Everything You Need To Know About The Chapter 11 Bankruptcy
Individuals and businesses who are in a lot of debt and are unable to fully meet their financial obligations can file for bankruptcy. Chapter 11 bankruptcy is one of the options available to them. Unlike the Chapter 7 bankruptcy, Chapter 11 bankruptcy code involves the reorganization of the individuals assets and liabilities. It is available to businesses that have huge debt burdens. Most of the businesses and corporations that file for a Chapter 11 have unsecured debts of more than $383,175 or secured debts of more than $1,149,525. Small businesses can also file for a Chapter 11. There is also a provision for Chapter 11 bankruptcy for individuals, though this is quite rare.
How Does Chapter 11 Bankruptcy Work?
A number of huge corporations, including General Motors, United Airlines and K-Mart have been in the news because they filed for a Chapter 11 bankruptcy protection. However, there are many other smaller and less well-known corporations that have filed for Chapter 11 bankruptcy. In this bankruptcy option, a company or institution has a lot of financial problems, and they turn to the bankruptcy courts for help. The court allows them to create a reorganization plan in order to restructure their finances. This plan usually includes details on how the business will:
- Reduce expenses and business costs;
- Negotiate their debts and modify their payment terms;
- Reduce their business obligations;
- Seek new sources of income;
- Maintain their profitability after filing for bankruptcy.
The reorganization plan usually helps the corporation to regain control of their finances so that they can continue to operate profitably. In this bankruptcy option, the corporation can go as far as selling some or all of their assets in order to downsize the business and pay their debts.
Chapter 11 Eligibility
In order to be eligible for this option, the debtor must meet the following Chapter 11 bankruptcy rules:
- They can be individuals, corporations, partnerships, or any other business entity.
- They are expected to file a schedule of their liabilities and assets, their current expenses, their current income, a statement of their financial affairs, and a schedule of their leases and contracts.
- They must appear in court and comply with court orders.
- They must have received credit counseling from an approved counseling agency within the 180 days preceding their petition.
- Debtors will not be eligible for the Chapter 11 bankruptcy option if they have a dismissed bankruptcy claim that they had filed during the 180 days preceding the current claim.
The Chapter 11 Bankruptcy Process: How To File a Petition
The bankruptcy petition can be filed by the creditors or the debtor. If the creditors decide to file for a Chapter 11 on behalf of a company, the process will be referred to as an involuntary petition. After the US bankruptcy court receives the bankruptcy petition, the case begins. An automatic stay will be issued on all of the company’s or individual’s assets. This means that creditors will stop all debt collection actions against the creditor. The debtor will not pursue any of the unpaid debt or any debt collection avenues unless the courts modify this stay. During this time, the business or individual can continue with their normal operations as they draft a reorganization plan that will help them to get back on their financial feet. The automatic stay helps them to come up with a feasible plan for repaying their debt without debt collectors knocking at their door.
The bankruptcy court will supervise the operations of the debtor as they figure out how to repay their loans and debts. Just like with other bankruptcy options, the repayment amount is usually lower than the actual debt. Throughout the bankruptcy period, the debtor is allowed to review claims made by their creditors and make sensible objections. The debtor is also expected to file monthly operating reports in order to update the bankruptcy court on their progress.
The Automatic Stay
This stay is invoked immediately after a bankruptcy petition is filed. Therefore, all of the creditor’s debt collection attempts after the petition is filed will be rendered null and void. However, after an automatic stay has been invoked, creditors can try to convince the United States Trustee to convert the petition to a Chapter 7 bankruptcy case. This motion will be granted if the courts determine that liquidating the company is in the creditors’ best interests. Sometimes, liquidation may be done under the Chapter 11 bankruptcy code.
However, not all debts are automatically stayed when bankruptcy is filed. Family law proceedings against parents or spouses may not be stayed automatically.
The Reorganization Plan
The ultimate goal of filing for bankruptcy Chapter 11 is to reorganize debts. This is supposed to help the company or individual to regain profitability. The reorganization plan can be filed up to 120 days after they file for bankruptcy. However, the debtor is allowed to seek permission from the courts to delay the filing of the reorganization plan by up to 18 months.
In the plan, the debtor can propose to renegotiate their contracts and leases. They can seek to partially pay some of their debts, or to ask that some debts be discharged. The plan usually groups the creditors into different classes. These classes will determine the priority in which the debts are handled.
The first priority class goes to federal and state tax agencies. Stakeholders and employees who are owed wages are also given high priority. The secured creditors are then placed in their own group. The last group comprises of unsecured creditors. The plan could modify the payments terms and amounts that are owed to these creditors. Creditors usually cooperate fully in such plans because they know that they will not receive more favorable terms with other bankruptcy options such as the Chapter 7 bankruptcy.
After the reorganization plan is filed, it is usually voted on by the creditors before being approved by the court. In case the debtor does not file a reorganization plan within the stipulated time, the creditors can file the plan on the debtor’s behalf.
If the creditors accept the plan, the judge can confirm and approve it. If one of the creditors’ classes votes against the plan, it can still be approved if it meets the cram down requirements. This means that the courts will approve the plan as long as it does not discriminate against any class of creditors, and it is equitable and fair to the various classes.
