What is Chapter 11 Bankruptcy?

Man showing empty trouser pocket, mid section
Diane Macdonald/ Photographer's Choice RF/ Getty Images

When money is tight, and businesses are having trouble making ends meet, their owners look for ways to take the heat off. One tool often used by large businesses is a bankruptcy Chapter 11 reorganization case. American Airlines, GM, Chrysler, Macy's and a host of other companies have successfully employed Chapter 11 to reorganize debt and keep moving forward. 

It's not just big companies filing Chapter 11 cases.

Small companies and even some individuals file, too. Although less commonly filed in comparison to Chapters 7 and 13, Chapter 11 still far outnumbers the other less common bankruptcy chapters, such as Chapter 9, which is used by municipalities to reorganize their debt.

Who is Eligible to File a Chapter 11?

Any business or individual can file for Chapter 11 bankruptcy protection. Businesses include anything from a sole proprietorship to a national corporation. The bankruptcy cases filed by President Trump's companies were all Chapter 11. (Donald Trump has never personally filed bankruptcy.)

Because it's commonly known by the public as a tool for large companies like Borders Books, they're often surprised that individuals can use Chapter 11, too.  

Chapter 11 is most often used by individuals when their debts exceed the limits allowed for a Chapter 13, specifically: $394,725 in unsecured debt and $1,184,200 in secured debt as of April 1, 2016.

(These figures will re-adjust on April 1, 2019.)

Debtor-in-Possession

Upon the filing of the Chapter 11 bankruptcy petition, the debtor, be it a business or an individual, becomes a debtor and debtor-in-possession. The term debtor-in-possession refers to the fact that the Chapter 11 debtor retains its property and continues as a going concern.

 The debtor-in-possession has the majority of the rights and responsibilities of a bankruptcy trustee. The only right not available is the right to compensation. The debtor-in-possession can file lawsuits to avoid transfers of money to creditors, obtain loans for the debtor, and accept or reject contracts. Many of these powers must be exercised with court approval. Any creditor or the court, on its own, may seek the appointment of a bankruptcy trustee to replace the debtor-in-possession if they believe that it is in the best interest of the bankruptcy estate and creditors, such as if the debtor-in-possession is mismanaging its assets.

Process

After the case is filed, schedules and other documents are filed, and the meeting of creditors has been held, the debtor-in-possession starts the process of producing a workable reorganization plan acceptable to the creditors and the court. 

   1. Disclosure Statement

The first step in a Chapter 11 bankruptcy reorganization is the drafting and approval of a disclosure statement. The disclosure statement is a document that describes the structure of the debtor and how it conducts its business. The disclosure statement must give sufficient information for the creditors to determine whether reorganization is possible.

The court must approve the disclosure statement before the next step in the Chapter 11 process, which is voting on the Plan.

      2. Confirmation

The next step is confirmation. The debtor will propose a plan of reorganization to the creditors. The creditors are divided into classes according to type of debt. The creditors then vote on the plan. In order for a plan to be confirmed, the judge must approve it, and every impaired class of creditors must approve it. An impaired class is a class of creditors that will receive less than what they are owed (usually most creditors are impaired). There is an exception to this rule which permits confirmation under a process called "cramdown."

    3. Post-Confirmation

Usually plans provide for the appointment of a plan agent, a third-party that executes the plan.

For example, the plan may provide for payments of $50,000 a month to creditors. The plan agent would deal with the logistics of making the payments. The plan may also provide for how the individual or business will operate to generate money for creditors during the plan period, as the plan may endure for several years.

Discharge

The confirmed plan of reorganization will provide for when the debtor receives a discharge of debts. The discharge will usually occur upon substantial consummation of the plan, such as the majority of payments to creditors are made.

Cost

Likely the largest and earliest obstacle in Chapter 11 bankruptcy is the cost. Since 2006, the fee to file a Chapter 11 case is $1,167 (as of September 2016), far greater than the Chapter 7 fee. Chapter 11 debtors also pay regular administrative fees to the US Trustee to offset the cost of the US Trustee's participation in the case. Furthermore, Chapter 11 is highly complex, requiring the retainer of an experienced bankruptcy attorney. This results in a skyrocketing cost of filing for Chapter 11. Moreover, Chapter 11 cases can be highly contentious and involve multiple sophisticated creditors, which further increases the cost of the case.

Updated by Carron Nicks May 2017.