Chapter 11 Bankruptcy
Chapter 11 bankruptcy is typically used by companies facing significant financial difficulties. It provides a restructure to the bankrupt business's debts and creates a manageable reorganization plan and repayment plan.
Basics and Eligibility for Chapter 11
Large corporations most frequently use Chapter 11 bankruptcy. However, small businesses (and in rare cases, even individuals) are eligible.
Chapter 11 Compared to Other Chapters
Businesses that know they need to declare bankruptcy and close up shop should consider a Chapter 7 business bankruptcy rather than continue to operate.
Another type of lesser-known bankruptcy case is Chapter 12. This is typically used by individuals who are family farmers or fishermen.
If you do not run a business, you might be looking for Chapter 7 bankruptcy and Chapter 13 bankruptcy. These are the most common types of bankruptcy filings for individuals and some companies in specific circumstances.
What Is a Chapter 11 Bankruptcy?
Chapter 11 bankruptcy uses reorganization to help businesses with heavy debt burdens. Companies that file for Chapter 11 under the U.S. Bankruptcy Code work with creditors to reorganize their debts and restructure their businesses.
The company files a proposed plan post-bankruptcy, which may include:
- Reducing costs
- Seeking new sources of income
- Temporarily postponing payment to creditors
- Ideas for profitability
Benefits of Chapter 11 Bankruptcy
Chapter 11 bankruptcy restructuring has some key benefits. It:
- Avoids total liquidation of the business (your business can stay in operation)
- Provides more time to develop and file a plan
- Allows reorganizing of things that are not working
- Allows you to retain control of your business
On the other hand, Chapter 11 is also more time-consuming and costly than other forms of bankruptcy.
Eligibility for Chapter 11: Owners vs. Creditors
Either the business owner in debt or its creditors can file for Chapter 11 bankruptcy. If the creditors decide to file, it is called an "involuntary petition."
No matter which party files the petition, the business is the one that goes through the bankruptcy process.
Filing a Chapter 11 Petition
You can start the petition process with an attorney or by yourself. The debtor then begins to develop their reorganization plan.
The bankruptcy court will accept a reorganization plan if it is:
- Developed and structured "in good faith." This means it was created honestly and with good intentions. Courts will review all the paperwork in the case to determine if you had good or bad faith.
- In compliance with all applicable laws, local laws, court orders, Bankruptcy Code, reformed laws, Bankruptcy Rules, and all current temporary laws
Once approved, the court will confirm the plan. Any debts that existed before the confirmation date but were not directly addressed in the plan may be discharged. The company is obligated to pay the remaining creditors following the reorganization plan.
Some debt is dismissed or negotiated to be less money. This allows repayment plan amounts to be much lower than the original debt.
The debtor will need to:
- Examine each creditors' claims throughout the process
- Make objections where it makes sense
- Provide monthly operating reports to keep the court updated on progress
The business gets to continue their day-to-day work after the petition is filed. While they carry on without interruption, the debtor will create a repayment plan under the bankruptcy court's supervision.
Chapter 11 Filing Fees and Administrative Fees
As of 2020, you will pay $571 to file a Chapter 11 bankruptcy. This is considered an administration fee.
If you ask to divide a joint case (such as two business owners filing separately), you will pay another $571 in administration fees. Then, you will pay $1,167 to file the new motion with divided cases. It is $1,167 to reopen a dismissed case.
Required Information to Submit When Filing Chapter 11
Small businesses must file the following forms with the court:
- The most recent balance sheet
- Statement of operations
- Cash-flow statement
- Most recent federal income tax return
The bankruptcy court has greater oversight of small business Chapter 11 filings than for larger entities. Courts require businesses to report on their profitability and projected cash receipts and disbursements. Also, they appoint U.S. bankruptcy trustees to these cases.
Chapter 11 Reorganization Plan 101
Chapter 11 bankruptcy protection makes it possible to become profitable again, versus Chapter 7, which just dismisses debts.
To achieve this goal, the company's first moves are to:
- Renegotiate leases
- Renegotiate contracts
- Have debts discharged or partially repay them
Creditors have an incentive to work with the business owner, accept less debt repayment, and make compromises. This is possible because they likely won't get better terms or more money in a Chapter 7 bankruptcy action.
