What Is Chapter 11 Bankruptcy?

Definition and Examples of Chapter 11 Bankruptcy

Owners look for ways to take the heat off when money is tight and businesses are having trouble making ends meet. One tool often used by large businesses is a Chapter 11 bankruptcy reorganization case. The debtor can present a plan for debt repayment under Chapter 11, as well as the accompanying business and financial restructuring that's needed to accomplish that repayment. The plan must be approved by the courts.

Any business or individual can file for Chapter 11 bankruptcy protection. Businesses include everything from sole proprietorships to corporations. It's commonly known by the public as a tool for large companies, so people are often surprised that individuals can file for Chapter 11, too.  

Chapter 11 is most often used by individuals when their debts exceed the limits allowed for a Chapter 13 bankruptcy: $394,725 for noncontingent, unsecured debts and $1,184,200 for secured debts. These limits are adjusted occasionally, based on the consumer price index.

A debtor seeking Chapter 11 relief must not have had a recent bankruptcy case dismissed for failing to appear in or to comply with a court order in the last 180 days. They must also have received credit counseling from an approved agency within that time frame.

• Alternate name: Reorganization bankruptcy

How Chapter 11 Bankruptcy Works

A Chapter 11 bankruptcy filing takes place in the state where a business is located or incorporated. The petition can come from the debtor (a voluntary petition) or from a creditor (an involuntary petition). The debtor must include the required financial statements, fees, list of debts and creditors, and proof of credit counseling if they're filing the petition.

The largest and earliest obstacle in a Chapter 11 bankruptcy is the cost. The fee to file this type of case is $1,167 plus a $571 miscellaneous administrative fee. Chapter 7 fees total just $335. Chapter 11 debtors must also pay regular administrative fees to the U.S. trustee to offset the cost of the trustee's participation in the case.

Chapter 11 is highly complex, requiring the assistance of an experienced bankruptcy attorney. This can result in a skyrocketing cost of filing for Chapter 11. These cases can also be highly contentious. They tend to involve multiple sophisticated creditors, thus increasing the cost.

Types of Chapter 11 Relief and Limitations

Bankruptcy proceedings offer both short- and long-term relief to debtors, but they also set some strict rules and limitations.

The Debtor-in-Possession

The debtor becomes a debtor and a debtor-in-possession when they file a Chapter 11 bankruptcy petition. The term "debtor-in-possession" refers to the fact that the Chapter 11 debtor retains its property and continues as a going concern.

A debtor-in-possession has the majority of the rights and responsibilities of a bankruptcy trustee. The only right that's not available is that to compensation. The debtor-in-possession can file lawsuits to avoid transfers of money to creditors, obtain loans for the debtor, and accept or reject contracts. Many of these powers can't be exercised without court approval.

Any creditor or the court can seek the appointment of a bankruptcy trustee to replace the debtor-in-possession if they believe that this is in the best interest of the bankruptcy estate and its creditors. This might happen if the debtor-in-possession is mismanaging its assets, for example.

The Chapter 11 Process

Schedules and other documents are submitted after the case is filed, the meeting of creditors has been held, and the debtor-in-possession begins the process of producing a workable reorganization plan that's acceptable to the creditors and to the court. 

The first step in a Chapter 11 bankruptcy reorganization is the drafting and approval of a disclosure statement, which is a document that describes the structure of the debtor and how it conducts its business. The disclosure statement must give sufficient information for the creditors to determine whether reorganization is possible. The court must approve the disclosure statement before the next step in the Chapter 11 process, which is voting on the plan.

The next step is plan confirmation. The debtor will propose a plan of reorganization to the creditors. The creditors are divided into classes according to the type of debt they hold. The creditors then vote on the plan. The judge must approve it in order for the plan to be confirmed. Every impaired class of creditors must approve it. An impaired class is made up of those creditors that will receive less than what they're owed. Most creditors are impaired.

Chapter 11 plans usually provide for the appointment of a planning agent, which is a third party that executes the plan. They may provide for payments of $50,000 per month to creditors. The plan agent would manage the logistics of making those payments. The plan may also provide for how the individual or business will operate to generate money to pay creditors during the plan period, because it may last for several years.

Chapter 11 Discharge

The confirmed plan of reorganization will provide for when the debtor will receive a discharge of debts. The discharge will usually occur when the payments to creditors are complete.

Chapter 11 Bankruptcy vs. Chapter 7

Chapter 11 bankruptcy allows a business to continue its operations while paying off its debts. This is in contrast to a Chapter 7 bankruptcy, also known as a "liquidation bankruptcy." With Chapter 7, a business's or individual's assets are sold. The trustee uses the proceeds to pay debts, which often means ceasing operations for a business.