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Chapter 11 Bankruptcy

Chapter 11 bankruptcy is intended primarily for the reorganization of businesses with heavy debt burdens, most often associated with corporations but available to small businesses as well. Although it's uncommon, consumers may file for Chapter 11 in some rare instances. Chapter 11 allows the debtor to propose a plan for profitability post-bankruptcy, which may include trimming costs and seeking new sources of revenue or income, while temporarily holding creditors at bay. In contrast, Chapter 7 bankruptcy (often referred to as a liquidation) involves the closure of the debtor business and the sale of liquid assets to repay creditors. While Chapter 11 has certain advantages for those that qualify, including more time to file a plan and the opportunity to reorganize, it is more time-consuming and costly than other forms of bankruptcy.

The Chapter 11 Process

Filing a Petition:

Either the debtor or its creditors may file a petition for Chapter 11 bankruptcy protection, the latter route referred to as an involuntary petition. Once the petition is filed with the U.S. Bankruptcy Court, the case begins and an automatic stay of all collections actions is put into effect. This means creditors may not pursue existing or new collection activities for unpaid debts unless the court issues a modification to the stay. This provides an opportunity for the debtor to draft a reorganization plan and negotiate more feasible repayment terms without worrying about its debt obligations.

After the petition is filed, the business (or, in rare circumstances, the consumer) continues about its affairs without interruption. Meanwhile, under the supervision of the bankruptcy court, the debtor turns its attention to figuring out a repayment plan for its creditors. As with other types of bankruptcy, repayment amounts typically are much lower than the original debt totals. Throughout the case, the debtor may review its creditors' claims and make objections where it makes sense. Monthly operating reports filed by the debtor keep the court apprised of its progress.

Reorganization Plan:

The goal of filing for Chapter 11 bankruptcy protection, versus Chapter 7, is to become profitable. To achieve this goal, the debtor's first move is to renegotiate leases and contracts and either have debts discharged or partially repay them. Creditors have an incentive to work with the debtor and make compromises, since they generally would not get better terms in a Chapter 7 action.

A reorganization plan puts creditors into different classes with respect to how their claims are handled. The creditors with first priority for repayment include state and federal tax agencies, employees owed wages and stockholder interests; they are each put into their own class. Each secured creditor also is placed in its own class, while unsecured claims are placed together in one class. The plan may modify the amounts and terms for repayment of debts to these creditors. A reorganization plan must be voted on by creditors and approved by the court.

Confirmation and Debt Discharge:

If your reorganization plan is reasonable, done in good faith and in compliance with the law, the court typically will confirm it. Once the plan is confirmed, debts that existed before the confirmation date (but not directly addressed in the plan) are discharged. At this point, the debtor is required to repay creditors in accordance to the respective agreements and operate in compliance with the terms of the reorganization plan.

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; as such, "small businesses" make up the vast majority of Chapter 11 filings. But they don't always remain in Chapter 11. Chapter 11 bankruptcies often get dismissed and converted to Chapter 7, typically 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 which has total debts of $2.19 million or less at the time of the petition. "Single asset real estate cases" under Chapter 11 involve debtors with non-residential property having 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.

Small businesses have the following court filing requirements:

  • Copy of the business entity's most recent balance sheet
  • Statement of operations
  • Cash-flow statement
  • Copy of the most recent federal income tax return

Bankruptcy court exerts greater oversight of small business Chapter 11 filings than for larger entities, including the requirement to report on its profitability and projected cash receipts and disbursements. In addition, the court appoints a U.S. trustee to the case.

While Chapter 11 affords small businesses the advantage of additional time to file a plan and renegotiate terms with creditors (180 days, versus 15 days for Chapter 7), it also has its drawbacks. It can cost tens of thousands of dollars in legal fees, which may be untenable for a struggling small business. If the emergence from bankruptcy protection proves successful, though, 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 making a decision.

Chapter 11 for Consumers

Chapter 11 bankruptcy reorganization was originally intended for businesses, but the 1991 U.S. Supreme Court case Toibb v. Radloff held that non-business, individual consumers also are eligible. This is exceedingly rare, though. Only 0.1 percent (or 1 out of 1,000) consumer bankruptcies filed in 2009 were Chapter 11, compared to 71.4 percent Chapter 7 and 28.5 percent Chapter 13 filings.

This unusual route usually is pursued by individuals who still have substantial personal earning potential but whose debts exceed the limits set forth by Chapter 7 and Chapter 13. A typical non-business Chapter 11 bankruptcy filer might be a celebrity who just got in over his or her head with bad investments but who conceivably still has 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.

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