Understanding Chapter 11 Bankruptcy
When people think of bankruptcy, they often imagine a complete closure of a business or a total liquidation of assets. However, for corporations or partnerships that want to remain open despite financial difficulties, Chapter 11 bankruptcy is an option. In this article, we will explain what Chapter 11 bankruptcy is and how it works.
Chapter 11 bankruptcy is a form of bankruptcy reorganization available to individuals, corporations, and partnerships.
Unlike Chapter 7, which requires a complete liquidation and closure of the business, Chapter 11 allows the debtor to restructure their debts over a period of time while remaining in business. It is the usual choice for large businesses seeking to restructure their debt.
When filing for Chapter 11 bankruptcy, the debtor creates a debt reorganization plan and files it with the court. In this plan, the debtor will keep possession of assets, becoming a "debtor in possession." As a debtor in possession, the business continues to operate and will do so until either the bankruptcy is completed, the bankruptcy is converted to a Chapter 7 filing, or a trustee is appointed.
The debtor in possession is a fiduciary for the creditors, meaning they have a legal obligation to act in the best interests of the creditors. If the debtor's management is ineffective or less than honest, a trustee may be appointed.
A creditors committee is usually appointed by the U.S.Trustee from among the 20 largest, unsecured creditors who are not insiders. The committee represents all of the creditors in providing oversight for the debtor's operations and a body with whom the debtor can negotiate an acceptable plan of reorganization.
The debtor's proposed new plan must get the required creditor approvals and meet all legal requirements, which include getting credit counseling from an approved organization. Creditors should expect to have their debt negotiated when Chapter 11 proceedings occur. The negotiation might attempt to lengthen the time the debt is owed, thereby reducing the monthly payments, or to reduce the debt to a lesser amount. It might also request temporary relief from debt payments while the debtor raises capital through the sale of assets or other means to make the payment.
If the debtor cannot get the votes to confirm a plan, the debtor can attempt to "cram down" a plan on creditors and get the plan confirmed despite creditor opposition, by meeting certain statutory tests.
However, the rate of successful Chapter 11 reorganizations is depressingly low, sometimes estimated at 10% or less.
The complex rules and requirements in Chapter 11 increase the costs to file the case and prosecute a plan to confirmation far beyond than other forms of bankruptcy.
It is important to note that Chapter 11 bankruptcy does not wipe out debt, but rather restructures it such that the debtor is able to pay it down. A Chapter 11 bankruptcy also remains on the debtor's account for up to 10 years, affecting their ability to obtain new debt and leases.