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Chapter 11 Bankruptcy

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Chapter 11 Bankruptcy is commonly used to reorganize financially stressed corporations, partnerships and other businesses, and is the only bankruptcy option for these entities if they wish to remain in business. Select individuals may also be good candidates for Chapter 11(see sidebar). Under the protection and supervision of the court, Chapter 11 debtors get to retain control of their assets and day-to-day operations while renegotiating new payment terms with their creditors.

Chapter 11 is the most flexible type of bankruptcy, but it is also much more complicated and expensive (the filing fee alone is $1,000) than other bankruptcy proceedings. A bankruptcy attorney can help determine if Chapter 11 is right for you.

To learn more about other bankruptcy topics such as Chapter 7 Bankruptcy, Chapter 13 Bankruptcy and the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA), make sure to visit our pages dedicated to these subjects.


Chapter 11: How it Works

Special Chapter 11 Debtors

Chapter 11 is primarily used by large corporations, partnerships and businesses. In many cases small businesses and individual debtors find other chapters are more beneficial to their situation. However, Chapter 11 may be a better (if not the only) bankruptcy option for some debtors, such as:

  • Individual debtors whose debt exceeds the limits of Chapter 13 and who do not qualify and/or wish to file Chapter 7. Though it is more expensive, individual Chapter 11 debtors get to remain in control of their finances and have more time and flexibility with respect to their repayment plan.
  • Small businesses, which may be able to save time and money due to special treatment afforded to this class of debtors. In order to qualify, the debtor must be engaged in "commercial or business activity" (but not primarily real estate) and have debts under $2,190,000. Additionally, to qualify, businesses must be lacking enough creditors willing to serve on a creditors' committee; or, the committee must be considered to be not active enough to provide oversight to the debtor.
  • Single asset real estate (SARE) debtors, who also enjoy special treatment such as special protection under the automatic stay (which is not available to other debtors). SARE debtors are debtors with "a single property or project, other than residential real property with fewer than four residential units, which generates substantially all of the gross income of a debtor who is not a family farmer and on which no substantial business is being conducted by a debtor other than the business of operating the real property and activities incidental."

To learn more about the rules for special Chapter 11 debtors, speak to a bankruptcy attorney.

A Chapter 11 case can be started by the debtor or even involuntarily by a creditor. As soon as a Chapter 11 petition is filed by any party, the "automatic stay" goes into effect. The automatic stay freezes any and all collection efforts (e.g., foreclosures, lawsuits) against the debtor and the debtor's property during the bankruptcy process.

The following are some key topics pertaining to Chapter 11:

Debtor in Possession (DIP). A Chapter 11 debtor is called a DIP, which essentially means the debtor acts as the trustee of the bankruptcy estate. The DIP retains possession and control of the assets and manages the day-to-day operations under the supervision of the court. As a fiduciary to the creditors, the debtor has a long list of powers and responsibilities. For example, the DIP can avoid (reverse) pre-petition transfers of money or property (within 90 days prior to filing the bankruptcy or up to a year for interested parties) to ensure creditors are on an equal footing. If at any time there is evidence of fraud or mismanagement by the DIP the court may appoint a case trustee instead. To learn more about the responsibilities of a DIP, speak with a bankruptcy attorney.

Types of Claims. Priority claims, which may include certain taxes, bankruptcy expenses, wage obligations, post-petition expenses relating to the debtor's ongoing business, and domestic support, must be paid in full unless the creditor agrees otherwise. Secured claims, such as car loans, give creditors the right to take the collateral if the debtor defaults. Unsecured claimholders (e.g., stockholders) have no right to property but have the right to be paid at least as much as they would under Chapter 7 (liquidation or "straight bankruptcy").

Creditors Committee. In a typical Chapter 11 case, the Creditors Committee is formed from a group of unsecured creditors with the largest claims. These creditors have the most to lose if the reorganization is not successful. The Creditors Committee will, among other things, investigate the DIP's conduct and operation of the business and consult with the DIP on the reorganization plan. In certain cases, additional committees may be formed to represent equity interests as well as secured creditors.

Plan of Reorganization

Chapter 11 Conversion or Dismissal

A Chapter 11 case can be dismissed or converted to a Chapter 7 case "for cause." Any interested party can make a motion to the court. According to Chapter 11 of the United States Bankruptcy Code, some of the reasons that represent cause for dismissal include:

  • Substantial or continuing loss to the estate and the absence of a reasonable likelihood of rehabilitation
  • Gross mismanagement of the estate
  • Unauthorized use of cash collateral that is substantially harmful to a creditor
  • Failure of the (individual) debtor to pay post-petition domestic support obligations
  • Unexcused failure to timely comply with reporting and filing requirements
  • Failure to attend the meeting of creditors or other required appearances without good cause
  • Failure to timely provide information to the U.S. trustee
  • Failure to timely pay post-petition taxes or timely file post-petition returns
  • Failure to file a disclosure statement or to file and confirm a plan within the time fixed by the Bankruptcy Code or order of the court
  • Inability to consummate a confirmed plan

The court will decide whether to convert or dismiss the case, or alternatively may appoint a Chapter 11 trustee or examiner, whichever is in the best interests of creditors and the estate.

The plan of reorganization is usually developed by the DIP with the assistance and approval of the creditors, but the plan must be confirmed by the court in order to be put into effect. The key steps in the plan of reorganization are as follows:

Develop the reorganization plan. Usually the Chapter 11 plan of reorganization comes from the debtor, who has an exclusive right to submit a plan for the first four months after the bankruptcy petition is filed. The plan should include classification of the various types of claims and interests (e.g., priority vs. unsecured, bondholder vs. shareholder), how each class will be treated under the plan and the means for carrying out the plan. While there are no time limits for corporate reorganizations, individual plans cannot exceed five years.

Seek creditor approval. Creditors whose rights do not change under the reorganization plan do not need to approve the plan. However, impaired classes — meaning classes of creditors who will receive less than the full value of their claims or whose legal rights are affected by the plan — are entitled to vote.

Seek confirmation of the court. Even if creditors reject the plan, the court can "cram down" (i.e., overrule and confirm) the plan of reorganization if it finds that the plan treats creditors fairly.

If the debtor does not submit a plan, or if the plan is not approved, the creditors can submit their own plan, which may be less favorable to the debtor. To help save time and money, you may wish to ask an attorney for help with a "prepackaged bankruptcy" — a plan that is accepted by creditors even before filing the petition.

Is Chapter 11 Right for You?

From the protection of the automatic stay to the ability to maintain financial control and the authority to modify or get rid of difficult contracts, Chapter 11 is a unique opportunity for struggling debtors to save personal assets or a business. Contact an attorney to learn more about Chapter 11 bankruptcy.

Did You Know?

The largest Chapter 11 case, involving more than 65,000 claims totaling approximately $875 billion, was filed by Lehman Brothers after their 2008 collapse.

Source: Wall Street Journal