the IRS should ensure that a plan provides for the retention of tax liens on the debtor’s property which secures the IRS’s claim. Otherwise, the tax liens may be stripped from all of the debtor’s property when the plan becomes effective. 11 USC § 1141(c).

  5. Prepackaged Chapter 11 plans sometimes provide for most of a debtor’s unsecured debts (including some or all of its potential tax debts) to pass through confirmation of the prepackaged plan with no alteration. A prepackaged Chapter 11 plan may provide this passthrough treatment for most types of unsecured debts because the debtor may be primarily concerned with restructuring only its most significant debts and stock ownership in a pre-agreed manner, and involving all of its creditors in the bankruptcy proceeding could slow down approval of its narrowly drawn prepackaged plan. Nevertheless, the IRS should carefully review the proposed terms of a prepackaged plan that provides for passthrough treatment of some unsecured debts to be sure that the passthrough terms of the proposed plan actually cover all of the potential claims of the IRS against the debtor.

  6. If the confirmed plan of a non-individual Chapter 11 debtor provides for the liquidation of all or substantially all of the property of the debtor’s bankruptcy estate and if the debtor does not engage in business after the plan is confirmed, then the debtor does not receive a discharge of its pre-confirmation debts automatically pursuant to 11 USC § 1141(d)(3).

    1. In many liquidating Chapter 11 cases of this type, the terms of the debtor’s Chapter 11 plan itself frequently provide for the non-individual debtor’s pre-confirmation debts to be discharged or released under the plan.

    2. The debtor’s creditors may choose not to object to this treatment of their debts because there may be no collection source for their debts apart from distributions under the liquidating Chapter 11 plan anyway.

5.17.10.10.2  (08-01-2010)
The Binding Effect of Chapter 11 Plans

  1. The provisions of a confirmed Chapter 11 plan generally bind the debtor, any entity acquiring property under the plan, and any creditor (including the IRS), whether or not the claim of such creditor is impaired under the plan and whether or not the creditor has accepted the plan. 11 USC § 1141(a). While is it always the better practice to object to a plan that contains inappropriate provisions, there are specific statutory exceptions to the general rule that a plan’s terms are binding upon creditors. Statutory exceptions are made for:

    1. debts excepted from discharge by 11 USC § 523(a)(1), in the case of individuals;

    2. the denial of discharge by 11 USC § 1141(d)(3), which denies a discharge to liquidating non-individual debtors;

    3. the withholding of an individual Chapter 11 debtor’s discharge until the completion of payments under the plan; and

    4. debts excepted from discharge by 11 USC § 1141(d)(6), including non-dischargeable tax debts relating to a fraudulent return or the willful attempt to evade such taxes in the case of corporate debtors.

  2. If the terms of a confirmed Chapter 11 plan purport to limit or reduce IRS priority tax claims to an amount less than what the IRS is entitled to under the Bankruptcy Code, and if there was no tax determination proceeding in the bankruptcy, the IRS may also argue that the debtor misused the plan confirmation process to produce an adjustment of rights that the debtor should have pursued through a contested bankruptcy proceeding, apart from the plan confirmation process. In such cases the United States has persuaded several courts that terms of this type in a confirmed Chapter 11 plan are not binding on the IRS. See In re DePaolo, 45 F.3d 373 (10th Cir. 1995); In re Taylor, 132 F.3d 256 (5th Cir. 1998).

5.17.10.10.3  (08-01-2010)
Status of the Automatic Stay and Collection SOL after Plan Confirmation for Non-Individuals

  1. When a Chapter 11 plan becomes effective, the non-individual debtor generally receives a discharge of at least some of its debts. Pursuant to 11 USC § 362(c), the stay of acts against property of the estate ends only when the property is no longer in the estate, and property of the estate typically revests in the debtor upon confirmation of a plan. Section 362(c) provides that the stay remains in effect until the earliest of three events: grant or denial of discharge, closing of the case, or dismissal.

  2. In a Chapter 11 case of a non-individual, the discharge is typically granted or denied when the plan is confirmed.

  3. When the automatic stay is lifted upon confirmation of the plan, the IRS is not generally free to resume its normal collection activity for the debtor’s pre-confirmation tax debts. The plan is binding upon the debtor and all creditors. 11 USC § 1141(a). Also, the discharge injunction typically takes effect when the plan is confirmed and the discharge is granted. 11 USC § 524(a). However, the discharge injunction does not prohibit:

    1. the commencement or continuation of proceedings concerning the debtor before the U.S. Tax Court, or

    2. the setoff of discharged tax liabilities against prepetition refunds.

  4. To the extent that a Chapter 11 plan provides for full payment of the IRS’s pre-confirmation tax claims, in particular its administrative, priority, and secured tax claims, the plan precludes the IRS from attempting to collect these taxes (outside of receiving payments under the plan and making setoffs). If the debtor substantially defaults on making the payments on the taxes provided by the plan, the IRS may pursue administrative action to collect any unpaid portion of the amount which the confirmed plan originally provided for payment to the IRS, though default provisions in the plan should generally be followed. See IRM 5.17.10.12.1,Chapter 11 Plan Default Procedures.

  5. After a Chapter 11 plan becomes effective and the automatic stay is lifted, the statute of limitations for the IRS to collect a pre-confirmation tax, that is to be fully paid under a Chapter 11 plan, remains suspended pursuant to IRC § 6503(h)(2), unless the debtor substantially defaults on making plan payments of the tax at issue. See United States v. Wright, 57 F.3d 561 (7th Cir. 1995); United States v. McCarthy, 21 F. Supp. 888 (S.D. Ind. 1998).

