Chapter 11 Bankruptcy

Bankruptcy laws in the United States allow individuals and corporations to get out of debt, either by selling off a debtor's assets and repaying creditors (i.e., liquidation) or by undergoing a court-supervised reorganization of the debtor's finances. Filing for bankruptcy allows many unsecured debts to be discharged, or cancelled.

The Bankruptcy Code sets forth several paths for individuals and businesses to emerge from debt. Each route is contained within a chapter of the law. Chapter 11 allows debtors to reorganize their financial affairs. The reorganization process may last months or even years depending on its size and complexity, but in the end results in a clean slate for debtors.

Who may file for Chapter 11 bankruptcy?

While individuals may file for Chapter 11 bankruptcy, most elect to file under Chapter 7 or Chapter 13 instead because of the cost and complexity of Chapter 11. An individual may not file for Chapter 11 bankruptcy if he or she already did so in the previous 180 days and either the bankruptcy petition was dismissed or that individual failed to appear or comply with the court's orders. An individual also must complete credit counseling with an approved agency in the 180 days prior to filing for Chapter 11 bankruptcy, unless the court grants a waiver.

If a business with a lot of debt cannot service its debt or pay its creditors, it can file for federal bankruptcy protection under Chapter 11. Sole proprietorships, partnerships, or corporations may file under Chapter 11. Creditors can also force a business to file for bankruptcy under either Chapter 7 or Chapter 11. Chapter 11 is most commonly used by large corporations that can no longer pay their creditors, because Chapter 11 bankruptcy allows a business to continue operating while a court supervises a reorganization of the company's debts and finances. Many airlines, for example, have filed for Chapter 11 bankruptcy and taken advantage of its protections to devise new business plans while paying off creditors.

How It Works

Under certain conditions, creditors can force debtors into Chapter 11 bankruptcy by filing an involuntary petition. A business may also voluntarily file for Chapter 11 bankruptcy by submitting a petition with all required documentation of the company's finances and liabilities. An individual seeking bankruptcy protection under Chapter 11 must have completed credit counseling and file a petition with the bankruptcy court that includes his or her identifying information, required documentation of income, property, and debts, and intent to file a plan of reorganization. Individuals and businesses filing for Chapter 11 bankruptcy must pay applicable fees unless the court waives them.

Once an individual or business has filed for Chapter 11 bankruptcy, the law provides for an automatic stay of outstanding debts, which means that creditors cannot carry out collection attempts, repossession of property, and foreclosures. Creditors must be heard by the court in order to be repaid. There are some exceptions to the automatic stay, such as for some professional fees and secured creditors. In a Chapter 11 bankruptcy, the U.S. Trustee holds a meeting with all creditors and the debtor, wherein the debtor may be questioned under oath about financial status and obligations, and is given instructions on what must be done while the reorganization process moves forward.

While the court is working with creditors and the debtor to identify the financial status of the debtor and create a viable plan of reorganization, the business is still operating, though it is monitored by the court. The business becomes the "debtor in possession." A trustee may be appointed to supervise the debtor's business in cases where the company's leaders have been guilty of gross mismanagement or some wrongdoing. If the business has publicly-traded stock on the NASDAQ, New York Stock Exchange, or American Stock Exchange, the stock exchanges generally will delist the company's stock after a Chapter 11 petition is filed.

Plan of Reorganization

The plan of reorganization must include all debts, the status of each debt, and how each will be resolved. A business's reorganization plan may include less than full payment for some creditors, and those creditors get to vote on the plan's approval. Some creditors have higher priority than others, depending on the nature of the debt and whether a creditor has a security interest in the debtor's assets. The court has the ability to extinguish many of an individual or corporation's unsecured debts, and can free businesses from contractual obligations, such as union contracts or long-term leases, enabling it to make changes and emerge from debt. For a plan of reorganization to become effective, the court must approved it.

If a debtor fails to file a plan of reorganization, the creditors may do so. Sometimes, the court does not approve a plan of reorganization. This may convert the case to a Chapter 7 liquidation bankruptcy, meaning the business' assets are sold and creditors paid with the proceeds. The court could also dismiss the case, and the debtor will be in the same position as before the petition was filed—all outstanding debts will remain.

Depending on the value of assets held by a business and the plan approved by the court, the reorganization may leave the business and its stockholders (if any) with nothing, and the reorganized business owned by creditors. This occurs when creditors are more likely to recover money owed them from income generated by the business than if the business were to be liquidated and the proceeds given to creditors. The reorganization plan, however, may allow a business to operate more profitably once released from certain debts, leases, and obligations, enabling it to repay creditors and emerge from Chapter 11 bankruptcy.