Is Chapter 11 Bankruptcy Your Best Option? Weighing the Pros and Cons

Involving the restructuring of a debtor’s business affairs, debts, and assets, Chapter 11 is a type of bankruptcy also known as “reorganization” bankruptcy.

Takeaways

• A Chapter 11 bankruptcy enables a company to continue operating while reorganizing its financial commitments.
• In the event that a company chooses to submit a reorganization plan during the Chapter 11 filing process, it is required that the plan is beneficial to the creditors.
• If the debtor fails to propose a plan, the parties to whom they are indebted have the option to propose a plan themselves.
• Several large companies like General Motors and K-Mart have utilized Chapter 11 bankruptcy as a chance to manage their debts while still carrying out their operations.

the process of Chapter 11 bankruptcy

The title of Chapter 11 refers to a specific part of the U.S. Bankruptcy Code, which companies may use to seek a period of time to reorganize their debts and begin anew. This process is contingent upon the debtor meeting the requirements outlined in the reorganization plan.

In a Chapter 11 case, a business can receive assistance from the court to reorganize its debts and responsibilities. Usually, the company will continue to function normally. Numerous big American corporations, including General Motors, United Airlines, and K-mart, have used Chapter 11 bankruptcy to survive, as well as countless other businesses of varying sizes.

While it is typical for corporations, partnerships, and limited liability companies (LLCs) to utilize Chapter 11, individuals may also be able to file for it in certain situations where they have significant debt and do not qualify for Chapter 7 or 13. However, this is not common.

The Process is not Fast

Even if a business is in the process of filing for Chapter 11 bankruptcy, it can still function normally. Generally, the debtor, who is referred to as a “debtor in possession,” manages the business. However, if there are instances of fraudulent behavior, deceit, or severe incompetence, a court-appointed trustee will take over the administration of the company during the bankruptcy process.

The company is unable to make certain choices without the approval of the courts, such as selling assets, excluding inventory, initiating or terminating rental agreements, and altering business operations. The courts also have jurisdiction over decisions involving hiring and paying lawyers, as well as entering into agreements with suppliers and labor unions. Additionally, the debtor is prohibited from arranging a loan that will begin after the bankruptcy is over.

Chapter 11 provides the opportunity for a business or individual requesting bankruptcy to present a reorganization plan. This plan could involve scaling back business activities to decrease costs, renegotiating debts, or selling off all assets to pay back creditors. If the suggested course of action is reasonable and impartial, the courts will approve it, allowing the process to proceed.

Chapter 11 is focused on small businesses

The U.S. Small Business Reorganization Act of 2019, which became effective on February 19, 2020, introduced a new subchapter V to Chapter 11 with the aim of simplifying bankruptcy for small businesses. The U.S. Department of Justice defines small businesses as entities with debts of approximately $2.7 million or less that meet additional requirements.

According to the Justice Department, the law enforces reduced time limits for finishing the bankruptcy procedure, permits more adaptability in bargaining arrangements for restructuring with creditors, and establishes a private trustee to collaborate with the small business debtor and its creditors in facilitating the creation of an agreed-upon reorganization plan.

Which chapters are included in the U.S. Bankruptcy Code?

The U.S. Bankruptcy Code is divided into six chapters, namely Chapter 7 (liquidation), Chapter 9 (for municipalities), Chapter 11 (reorganization, typically for businesses), Chapter 12 (for family farmers), Chapter 13 (providing repayment options), and Chapter 15 (for international bankruptcies). Among these, Chapter 7, Chapter 11, and Chapter 13 are the most frequently used.

How do Chapter 7 and Chapter 11 differ?

Chapter 7, which is also known as liquidation bankruptcy, involves the selection of a trustee by the court to manage the sale of an individual’s assets. The proceeds are then utilized to compensate creditors. Unsecured debts, such as credit card debts, are usually eliminated, but tax obligations and student loans are not. Individuals are permitted to retain certain “exempt” assets.

In contrast, Chapter 11 bankruptcy allows a debtor, usually a business, to reorganize their debts, assets, and business affairs without having to sell off their assets. This type of bankruptcy may also be available to some individuals, but the main difference is that the debtor retains control of their operations.

What advantages are there in applying for Chapter 11?

The main benefit of Chapter 11 is that a company can keep functioning during the reorganization process, which helps generate income that can be used to pay back debts. Additionally, the court provides an order that prevents creditors from taking action. Creditors usually prefer Chapter 11 because they are likely to recover more, if not all, of the money they are owed compared to if the company were to shut down completely.

What are the negative aspects of submitting for Chapter 11?

Chapter 11 bankruptcy is a highly intricate form of bankruptcy and is often accompanied by significant expenses. If a company is in such a dire financial situation that it is contemplating bankruptcy, the legal fees alone could be burdensome. Additionally, the reorganization strategy must pass the bankruptcy court’s scrutiny and be feasible enough for the company to repay its debts within a reasonable period.

Amongst all kinds of bankruptcy, Chapter 11 is the most complex and expensive. In case a company is considering filing for bankruptcy because of financial problems, the legal costs involved could be a major burden. Moreover, the bankruptcy court must approve the plan for restructuring, which must be practical for the business to gradually settle its debts.

