Chapter 11 Bankruptcy

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Chapter 11 bankruptcy allows struggling businesses to restructure their finances. Individuals may also file under Chapter 11 if they have too much debt or income to qualify for Chapter 7 or Chapter 13. There is no limit on the duration of a Chapter 11 case and they can last from a few months to more than two years.

Chapter 11 is an alternative to Chapter 7 bankruptcy for businesses. While Chapter 11 can allow a business to continue operating, the costs associated with Chapter 11 can be substantial. Small business may be able to take advantage of special provisions of the bankruptcy code to reduce such costs.

Chapter 11 Process

Usually, no trustee is appointed in a Chapter 11 case. Instead, the debtor continues operating its business as the “debtor in possession”. The bankruptcy court can appoint a trustee to take over the business if there is sufficient cause such as fraud, dishonesty, or gross mismanagement.

Although the debtor in possession continues to run the business, the bankruptcy court must approve any major decisions. The court has control over decisions such as sales of assets, entering into or breaking a lease, obtaining financing, entering into or modifying certain contracts, and the retention of attorneys and other professionals.

Creditors, shareholders, and other parties in interest are allowed to support or oppose actions that require approval of the bankruptcy court. The court will consider input from these parties in deciding how to proceed. Unsecured creditors can participate in a Chapter 11 case through a committee that is appointed to represent their interests.

Chapter 11 Reorganization Plan

Generally, the debtor has the exclusive right for four months after filing Chapter 11 to propose a reorganization plan. This period can be extended by the court up to 18 months upon a showing of good cause.

Once the “exclusivity period” expires, the debtor’s creditors and other interested parties can propose competing reorganization plans, although this is relatively rare. More often, creditors or other parties that are dissatisfied with the debtor’s progress will move to dismiss the case or convert it to a Chapter 7 bankruptcy.

A Chapter 11 plan allows a debtor to reorganize its financial affairs and governs how the debtor will operate and pay its obligations in the future. Most plans call for some downsizing of the debtor’s operations to reduce expenses and free up assets.

Creditors and equity holders are entitled to vote on whether they accept a proposed plan. At least one class of “impaired” claims must vote in favor of a Chapter 11 plan for it to be approved by the bankruptcy court. An “impaired” claim is an obligation that will not be paid in full upon plan confirmation.

The court has the ultimate authority to decide whether a plan is approved, and the court bases its decision on several requirements. These include (1) whether the court finds that the proposed plan is feasible or likely to succeed, (2) whether the court finds that the plan has been proposed in good faith, (3) whether the plan is in the best interests of the creditors, and (4) whether the plan is fair and equitable.

About 10%-15% of Chapter 11 cases result in successful reorganizations. Some notable companies that have used Chapter 11 bankruptcy include General Motors, United Airlines, Lehman Brothers, and K-Mart. Most cases, however, are dismissed or converted to Chapter 7 liquidations.

Chapter 11 for Small Businesses

The bankruptcy laws include special provisions to streamline Chapter 11 cases involving small business debtors. These special provisions include:

  • In a small business case, the bankruptcy court can order that no creditors’ committee be appointed to represent unsecured creditors. A creditors’ committee typically can retain attorneys and other professionals at the debtor’s expense, so this can significantly cut down on the cost of Chapter 11 for small businesses.

  • Generally, small business debtors have a longer exclusivity period to propose a Chapter 11 plan.

  • Typically, Chapter 11 debtors must prepare and distribute a disclosure statement that is similar to a prospectus for a stock offering and includes extensive information. For small businesses, the court can waive the requirement of a disclosure statement, which can significantly expedite the process and reduce legal and other costs.