5.17.10.11  (08-01-2010)
Individuals in Chapter 11

  1. BAPCPA made several changes to Chapter 11 to make cases of individuals similar to Chapter 13 cases, often adopting language from relevant Chapter 13 provisions.

  2. Under new 11 USC § 1115, an individual Chapter 11 debtor’s bankruptcy estate now includes post-petition property and earnings of the debtor. New 11 USC § 1129(a)(15) provides that individuals must apply their projected disposable income to the plan for a minimum of five years, although Chapter 11 plans can be longer. These changes impact how the individual debtor and the debtor’s bankruptcy estate are each taxed under IRC § 1398.

    1. For an individual debtor filing a Chapter 11 case (as in individual Chapter 7 cases), the individual and the individual debtor’s bankruptcy estate are treated as separate taxpayers by IRC § 1398. See IRM 5.9.8.13 for further discussion on the separate taxation of an individual Chapter 11 debtor and the bankruptcy estate.

    2. Given the broader definition of property of the estate under 11 USC § 1115, income that would otherwise have been taxable to the Chapter 11 debtor had section 1115 not been enacted is arguably taxable to the Chapter 11 estate. Such income may include (1) all wages and other income from the performance of services earned after the bankruptcy filing and (2) all rents, dividends, and other income from property acquired after the filing.

    3. This approach was, however, not likely intended by Congress at least insofar as post-petition income from the performance of services is concerned. Notice 2006-83 provides further guidance on the effects of 11 USC § 1115 on the taxation of Chapter 11 bankruptcy estates and individuals.

  3. The bankruptcy estates of individuals in Chapter 11 often need to be closely monitored for compliance with their administrative period income tax obligations pursuant to IRC § 1398.

    1. The IRS has generally made the Chapter 7 panel trustees aware of their federal income tax obligation to file Form 1041 returns for an individual debtor’s bankruptcy estate through circulation of IRS Publication 908 (Tax Information on Bankruptcy) and through various meetings with the trustees.

    2. In some cases, it may be appropriate for the IRS to ask the debtor in possession to abandon, or the bankruptcy court to order abandonment, of estate property to the individual debtor (11 USC § 554) before the taxable transfer of that property occurs. See In re Olson, 930 F.2d 6 (8th Cir. 1991); In re Nevin, 135 B.R. 652 (Bankr. D. Haw. 1991).

  4. Under new 11 USC § 1127(e), upon the request of a party in interest, the amount or timing of plan payments can be modified any time before completion of the plan.

  5. The changes made by BAPCPA have also made the Chapter 11 discharge for individuals similar to the discharge for individuals in Chapter 13 cases.

    1. Under new 11 USC § 1141(d)(5), Chapter 11 debtors who are individuals will not receive a discharge upon confirmation of the plan. As in Chapter 13, the discharge occurs after completion of payments under the plan. The court may, however, grant the debtor a hardship discharge before the completion of plan payments.

    2. The types of tax debts excepted from discharge have not changed — many prepetition secured and unsecured tax debts survive plan confirmation whether or not the IRS files a claim for the tax in the bankruptcy case. See Matter of Fein, 22 F.3d 631 (5th Cir. 1994); In re DePaolo, 45 F.3d 373 (10th Cir. 1995); In re Gurwitch , 794 F.2d 584 (11th Cir. 1986). In particular, tax debts that are excepted from discharge under 11 USC §§ 523(a)(1)(A)-(C), such as priority taxes, are not discharged when an individual completes payments under the Chapter 11 plan. 11 USC § 1141(d)(2).

  6. Claims for post-petition administrative period interest that is due on non-dischargeable taxes against an individual in Chapter 11 are not allowed and cannot be paid under the Chapter 11 plan. However, the individual debtor remains personally liable for paying this post-petition interest, after confirmation, outside of the plan. See In re Tuttle, 291 F.3d 1238 (10th Cir. 2002).

  7. In Chapter 11 cases, a claim for an individual debtor’s own (as opposed to the estate’s) post-petition federal tax liabilities may not be filed in the bankruptcy case, but these post-petition pre-confirmation debts of the individual survive confirmation and may be collected from the individual. See In re Johnson, 190 B.R. 724 (Bankr. D. Mass. 1995); In re Wood, 240 B.R. 609 (C.D. Cal. 1999).

5.17.10.12  (08-01-2010)
Monitoring Compliance with Chapter 11 Plans

  1. In a Chapter 11 case where a plan confirmation order is procured by fraud, an interested party may file an adversary complaint to revoke the confirmation order and the discharge received by the debtor at any time before the 180th day after the confirmation order was entered. 11 USC § 1144; Bankruptcy Rule 7001. The circumstances constituting procurement by fraud must be plead with particularity and proven by a preponderance of the evidence. Bankruptcy Rule 7009; Federal Rule of Civil Procedure 9(b). It is relatively rare for the IRS to seek revocation of a Chapter 11 plan.

5.17.10.12.1  (08-01-2010)
Chapter 11 Plan Default Procedures

  1. Many Chapter 11 plans specify the procedures applicable to all creditors or to the IRS when the reorganized debtor defaults on its required payments under the plan.

  2. In the case of a default, Insolvency may refer the case to a revenue officer to resume administrative collection activity.

  3. Insolvency may also refer the case to Area Counsel to file a motion to dismiss or convert the debtor’s Chapter 11 case to a Chapter 7 case. However, dismissal or conversion would only be appropriate if the bankruptcy estate retained property after confirmation. There is no provision that reinstates the automatic stay upon conversion.

    Note:

    Dismissal of a Chapter 11 case due to a default by a debtor with respect to a confirmed plan does not revoke any discharge which has been granted in the case. This is an issue in a Chapter 11 case of a non-individual debtor who receives a discharge on confirmation of a plan.


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