Business debtors who have mislead or defrauded investors could face harsh consequences in Chapter 11 bankruptcy. For example, if a debtor sought and gained investors while insolvent; but misrepresented that fact to the investors; if they file bankruptcy they may be facing the following problems:
- The Chapter 11 bankruptcy court could order that the investments be rescinded. If the investments are rescinded then the business debtors will be liable for the full amount of the investment. Compare that to the zero dollar amount most unsecured investors receive in a Chapter 11 bankruptcy reorganization.
- If it is found that the debtors mislead investors, the bankruptcy court could also award damages to the investors, costing the business debtors even more money.
- But the financial cost would not stop at the repayment of the investors' original investment they made before the debtor filed bankruptcy, they could also be liable for attorneys' fees and interest on the money that was loaned to them.
- The fallout from making misleading statements to investors could also have a domino effect, negatively impacting the company's survival in Chapter 11 bankruptcy. Investors who may be interested in providing debtor-in-possession financing may decide to back out if they see that the cash will be flowing out to junior creditors because of prepetition misstatements that mislead investors. The investor debacle could also create a an crabs in a barrel environment where other creditors begin to try to extract even more cash out of the company because they fear that their claims will be minimized by the slighted investors.