What Is Chapter 11 Bankruptcy?

Definition & Examples of Chapter 11 Bankruptcy

Chef looking distressed about his business
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Chapter 11 bankruptcy allows businesses to seek debt relief and protection from their creditors by reorganizing the business and its debts. It is the most complex, expensive type of bankruptcy in the U.S. Bankruptcy Code.

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 that file Chapter 11 cases, though. Small companies and even some individuals file, too. Learn more about how this type of bankruptcy works and who is eligible.

What Is Chapter 11 Bankruptcy?

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. Under chapter 11, the debtor can present a plan for debt repayment and accompanying business and financial restructuring needed to accomplish that repayment. This plan must be approved by the courts.

Any business or individual can file for Chapter 11 bankruptcy protection. Businesses include anything from a sole proprietorship to a national corporation. Because it's commonly known by the public as a tool for large companies, 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 for noncontingent, unsecured debts and $1,184,200 for secured debts. These limits are adjusted regularly based on the consumer price index.

Additionally, as in other forms of bankruptcy, a debtor seeking Chapter 11 relief typically must not have had a recent bankruptcy case dismissed for failing to appear in or comply with the court in the last 180 days. They must also have received credit counseling from an approved credit counseling agency within that time frame.

  • Alternate name: Reorganization bankruptcy

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.

How Chapter 11 Bankruptcy Works

A chapter 11 bankruptcy filing takes place in the state where a business is located or incorporated. The petition can come from the debtor (voluntary petition) or from a creditor (involuntary petition). If the debtor is filing the petition, they must include the required financial statements, fees, list of debts and creditors, and proof of credit counseling.

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.

As in other bankruptcy chapters, filing for chapter 11 initiates an automatic stay in which most creditors cannot attempt to collect payments from the debtor. This is intended to give the debtor time to negotiate a plan for repaying their debts.

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. 

  • 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.
  • 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 the 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).
  • Post-confirmation: Usually, plans provide for the appointment of a planning 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.

The debtor in a Chapter 11 bankruptcy case has exclusive rights to propose a repayment and reorganization plan for 120 days after the initial filing, after which creditors can propose a competing plan. The court may reduce this exclusive period or extended it up to a total of 18 months.

Chapter 11 Discharge

The confirmed plan of reorganization will provide for when the debtor receives a discharge of debts. The discharge will usually occur when the payments to creditors are complete.

Chapter 11 Cost

Likely the largest and earliest obstacle in Chapter 11 bankruptcy is the cost. The fee to file a Chapter 11 case is $1,167 plus a $550 miscellaneous administrative fee, far greater than the Chapter 7 fees, which total $335.  Chapter 11 debtors also pay regular administrative fees to the U.S. trustee to offset the cost of the U.S. 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.

Chapter 11 Bankruptcy vs. Chapter 7

Chapter 11 bankruptcy allows a business to continue its operations while paying off its debts. This is in contrast to chapter 7 bankruptcy, also known as liquidation. In chapter 7, a business or individual sells off assets and uses the proceeds to pay debts. For a business, however, this often means ceasing operations.

Chapter 11 Chapter 7
Discharge can take years Discharge takes 4 to 6 months
Retain assets and pay debts from future monthly income Sell assets to pay off debts
Reorgnanize debts and finances to pay debts Loan balances are not reduced
Very expensive No monthly payments

Key Takeaways

  • Chapter 11 bankruptcy allows an individual or business to reorganize financially to pay back its debts without forfeiting its assets.
  • Due to its complexity and high costs, most chapter 11 cases involve large corporations.
  • Any creditors who will get less than what they are owed must agree to the chapter 11 payment plan.
  • A chapter 11 debtor doesn't usually have a trustee unless creditors intervene to request one because they feel the debtor is mismanaging its assets.

Article Sources

  1. U.S. Courts. "Chapter 11 - Bankruptcy Basics." Accessed Aug. 21, 2020.

  2. U.S Courts. "Bankruptcy Filings Continue to Decline." Accessed Aug. 21, 2020.

  3. U.S. Courts. "Chapter 7 - Bankruptcy Basics." Accessed Aug. 21, 2020.