A Review of Chapter 11 Bankruptcy

Chapter 11 bankruptcy allows struggling businesses to restructure and maximize their return to creditors and owners.

In the past, only large corporations were able to afford Chapter 11 bankruptcy. Chapter 11 has improved and is now available to large corporations. And small businesses can be used to keep your doors open. Individuals who aren’t eligible for Chapters 7 or 13 may also file.

How does Chapter 11 Bankruptcy work?

When they are financially strapped, many businesses turn to Chapter 11 bankruptcy. This is often due to temporary downturns. A Chapter 11 bankruptcy can be a way for a business to keep its doors open while restructuring and plans for the future. 

Chapter 11 provides debt relief that helps businesses get back on track, whether struggling to pay rent or payroll or avoid vendors. Here’s how it works.

Collection Actions: Stop

The collection process is stopped by all bankruptcy chapters. Once filed, the “automatic stay” prohibits most creditors from pursuing you, giving you, your creditors, and the court the breathing room needed to address finances in an organized fashion. The stay can be temporarily halted as follows:

  • Payment requests
  • Eviction or foreclosure
  • a collections trial
  • Bank levies, until taps, property seizures, and
  • Other collection processes

Filer retains control of the business

Unlike other bankruptcy chapters, a bankruptcy trustee isn’t in charge of the business and other bankruptcy property. During Chapter 11, the filer will continue to manage the business’s day-to-day functions, even though they are longer a “debtor at large.”

A Payment Plan to Relieve Debt

Chapter 11 is designed to help the company remain open and flourish by creating a financial plan that creditors, the filing party, and the court can agree on. It can modify interest rates, due payment dates, or other terms. 

It can even eliminate (or reduce) all debt. Most plans allow for at least some reduction in the debtor’s activities to reduce expenses and free up assets. 

In some cases, “liquidating plans” shut down the debtor’s operations and provide for the orderly sale of its remaining property (although a debtor can accomplish this in a Chapter 7 business bankruptcy.)

The plan becomes a new contract if all creditors agree to it. If the creditors do not approve, the debt is immediately discharged. The court may approve the plan, except in Chapter 11, Subchapter V. 

In this case, creditor consent is not required. Before the debt discharge can be granted, the filer must pay all the necessary payments.

Is Chapter 11 the best bankruptcy option?

When possible, most debtors elect to file for bankruptcy under Chapter 7 or 13 to avoid the time, cost, and risk involved in Chapter 11 proceedings. So your first step should be to learn about personal bankruptcy and options for small businesses.

  • Chapter 7 for individuals. People who file for bankruptcy chapter 7 keep the items they require to support a household or employment. All other property is sold to creditors. Qualifying debt is discharged in exchange for no repayment obligation.
  • Chapter 7 for small-business owners. It is not common for a small business to file a Chapter 7 application. Chapter 7 will close most businesses. However, business entities other than sole proprietors are not eligible for a discharge of debt. 

A business owner can also discharge additional debt, personal and business-related, by filing a Chapter 7 case on his own after closing down a business. In certain cases, Chapter 7 may be a good option. Sole proprietors of service-oriented businesses are often able to file Chapter 7 bankruptcy. They can eliminate personal and business debts without jeopardizing their service-focused business. Check out there are differences between Chapter 7 bankruptcy and Chapter 11 bankruptcy.

  • Chapter 13: Individuals and small-business owners. A Chapter 13 case cannot be filed by companies. However, stakeholders can file Chapter 13 cases individually. If reorganizing their finances gives enough financial relief to keep them afloat, the company can file Chapter 13. Reducing personal debt and credit card payments can often help the filer draw less from the company. 
  • Chapter 11: Individuals and small-business owners. Sometimes, Chapter 11 bankruptcy is the only option for a small company. This is the case. Chapter 11, Subchapter VI Includes special provisions to speed up and streamline processes; small business owners can file Chapter 11 bankruptcy.

Learn more about the impact of bankruptcy on small businesses, how to qualify for Chapter 7 bankruptcy and whether you are eligible for Chapter 13 bankruptcy.

Filing for Chapter 11 Bankruptcy

Below is a summary of Chapter 11 bankruptcy. Chapter 11 bankruptcy, Subchapter V involves simpler procedures, and we’ve highlighted some of the significant differences.

