Chapter 11 Bankruptcy Explained
REORGANIZATION for corporations
Chapter 11 is a type of “reorganization” that is most often used by corporations. Filing for a Chapter 11 bankruptcy is far more costly and complex than a Chapter 7 or Chapter 13 because a debtor has to propose a plan of reorganization that provides a method to deal with its creditors. The plan may provide for the continued operation of a business or the sale of assets. Creditors are entitled to vote on the proposed plan and ultimately the court will have to approve the plan.
Once the plan is approved the debtor may be able to exit bankruptcy. A corporation can receive a discharge in Chapter 11. Small businesses may be able to take advantage of a more streamlined approach to Chapter 11 by opting for Subchapter V.
A Chapter 11 is usually filed voluntarily but it can be initiated by creditors seeking payment for goods or services that they provided. Debtors can benefit from the automatic stay which arises as soon as the case is filed. In many instances a company or individual is facing a trial date, a foreclosure, levy, or examination. The court imposes certain requirements immediately upon the bankruptcy filing, such as obtaining consent to use the cash collateral of secured lenders. The debtor will have deadlines to file monthly operating reports, to decide whether to assume or reject leases, and to file a plan and disclosure statement.
Proper legal representation is strongly recommended for Chapter 11 because of the complexity of the law. We have the necessary experience to deal with these cases as there usually are a variety of crossover issues involving corporate law, tax law, business law, and real estate law. Proper planning is necessary as it takes a lot of time and effort to keep the business alive and operational during the reorganization. Failure to succeed in a Chapter 11 will likely lead to conversion to a Chapter 7.
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In chapter 11 bankruptcy a debtor proposes a bankruptcy reorganization plan that deals with outstanding debt. The plan may pay some creditors in full or in part depending on the type of claim. The plan typically involves monthly payments over a certain timeframe but could also provide for the sale of property or the sale of a business. It is similar to a Chapter 13 bankruptcy plan but is a lot more complex. In Chapter 11, debtors prepare a disclosure statement which is like a stock prospectus. The disclosure statement is supposed to provide creditors with enough information about the reorganization proposal so that they can vote whether to accept or reject the plan. The bankruptcy court then must grant final approval.
Both businesses and individuals can qualify for bankruptcy under Chapter 11. Unlike Chapter 13, there is no limit to the amount of debt that can be discharged or repaid under a Chapter 11 bankruptcy. In addition, the plan term can be longer than the five-year maximum of Chapter 13.
A major advantage of a Chapter 11 filing is that the debtor gets the immediate benefit of the automatic stay upon filing of the case just like in other Chapters but also is allowed to remain in possession of its property and operate its business subject to court supervision. This is known as being a debtor in possession, or DIP. The debtor then acts as a trustee with respect to the property during the bankruptcy and submits monthly financial reports on the progress being made. Another key benefit is that until the plan of reorganization is approved the debtor does not have to pay on the pre-petition debts. This gives the debtor substantial breathing room and the opportunity to reorganize its business and restructure debts while continuing to operate the business. In many cases it may be a year or more before the plan is approved by the court.
For individual debtors, a disadvantage of a Chapter 11 bankruptcy is that there is no discharge unless the debtor makes all of the plan payments. Unsecured creditors can also object to the proposed plan and force payment in full or the receipt of all disposable income for the duration of the plan. There is also the cost. Chapter 11 bankruptcies can be costly and time consuming because of the complexities involved. Chapter 11 cases can also end up being converted into Chapter 7 if the debtor cannot propose a confirmable plan. Court approval is required to dismiss a Chapter 11 case whereas a Chapter 13 case can be voluntarily dismissed at any time.
Congress created Subchapter V to address the high costs and lengthy timeframes of Chapter 11 for small businesses. It is a form of Chapter 11 where the normal processes are streamlined. For instance, a plan must be quickly proposed after the case is filed, a trustee is assigned to assist in getting a consensual plan approved, and a discharge can be entered earlier than a normal Chapter 11. In addition, the plan and disclosure statements are combined into one document of which most courts have a suggested form to use. The result is a process which reduces overall costs and gets the company in and out of bankruptcy faster than a traditional Chapter 11.
One of the most important plan requirements is that creditors be classified because they vote to object or approve the plan based on class. For example, a Debtor may have three classes as follows: one for the first deed of trust holder on the residence, another for outstanding tax debt, and another for outstanding credit card debt. For individual chapter 11 debtors, the plan must specify that all or a portion of the debtor’s post-petition income from services or other future income will be used to fund plan payments. For all chapter 11 debtors, a disclosure statement describing the proposed plan must be prepared and approved by the Court as containing adequate information before it can be distributed to creditors and interest holders, and votes ultimately solicited for the approval of the plan.
Creditors whose claims or interests are not paid in full under the plan, also known as impaired parties, have the right to vote to accept or reject the plan. A plan is confirmed when the court holds a hearing after notice and after the vote. A plan that has been approved by creditors after a vote is not binding on the debtor until it has been formally approved by the court.
Chapter 11 cases are often converted to Chapter 7 when the debtor-in -possession fails to propose a plan that is approved by the court. Debtors generally always have the right to convert their case from a Chapter 11 to a Chapter 7 filing; however, Creditors may only request the conversion by filing a motion with the court.
Yes. The automatic stay goes into effect as soon as a petition for bankruptcy is filed. This stay goes into effect by operation of law and not by judicial action. The stay does not prevent creditor action against co-obligors, non-debtor spouses, and other classifications of interested parties not protected by the bankruptcy filing. The stay will operate as an immediate time out as to foreclosure sales, bank levies, and lawsuits.
The three most common classes of claims are: 1) administrative, tax, and other priority claims; 2) secured claims; and 3) general unsecured claims. Priority claims include recent tax obligations, domestic support obligations (child and spousal support), as well as debts owed to employees for wages and commissions owed with a certain period pre-petition.