Chapter 11 bankruptcy is a form of bankruptcy that reorganizes an individual’s business debts and assets. In Chapter 11 bankruptcy, a debtor’s business keeps running while their debts and assets are restructured. Chapter 11 is usually used when large corporations need financial relief. Chapter 11 gives the business time or breathing room to restructure their debts and start anew.
Chapter 11 Bankruptcy: Who Can File?
Chapter 11 bankruptcy is the most complicated form of bankruptcy. A Chapter 11 bankruptcy begins with the filing of a bankruptcy petition. Most times the bankruptcy petition will be filed where the business is primarily located. However, business owners can also choose to file the bankruptcy there if they are “domiciled” (location where they are incorporated.)
In Chapter 11 bankruptcy, the Court helps restructure a business. Thus, allowing the company to stay open. Some of the most well-known companies to file Chapter 11 bankruptcy are Sears, Pier 1 Imports, and General Motors. Not only can corporations file Chapter 11 bankruptcy, partnerships, limited liability companies, and individuals who do not qualify for Chapter 7 bankruptcy or Chapter 13 bankruptcy may file for protection under Chapter 11. Many times, individuals elect to file Chapter 7 bankruptcy or Chapter 13 bankruptcy if they qualify. Chapter 11 bankruptcy is a long expensive process that many individuals cannot afford.
Time Frame of a Chapter 11 Bankruptcy Case:
Typically, Chapter 11 bankruptcy cases can take two years to complete. However, in some cases, they can take as little as a few months.
What Happens in a Chapter 11 Bankruptcy?
In Chapter 11 bankruptcy the business continues to operate. An individual under a Chapter 11 bankruptcy is called a debtor in possession (“DIP”). The debtor in possession is the person or corporation who files the bankruptcy petition but still holds the assets or property that creditors have an interest in. The DIP continues to run the business as usual. In some cases where the Court suspects fraud, dishonesty, or incompetence a Trustee will be appointed to run the business instead of the DIP.
When a business files under Chapter 11 bankruptcy, the Bankruptcy Court determines what the business is permitted to do. The business is not able to make decisions without the Court’s approval. For the business to terminate agreements, sell assets, modify agreements, expand business operations, or enter contracts, it must obtain approval by the Court.
When a business files Chapter 11, any legal proceedings against the business such as foreclosures, collection actions, and judgments come to a grinding halt. This is known as the "Automatic Stay" and is one of the greatest protections given to debtors who file bankruptcy. Under the Automatic Stay, any creditors that continue to go after a debtor once a bankruptcy is filed can be fined by the Court.
Chapter 11 Repayment Plan
In Chapter 11 bankruptcy the individual has 120 days to propose a repayment or reorganization plan. A plan may include downsizing the business, negotiating debts, and liquidating assets. The Chapter 11 plan provides a way for the debtor to show its creditors how it will continue to operate and pay back the money owed to them. If the debtor needs more time to complete the reorganization plan the Court may allow the debtor extra time to do so if they can show it is done in good faith. Typically, if good faith is shown the Court will allow the individual up to 18 months to file the plan instead of 4.
For the Court to approve a debtor’s plan it must do the following:
- Identify the business debts.
- Identify each class of creditors and the number of claims in each class (i.e. priority, unsecured, secured.)
- Identify which debts will be paid in full.
- Identify which debts will be paid back a portion of what is owed.
- Provide details regarding how the debts will be repaid.
- Provide an explanation of how the company will continue to run under the plan.
Along with the plan, the debtor must provide information regarding the circumstances leading up to the bankruptcy filing.
Once the debtor has filed their reorganization plan, creditors can propose their own repayment plans. This is rare. In most cases, when creditors are not happy with a business’s repayment plan, they will try to get the business to convert to Chapter 13 bankruptcy or Chapter 7.
Once the plan is ready to go it is submitted to creditors for a vote on the plan. Creditors that are impaired by the plan or paid less than the full value of the plan can reject the plan. Every impaired class must approve a reorganization plan. For the plan to be approved it must be accepted by at least 2/3 of those claims that vote.
Confirming the Chapter 11 Plan
To confirm the plan the debtor will hold a confirmation hearing. The Bankruptcy Court will approve the Chapter 11 plan if:
It Complies with the law.
It was Proposed in Good Faith.
The Plan Is Feasible – The court will only confirm a Chapter 11 plan if the debtor can show that it is likely to succeed. The debtor will have to show the Court that it will generate enough income to be able to continue running and pay back the debts owed as stated in the repayment plan.
Creditors Are Treated Fairly – In most Chapter 11 cases, not all creditors will be paid back. If the business could afford to pay back all their debts, they would not need Chapter 11. For the plan to be confirmed it must be in the best interest of its creditors. This is also known as the “Best Interests of Creditors’ Test.” Under this test, creditors must receive the value of the property which cannot be less than what they would have gotten in Chapter 7 if the debtor’s assets were liquidated.
Depending on the surrounding circumstances the business will pay all or some of the creditors back. If not, all creditors are paid back, it is usually because the business is underwater.
The Plan is Fair and Equitable -
Secured Creditors: The Fair and Equitable Standard provides that any secured creditors receive payments equal to its secured claim. Further, it says that if the secured property is sold, the secured creditor retains liens on the proceeds. A secured creditor is a creditor that has a lien on any collateral (i.e. mortgage on a property, loan on a vehicle)
Unsecured Creditors: For unsecured creditors, the plan must meet the “Absolute Priority Rule.” The Rule states that the plan must repay all unsecured creditors in full or each class of creditors must be treated the same according to their assigned class.
Objection to the Plan
If a creditor objects to a plan this can be a major roadblock in the Court confirming the debtor’s plan. If the debtor and creditor cannot negotiate mutual terms the debtor will have to ask the judge to approve the case over the objection of the creditor.
Speak with an Attorney
Chapter 11 bankruptcy is a very complicated area of law. Many reports have shown that only 10% of chapter 11 cases are successful. In February of 2020, the Bankruptcy Court added a new subchapter V to Chapter 11 to make it easier and less costly for small businesses to file Chapter 11 bankruptcy. Individuals and businesses seeking to file Chapter 11 bankruptcy should speak with a bankruptcy lawyer to determine if Chapter 11 is right for them.