Chapter 11 Bankruptcy

The filing of a petition to bankruptcy court is the first step in a Chapter 11 case. The debtor is the one who initiates the bankruptcy process. Chapter 11 cases are generally voluntary. Occasionally, however, creditors will band together to file an involuntary bankruptcy petition against a defaulting debtor.

While most debtors file in their business location, business debtors may file bankruptcy wherever they are “domiciled,” which is when they are incorporated or organized. Businesses that are incorporated in Delaware may choose Delaware over their home states.

A Chapter 11 case can last for as long as you like. While some Chapter 11 cases are completed in a matter of months, it is more common for Chapter 11 cases to take between six and two years to complete.

Bankruptcy Court Decisions

The bankruptcy court must approve that the debtor continues to run the business normally as a debtor in possessing:

  • Any assets that the debtor would not sell in the normal course of business (e.g., real property)
  • Leases: Whether you sign or break it
  • Secured financing arrangements are available, such as a mortgage or another secured financing arrangement that allows the debtor to borrow money.
  • Expanding or closing down business operations
  • Modifying, entering into, or altering union, vendor, licensing, or other agreements.
  • The payment and retention of fees and expenses for attorneys and other professionals.

Creditors and The Creditor Committee

Bankruptcy court approval may be opposed by shareholders, creditors, and other interested parties. When deciding how to proceed, the bankruptcy court will consider input from creditors and other parties. However, formal votes by creditors or equity holders are only taken in connection to proposed Chapter 11 plans.

Chapter 11 cases are handled by an unsecured creditors committee. Unsecured creditors’ committees can hire attorneys and other professionals to help them at their expense. 

Sometimes equity security (i.e., shareholder) or other committees play an active role. (Chapter 11, Subchapter V cases don’t include creditor committees.)

The Disclosure Statement

To make sure that creditors can make informed decisions about the plan’s feasibility, the filer must disclose all background information. 

Two rounds of expensive litigation can be created because creditors may object to both the disclosure statement and the actual plan. (Chapter 11, Subchapter V filers don’t submit a disclosure statement). 

After approving the disclosure, the court will set dates for creditor voting and plan objections.

Chapter 11 Reorganization Plans

Ordinarily, the debtor is the only person who can propose a plan of reorganization for the first four-month. However, the court has the power to extend the “exclusivity period,” which can be extended for up to 18 months from the date of the petition. This is why Chapter 11 is so expensive. (Subchapter V filers in Chapter 11 are granted very few extensions).

After the exclusivity period ends, creditors’ committees or other parties may propose alternative reorganization plans. Often, however, creditors and other parties are dissatisfied by the progress of the debtor and will seek to dismiss the case or convert it to Chapter 7.

Creditors have the right to vote on whether or not they will accept a Chapter 11 plan. A Chapter plan must be approved by at least one class of “impaired claims.” 

An “impaired claim” is an obligation not paid in full after plan confirmation or when it was originally due.

Chapter 11 Plan Confirmation

In reality, creditors and the debtor can agree to any plan they wish. The court will take into consideration factors such as:

Possibilities

The bankruptcy court must determine that the plan is feasible and likely to succeed. The debtor must show that they can raise enough money to pay creditors and expenses.

Good faith 

The plan must be presented in good faith, and it cannot promote a schedule that is prohibited by law.

Best Interests of Creditors 

According to the “best interest” test, creditors should receive at least the same amount under a plan proposed as if the debtor’s case were converted into a Chapter 7 liquidation. 

In this scenario, the debtor would sell his property and distribute it to creditors. Sometimes, the “best interest” test may require the debtor to pay all its creditors in full. 

However, most Chapter 11 debtors are financially insolvent and can satisfy the “best interest” test by only paying creditors a small fraction of their owed amount.

Fair and Equitable

Also, the plan must be fair and equitable. The plan must meet the fair and equitable test.

  • Secured creditors have to be paid overtime at least the collateral’s value. Secured creditors are those who have a lien on real estate or personal property (such as inventory or equipment).
  • If all obligations are fully paid, the debtor’s equity owners can no longer retain any assets. In exchange for “new money,” the bankruptcy court may allow equity holders to keep ownership rights in the debtor. Equity holders will lose their ownership rights if the plan is not approved.

Consult with a Business Bankruptcy Lawyer

All businesses who file Chapter 11 must be represented by counsel. An attorney can help you understand your options and what to expect from your case.

 

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