For a judge to confirm a reorganization plan, it must meet the following requirements:
- The plan must be reasonable.
- The plan must be feasible. Therefore, the assets of the debtor will only be liquidated if liquidation is proposed in the plan.
- It must be drafted in good faith.
- It must comply with all of the provisions of the Chapter 11 bankruptcy code.
Acceptance usually occurs approximately 180 days after the reorganization petition has been filed. However, the courts may seek a delay of up to 20 months before they confirm the reorganization plan.
If the reorganization plan is confirmed and approved, its terms become legally binding to all the parties involved. Therefore, the treatment of all business debts as well as the running of the business will be determined by the terms of this plan for its entire duration.
In case the plan is rejected, the court may convert the bankruptcy claim to a Chapter 7 liquidation case. Sometimes, they may order that the status of the debts and liabilities are reverted to the pre-bankruptcy state. If this happens, the creditors will turn to the non-bankruptcy law to collect what is owed to them.
After the reorganization plan is confirmed, all the debts that existed before the confirmation date and which are not directly outlined in this reorganization plan are discharged. After this, the debtor will be required to repay their debtors based on the terms of the reorganization plan.
Chapter 11 For Small Businesses
Small businesses are defined as companies that have less than 500 employees. This group of businesses make the vast majorities of Chapter 11 petitioners. A lot of these petitions are usually dismissed if the court determines that there is no plan that could possibly return the business to a profitable state. In such instances, the business may be liquidated.
According to the Chapter 11 bankruptcy code, a small business debtor has debts of $2.19 million or less by the time they file the petition. When filing for a Chapter 11 bankruptcy, small businesses must meet the following requirements:
- The small business must provide a copy of their most recent balance sheet.
- They must provide a cash flow statement and a statement of their operations.
- They must provide a copy of the business’ most recent federal income tax returns.
The bankruptcy courts are usually stricter with smaller businesses than with larger corporations. They will require the small business to provide profitability reports as well as projected cash disbursements and receipts. In most cases, the courts will appoint a US trustee to this bankruptcy case.
The advantage of chapter 11 for small businesses is that it gives them more time to come up with a feasible repayment plan. However, it can be very expensive as it costs tens of thousands of dollars in legal fees. This may be an unreasonable amount for a small business that is already struggling financially. However, if the small business’ bankruptcy petition is confirmed, they may become successful and profitable in the long run. All small business owners are advised to consult a qualified bankruptcy attorney before they decide to file for this type of bankruptcy.
Chapter 11 Bankruptcy For Individuals
The Chapter 11 bankruptcy was initially intended for businesses. However, this changed in 1991 during the US Supreme Court Toibb vs Radloff ruling. This ruling held that non-business individuals and consumers can also be eligible for a Chapter 11 bankruptcy petition.
However, very few individuals ever file this type of bankruptcy. In fact, only 0.1% of consumers ever file for a Chapter 11 bankruptcy. Most of them prefer the Chapter 7 or the Chapter 13 options.
Individuals who choose this option usually have substantially large incomes. They are usually successful musicians, actors or sports celebrities who are in a bad financial rut because they made poor financial decisions. They may still earn a substantial amount through endorsements, but their debts exceed the limits that have been set by the Chapter 13 and Chapter 7 bankruptcy codes. For such an individual, the Chapter 11 bankruptcy could be more favorable. It will help them to recover from their poor financial choices and bad investments. It will also give them the chance to cram down some of their debt.
Chapter 11 Impact On Stock
A publicly traded company that files for a Chapter 11 will be de-listed from the stocks exchange if it is listed in the NASDAQ, New York Stock Exchange, or American Stock Exchange. If it is listed in the NASDAQ, the letter ‘Q’ will be placed at the end of its stock symbol to show that the company is in bankruptcy.
Advantages of the chapter 11 bankruptcy option:
- The business can continue to operate as they come up with a reorganization plan.
- The stakeholders and employees of the company are protected from liquidation.
- The company is forced to reevaluate its finances in order to regain profitability.
- The debtor may be allowed to cancel or reject contracts when reorganizing their financial obligations.
- The debtor will be protected from litigation against their company under the automatic stay.
- A Chapter 11 filing gives the company or individual more time to reorganize their finances and come up with a solid financial plan.
Disadvantages of chapter 11 bankruptcy plans:
- It is a complex, costly and time consuming process for the debtor.
- Critics believe that it gives the unskilled manages of a failing company an unwarranted escape from liquidation.
- Other critics believe that it gives such business an unfair competing advantage in the marketplace.
- When debtors are allowed to file for this type of bankruptcy, the value of collateral is weakened.
- This type of bankruptcy usually distorts the economics of the particular industry.
- Chapter 11 bankruptcy can increase the risks associated with secured loans.
The Chapter 11 bankruptcy option is costly and time consuming. However, it has plenty of advantages. A company that chooses this option will be given time to come up with a plan that will help them to get their financial footing. This way, they will be able to repay their debts and regain profitability at the end of it all.