What Is Chapter 11 Bankruptcy?
Traditionally, chapter 11 bankruptcy is used by corporations, partnerships, and LLCs to restructure their debt under the protection of the United States Bankruptcy Code (“the Bankruptcy Code”). Chapter 11 of the Bankruptcy Code is designed for business entities to restructure their debt, liquidate some of their assets, continue in business, and emerge from bankruptcy with a fresh start. The Bankruptcy Code allows any business or individual to file for chapter 11 bankruptcy relief. Though chapter 11 is usually used by business debtors, individual debtors who cannot restructure their debt under another chapter of the Bankruptcy Code may use chapter 11. In fact, a recent trend is for individuals with large real estate holdings to file chapter 11 for the advantages it offers.
What Should You Expect in A Chapter Case for You or Your Business?
Time and Expense. Chapter 11 bankruptcy relief can be advantageous to both debtors and creditors over other forms of bankruptcy relief, but it is also more expensive and the cases take longer to complete. Depending on the complexity of the debtor’s estate, a chapter 11 case can last anywhere from two months (if there are no major disputes) to over two years. If a business qualifies as a small business eligible for a streamlined process, the business will save time and money as compared to a traditional chapter 11 case.
Viability of the Business. A business does not have to be insolvent to file for chapter 11 relief. If your business does file a chapter 11 case, your business will have to continue operating throughout the chapter 11 proceeding under the supervision of the bankruptcy court. When you file the case, all attempts by creditors to enforce debts against you must cease. You can use that breathing room to develop a viable plan of reorganization. If your business is not viable even in a reorganized form or it cannot continue operations for any reason, you should expect the creditors to urge the court to liquidate the business or have the case dismissed.
Debtor in Possession Obligations. In chapter 11 cases, no trustee is appointed to operate the business unless evidence of fraud is present. Immediately upon filing the case, your business will become known as the “debtor in possession”. It will have the normal obligations to operate the business along with the additional responsibility of satisfying obligations imposed on debtors in possession by the Bankruptcy Code.
Hire Experts. You will be able to hire experts during the case. You should hire experts well before filing the case to determine options. You will need one or more of the following experts:
- Turn-around expert, accountant, and/or financial consultant to help determine whether the business can survive, and how to accomplish it.
- Bankruptcy attorney to assist with compiling the necessary documentation for filing a case.
A bankruptcy attorney experienced with chapter 11 cases can begin negotiations with your creditors in advance of filing. These early negotiations may accomplish an out-of-court workout, and if creditors are agreeable and the business has viability, you can avoid the need to file bankruptcy. If not, it may be possible to develop an agreed upon plan, also called a “pre-packaged” plan, which can save time and money once the case is filed.
Viable Plan. Whether you enter into work-out or a bankruptcy, creditors will want a viable plan of reorganization showing how the business will continue to operate, where the debtor will get funds to continue operating and pay debts, and most importantly, how and when they will be paid. The plan can incorporate a variety of measures. The plan can:
- Restructure debts.
- Liquidate assets.
- Cancel leases and contracts not yet performed.
- Downsize the business.
- Provide new sources of cash.
The bankruptcy court will confirm the plan if the debtor can show it is viable, fair, and in the best interests of creditors, meaning that the plan complies with the payment priorities outlined in the Bankruptcy Code and creditors will be paid at least as much as they would be paid in a straight liquidation under Chapter 7 Bankruptcy.
Summary of Advantages of Chapter 11 Compared to Other Forms of Bankruptcy Relief
As mentioned above, chapter 11 is expensive, but it has some advantages over liquidating in chapter 7 that may appeal to you. Such as:
Flexibility. In chapter 11, the debtor in possession has flexibility in developing a plan that can discharge almost any kind of debt, including some debt that is not dischargeable in chapter 7.
Debt Restructuring. The repayment obligations of the debtor in possession under the plan can be reduced and spread out over a very long period of time. Chapter 11 has no time limit on the duration of the plan. This is a big advantage for debtors with very large debts.
Automatic Stay Protection. No matter which type of bankruptcy a debtor files, the filing of the case triggers the automatic stay. The automatic stay prohibits creditors from taking any steps to enforce a debt against a bankruptcy debtor or its property without the permission of the bankruptcy court. In a chapter 11 case, business can continue to operate under the protection of the automatic stay against creditors’ collection attempts.
Debtor in Possession Retains Control. In the absence of fraud or mismanagement, only the debtor can propose a plan of reorganization during the first 120 (usually extended to 180) days of the chapter 11 case,. The debtor in possession serves in the role of the trustee. If the debtor is an individual rather than a business, the debtor may be able to force mortgage creditors to restructure real estate debt to require the debtor to pay only what the property is worth, not what is actually owed. Chapter 11 is an excellent way to get real estate lenders to the table for individuals and businesses seeking to restructure their real estate mortgages.
Cram Down. The plan can be confirmed over the objection of the creditors, also called a “cram down”, provided that the plan meets the minimum requirements under the Bankruptcy Code.
If you are considering filing for chapter 11 bankruptcy relief, you will be well served to engage counsel with a significant amount of experience in chapter 11 cases.