A reorganization plan will put creditors into different classes concerning how their claims are handled. The creditors with first priority for repayment include:
- State and federal tax agencies
- Employees owed wages
Each secured creditor is placed in its own class, while unsecured claims are put together in one class. The plan might change the money or terms creditors get during repayment of debts. A reorganization plan must be voted on by creditors and approved by the court.
The "Automatic Stay"
Filing a petition puts an automatic stay on all collection actions (unless the court indicates otherwise). Creditors and collections agencies can no longer call or harass you, and you will get time to create your reorganization plan.
However, taking on any new debt will be outside of this bankruptcy. The automatic stay does not stop or dismiss new debt.
Chapter 11 for Small Businesses
Chapter 11 bankruptcy reorganization is commonly associated with larger corporations, but it is available to qualifying small businesses.
A "small business" is one with fewer than 500 employees, as defined by the Small Business Administration. Small businesses make up most of the Chapter 11 filings. But they don't always remain in Chapter 11.
Small business Chapter 11 bankruptcies often get dismissed and converted to Chapter 7. This typically happens because the court decides the business has little or no chance of becoming profitable. Partnerships, which have very few bankruptcy options, may file for Chapter 11 if the business entity has a chance of surviving and profiting on its own.
According to the U.S. Bankruptcy Code, a "small business debtor" is an individual engaged in business activities with total debts of $2,725,625 or less at the time of the petition.
Subchapter V for Fast-Paced Small Business Bankruptcy
In February 2020, the Small Business Reorganization Act of 2019 (SBRA) created subchapter V for small business owners. This may help business owners facing the aftermath of the pandemic.
This process moves faster and is cheaper than a normal Chapter 11 and uses a private bankruptcy trustee to help you create and approve a consensual reorganization plan.
You can file for this new option if you:
- Meet the normal Chapter 11 requirements
- Approve of the courts having conferences on your case's status in the first 60 days of the case (you must provide this status report for their review 14 days before their meeting)
- File the reorganization plan within 90 days of filing for bankruptcy
- Can move quickly on timing and paperwork
- Choose to file for it (otherwise, you will go through the normal Chapter 11 process)
This subchapter might make sense for you if you want:
- A private trustee's help to create the bankruptcy plan
- To avoid paying quarterly fees to the trustee
- More control in negotiating your reorganization
There are other requirements and details to this subchapter, so it is important to learn about it in more detail or ask your bankruptcy attorney.
Single Asset Real Estate (SARE) Debtors
Small business owners of real estate can also file for Chapter 11. Typically this includes office buildings, warehouses, and shopping centers.
This is called "single asset real estate cases" under Chapter 11. It involves debtors with:
- Non-residential property
- Less than four residential units that generate nearly all of the debtor's income
Those whose primary business is owning and operating real property are not eligible.
Downsides to Chapter 11 Bankruptcy for Small Businesses
If you own a small business, you will want to seriously consider whether Chapter 11 is right for you.
Chapter 11 gives small businesses extra time to create a plan, file it, and renegotiate repayment terms with their creditors (180 days versus 15 days for Chapter 7). But it also has its drawbacks.
It can cost tens of thousands of dollars in legal fees, which may be unsustainable for a struggling small business.
If the emergence from bankruptcy protection proves successful, these costs are offset by the ultimate reward of becoming profitable. In any case, it's best to discuss your options with a seasoned business bankruptcy attorney before deciding.
Rare Cases: Chapter 11 for Individuals
Chapter 11 bankruptcy reorganization was initially intended for businesses. The 1991 U.S. Supreme Court case Toibb v. Radloff decided that non-business, individual consumers are also eligible.
This is exceedingly rare. This unusual route usually is pursued by individuals who:
- Still have substantial personal earning potential
- Have debts exceeding the limits set forth by Chapter 7 and Chapter 13
A typical non-business Chapter 11 bankruptcy filer might be a celebrity who got in over their head with bad investments. They would possibly still have earning potential through product endorsements, for example.
Chapter 11 is generally considered more debtor-friendly than other types of bankruptcy, including the ability to "cram down" certain forms of debt. This means the court pushes through a plan over the objections of some creditors.
Talk to an Attorney to Learn About Chapter 11
Being in debt can be overwhelming, but bankruptcy may be an option to help with your debt woes. Your business might need the protection afforded by a Chapter 11 bankruptcy filing. You'll likely need outside expertise to see the process through smoothly. Don't go it alone.
If you're considering filing for bankruptcy, it's a good idea to consult with an experienced bankruptcy attorney who can explain the options based on your particular situation.