Final Thoughts

Chapter 11 bankruptcy provides a chance for a struggling business to recover and reorganize its operations. However, it is a complex and costly process that can take months or even years to complete. As such, a company should carefully evaluate all other available options before pursuing Chapter 11 restructuring. This may include exploring debt restructuring, seeking financial assistance or investment, or implementing cost-cutting measures.

Ultimately, the decision to pursue Chapter 11 should only be made after a comprehensive analysis of the business’s financial health, future prospects, and potential risks and benefits. While it can be a challenging and daunting process, Chapter 11 can also offer a path to a more sustainable and successful future for a struggling company.

FAQs

What is Chapter 11 bankruptcy?

Chapter 11 bankruptcy is a legal process that allows businesses and individuals to reorganize their financial affairs while still remaining in operation.

Who can file for Chapter 11 bankruptcy?

Any business or individual can file for Chapter 11 bankruptcy, but it is typically used by businesses with significant debt and financial problems.

What are the advantages of Chapter 11 bankruptcy?

The advantages of Chapter 11 bankruptcy include the ability to restructure debt, keep assets, and continue operating the business.

What are the disadvantages of Chapter 11 bankruptcy?

The disadvantages of Chapter 11 bankruptcy include the high costs of legal fees and the potential loss of control over the business.

How long does the Chapter 11 bankruptcy process take?

The Chapter 11 bankruptcy process can take anywhere from a few months to several years, depending on the complexity of the case.

Can Chapter 11 bankruptcy help me avoid foreclosure?

Chapter 11 bankruptcy can help you avoid foreclosure by allowing you to restructure your debt and develop a repayment plan.

What happens to my assets during Chapter 11 bankruptcy?

Your assets will be protected during Chapter 11 bankruptcy, and you will have the opportunity to restructure your debt and keep your assets.

What is the role of the bankruptcy court in Chapter 11 bankruptcy?

The bankruptcy court oversees the Chapter 11 bankruptcy process and ensures that all parties involved are treated fairly.

Can I continue operating my business during Chapter 11 bankruptcy?

Yes, you can continue operating your business during Chapter 11 bankruptcy, but you will need to develop a repayment plan to pay off your debts.

How can I determine if Chapter 11 bankruptcy is the best option for me?

You should consult with a bankruptcy attorney to determine if Chapter 11 bankruptcy is the best option for your specific situation. They can help you weigh the pros and cons and develop a plan for moving forward.

Glossary

• Chapter 11 Bankruptcy: A legal process that allows businesses to reorganize their debts and operations while continuing to operate.
• Debtor-in-Possession: The company in Chapter 11 bankruptcy remains in possession and control of its assets and operations.
• Automatic Stay: A court order that prohibits creditors from taking legal action to collect debts from a company in Chapter 11 bankruptcy.
• Reorganization Plan: A detailed proposal outlining how a company in Chapter 11 bankruptcy will restructure its operations and debts.
• Creditors’ Committee: A group of creditors appointed by the bankruptcy court to represent the interests of all creditors in Chapter 11 bankruptcy.
• Priority Claims: Debts that have a higher priority for repayment in Chapter 11 bankruptcy, such as taxes and employee wages.
• Secured Claims: Debts that are secured by collateral, such as a mortgage or lien, and have priority over unsecured claims in Chapter 11 bankruptcy.
• Unsecured Claims: Debts that are not secured by collateral and have a lower priority for repayment in Chapter 11 bankruptcy.
• Executory Contract: A contract in which both parties have ongoing obligations at the time of Chapter 11 bankruptcy filing, such as a lease or supply agreement.
• Debtor-in-Possession Financing: Financing obtained by the company in Chapter 11 bankruptcy to fund its operations during the reorganization process.
• Discharge: The legal release of a company in Chapter 11 bankruptcy from its debts and obligations after successfully completing its reorganization plan.
• Liquidation: The process of selling a company’s assets to repay its debts in Chapter 11 bankruptcy if a reorganization plan is not feasible.
• Cramdown: A court-approved reorganization plan over the objections of one or more classes of creditors in Chapter 11 bankruptcy.
• Insider: A person or entity with a close relationship to the company in Chapter 11 bankruptcy, such as a director or major shareholder.
• Equity Security Holder: A shareholder or other person holding an ownership interest in the company in Chapter 11 bankruptcy.
• Disclosure Statement: A document filed with the bankruptcy court that provides information on the company’s financial situation and proposed reorganization plan in Chapter 11 bankruptcy.
• Confirmation Hearing: A court hearing to approve or reject the company’s proposed reorganization plan in Chapter 11 bankruptcy.
• Plan Administrator: A person appointed by the bankruptcy court to oversee the implementation of the company’s reorganization plan in Chapter 11 bankruptcy.
• Exclusivity Period: A period of time during which only the company in Chapter 11 bankruptcy can file a reorganization plan without interference from creditors.
• Turnaround Time: The time it takes for a company to successfully complete its reorganization plan and emerge from Chapter 11 bankruptcy.