What is Chapter 11 Bankruptcy and Who Qualifies?
Chapter 11 of the bankruptcy code allows businesses to create a financial plan for survival and continuation, which can include modification of interest rates, reduction in debt load, and downsizing to free up assets and lower expenses. The reorganization plan offered by the filer must be agreed upon by the creditors and the court.
One major difference between Chapter 11 and other forms of bankruptcy, such as Chapter 7 and Chapter 13 (which isn’t available for businesses), is that the business owner or owners oversee the plan. No trustee is appointed unless dishonesty, fraud, or incompetence forces the court to appoint one. In most cases, the debtor — known as the “debtor in possession” under Chapter 11 — runs the business as usual.
However — and this is one reason only the largest corporations were traditionally able to use Chapter 11 — the business must organize a creditor committee comprised of the seven largest unsecured creditors to ensure the debtor in possession is running the business properly.
Because of the cost and time involved in a Chapter 11 filing, small businesses generally shunned it until the introduction of Chapter 11, Subchapter V. Small business filings are now much less onerous. For one, the creditor committee requirement has been eliminated. This was accomplished through the CARES (Coronavirus Aid, Relief, and Economic Security) Act and the Small Business Reorganization Act of 2019.
The Chapter 11 Process
A business can choose to file for Chapter 11 or creditors can impose a bankruptcy petition on the business. The filing can take place where the business is physically located or where it is domiciled (i.e., incorporated or otherwise organized). Corporations organized in Delaware but operating elsewhere often choose to file in Delaware, which is considered more corporate-friendly.
The filing, regardless of its origin, results in what is called an “automatic stay,” which provides a period of time when all judgments, collection activities, foreclosures, and repossessions are suspended.
Thereafter, though the debtor in possession generally runs the business as usual, the court must approve the following activities:
- Sale of assets, such as real property, not sold in the normal operations of the business
- Entering into or breaking a lease
- Obtaining a mortgage or other secured loan that allows the debtor to borrow money
- Shutting down or expanding the business
- Entering into or modifying contracts, licenses, and agreements with vendors, unions, and other entities
- Paying attorneys and other professionals
The creditor committee, other creditors, shareholders, and interested parties may weigh in to oppose or support any of the debtor actions listed above.
As part of the filing, the company seeking bankruptcy protection must also submit what is called a disclosure statement providing background information — such as assets and liabilities — justifying the use of Chapter 11. Creditors can object to the statement and the need for the particular type of filing. Once the court approves the disclosure statement following input and/or objections from the creditors, it sets dates for considering and voting on the company’s upcoming proposed plan.
The filing party has four months to exclusively submit a reorganization plan, but the deadline can be extended up to 18 months by petition to the court. With no plan proposed after the expiration of exclusivity, the creditors can propose alternative plans or move to convert the filing to a Chapter 7 liquidation.
How Disputes are Resolved
If creditors object to the plan, the court will weigh whether the plan is feasible — i.e., can it succeed? — and whether it is being offered in good faith. There is also a “best interests” test, by which the plan must pay the creditors at least as much as they would receive under a Chapter 7 liquidation.
The proposed plan must also be fair and equitable under the “absolute priority rule,” which establishes the order of payment among creditors and shareholders similar to a Chapter 7 liquidation.
Of all bankruptcy filing types, Chapter 11 presents the most complications and potential pitfalls, as well as being the longest time-wise from which to emerge. You need the guidance and knowledge of an experienced bankruptcy attorney to help you persevere and pursue the results you desire.