Chapter 11 Bankruptcy: A Guide
A bankruptcy case is never simple. Whether your goal is complete liquidation or reorganization, it can be a stressful and costly process that lasts for months or even years. One of the first steps on this long and winding road is to choose which bankruptcy code is right for you.
If you run a business (corporation, partnership, limited liability) then Chapter 11 may be the solution.
What Happens in a Chapter 11 Bankruptcy?
Most bankruptcy cases involve a United States trustee, someone whose job it is to restructure, reorganize, and generally assume control. However, with a Chapter 11 the owner of the business often remains in control and becomes the Debtor in Possession.
They are the ones who file for bankruptcy (although their creditors can also initiate the process) and unless there is cause for appointing a trustee (including fraud and dishonesty on behalf of the business) they won’t be appointed.
The debtor will continue to oversee operations and run the business as normal, albeit with some court-appointed changes. Bankruptcy protection is only granted on the basis that the debtor agrees to consult with the court before:
- Selling any assets or possessions (does not include stock).
- Acquiring a new premises or lease.
- Breaking with a current lease.
- Shutting down the business.
- Expanding the business.
- Retaining lawyers and bankruptcy attorneys.
- Entering into financial arrangements (such as a mortgage) that secure money after the bankruptcy filing.
During Chapter 11 bankruptcy, a creditor’s committee may be created at the debtor’s expense. This committee represents the interests of unsecured creditors and their involvement can greatly increase the cost for the debtor. However, this doesn’t apply if they qualify as a “small business debtor”, as discussed below.
The Plan of Reorganization
You need to submit multiple documents during a bankruptcy filing and the plan of reorganization is one of the most important. You have 120 days to submit this plan, after which you lose the right of exclusivity and your creditors can file their own plans.
A plan of reorganization is simply a restructuring and reorganization plan that details ways the debtor will repay their creditors. It includes all classes of debt (secured, priority unsecured, general unsecured, equity holders) and must be accepted by creditors before it can be confirmed by the court.
The Disclosure Statement
During a bankruptcy filing, you must submit a disclosure statement to the bankruptcy court. This statement needs to include detailed information about your finances, including your assets, secured debt, payments, and other essential information.
The disclosure statement will then be seen by all creditors. They will decide whether to accept or reject your bankruptcy petition based on this statement, after which it must be accepted by the bankruptcy court before the filing can continue.
Can Your Creditors Collect?
Once the petition is filed then an automatic stay will be granted, which means that creditors cannot continue with their collection efforts. At this point, you are a debtor in possession, as discussed above, and will remain in control as the business is restructured.
There will be documents to submit and fees to pay during this process and it’s best to work with a bankruptcy attorney, ensuring that you have a professional, experienced individual to turn to when needed.
What are the Differences Between the Types of Bankruptcy Filings?
A Chapter 11 bankruptcy works in a similar way to a Chapter 13, only it’s aimed at businesses and not individuals. The goal is to help the debtor create a repayment plan that their creditors agree to, one that allows for some restructuring and provides them with a little leeway, but nevertheless insists that the plan is:
- Feasible: Is it likely to succeed? Can the debtor prove to the court that they can raise the funds needed?
- Based on Good Faith: Was it produced in good faith or have any underhanded tactics been used?
- In the Best Interests of Creditors: The creditors are ultimately the beneficiaries of this plan, so is it actually in their best interests? The court will determine the best interests based on the extent of the debtor’s finances, determining whether it means they are required to pay their debts in full or to cover a small fraction of the balances.
A Chapter 11 bankruptcy case does not lead to complete liquidation, as is the case with Chapter 7. There will be filing fees, bankruptcy laws to abide by and a bankruptcy proceeding to attend, but generally it’s a good option for struggling businesses that have exhausted all other possibilities.
Chapter 11 Bankruptcy for Small Businesses
Small businesses have to follow many of the same rules and processes when making a Chapter 11 filing. However, there are some exceptions for anyone classed as a “small business debtor”. This term applies to any business owner that owes no more than $2,725,625 (subject to change).
In such cases, there are a few key differences:
- No Committee: A creditors’ committee can cost you dearly, with the actual cost depending entirely on the work that they do. With a small business, however, there’s no need for a creditors’ committee, so you can avoid this costly expense.
- No Disclosure Statement: The court may waive the disclosure statement for a small business debtor curing a Chapter 11 bankruptcy filing.
- Extra Requirements: There are additional filing requirements for small businesses. For instance, they need to attach a balance sheet and cash flow statement, along with a federal tax return. They are also subject to additional oversight by a trustee.
- Deadline: A small business debtor has just 300 days to file, a deadline that is not imposed on other businesses.
How to Succeed in Chapter 11 Bankruptcy
Chapter 11 isn’t always successful. Studies suggest that it works for between 10 and 15 out of every 100 bankruptcy filings. The vast majority of cases are dismissed, while others are converted to Chapter 7, a bankruptcy code that essentially liquidates assets and then uses them to repay creditors.
The bankruptcy court will determine the course of action on a case-by-case basis. You can improve your chances by hiring an attorney, but it’s not a guarantee. They will talk you through the process, remind you of the risks and obligations, and help to safeguard your assets.
They also understand bankruptcy laws much better than you do and know how to work the court, so it’s definitely worth requesting their help. If you receive bankruptcy protection then it can help you reorganize your business and take a second bite of the cherry, potentially providing you with the new lease of life that you need.