Chapter 11 Bankruptcy: What You Need To Know (2024)

If your business is behind on its bills, struggling with too much debt and besieged by creditors, you may be able to catch a break with Chapter 11 bankruptcy and get back on track.

What Is Chapter 11 Bankruptcy?

Typically, corporations or partnerships file for Chapter 11 bankruptcy, though individuals can use it as well. With this type of bankruptcy, debtors propose a plan of reorganization to pay creditors over time.

Chapter 11 stops creditor collection efforts, facilitates negotiations to settle debts and can even allow a business to get new financing on better terms. The goal is to keep your business afloat and keep creditors at bay while you restructure your debt obligations.

Chapter 11 is fundamentally different from Chapter 7, the other option for a company that is in too much debt to continue doing business. In a Chapter 7 bankruptcy, rather than reorganizing to try and save the business, the business is shut down and its assets are sold, with the proceeds distributed to creditors.

How Does Chapter 11 Bankruptcy Work?

The central element of a Chapter 11 bankruptcy is the creation of a plan to repay creditors all or part of what is owed. Once the bankruptcy court approves this, the business still has to repay its remaining debts but the legal part of the bankruptcy process is essentially over.

The process begins with the business filing a petition for bankruptcy protection in federal bankruptcy court. Creditors can also file an involuntary bankruptcy to force a business not meeting its obligations into court to cut a deal.

Once the court accepts the petition, creditors must end collection efforts. That includes evictions, foreclosures, lawsuits, property seizures and requests for payment. This automatic stay of collections lasts for the duration of the case, although the court may lift it if a creditor asks. The business seeking protection also has to submit details about its debts, assets, income and expenses.

Debtor in Possession

After filing a voluntary or involuntary petition, the business is considered a “debtor in possession,” which means it retains control of its assets while undergoing Chapter 11. This is unlike other chapters of bankruptcy, which appoint a bankruptcy trustee to take control of the business and its assets. But the debtor in possession must perform all of the duties of a trustee. These duties include, among others, accounting for property, examining and objecting to claims, and filing informational reports.

As a debtor in possession, a firm can get new loans through debtor-in-possession financing, which may be cheaper than any the firm could get before the filing. This can help keep the organization afloat while it undergoes bankruptcy. Even more help can come from the ability of a business in bankruptcy to unilaterally cancel leases and other contracts that are costing too much.

With the court’s approval, the business can also raise money for operations by selling underused assets, including those that may have been burdened with liens. The entire business can even be sold.

The Reorganization Plan

The linchpin of the entire process is the business’s creation of a reorganization plan, including a proposal for how much to pay each creditor. After the plan is presented to the court, the business meets with a court-appointed committee of major creditors. At this get-together, called a Section 341 meeting, a business representative has to answer, under oath, creditors’ questions about the business.

Next, creditors submit their desired modifications to the plan, which may be extensive. After some back and forth, the court approves an often-heavily modified version. Then creditors get to vote. If two-thirds accept the plan, the court confirms it and the legal part of the bankruptcy is over.

After this process, the debts are considered discharged and are replaced by the debts confirmed by the court. The business has to make the payments set forth in the plan, but creditors have to accept the plan, even if they will get less than they were originally due.

The Limits of Chapter 11

Not all debts can be discharged this way. For example, sole proprietors seeking Chapter 11 may be held personally responsible for the business’s debts since a sole proprietorship doesn’t exist separately from its owner(s), like a corporation. In some cases, the personal assets of members of partnerships may be used to pay creditors. When that happens, only personal bankruptcy can discharge the debts. Shareholders of corporations, on the other hand, are personally shielded from creditor actions.

Sometimes the court converts a reorganization bankruptcy to a Chapter 7 liquidation proceeding. This can happen if a creditor successfully claims managers aren’t running the business properly, have no chance of continuing operations or are misusing assets. The court can also simply dismiss the case, exposing the business to its creditors again. And even if not converted to Chapter 7 or dismissed, some Chapter 11 proceedings still result in the business closing its doors and liquidating rather than reorganizing.

All this can take a long time. A filer has 18 months to file a reorganization plan and up to 20 more months to get creditors to accept it. As a result, while a Chapter 7 liquidation can be resolved in a few months, a typical Chapter 11 can take six months to two years.

Chapter 11 is also expensive. There’s a standard $1,167 case filing fee and a $571 miscellaneous administrative fee. In addition, filers have to pay quarterly court fees ranging from $325 to $30,000, depending on how much the filer has paid out during the quarter, for the duration of the case.

The complexity of Chapter 11 cases also leads most filers to hire bankruptcy attorneys to represent them and other experts to support the process, significantly adding to the cost.

Benefits and Disadvantages of Chapter 11 Bankruptcy

For all its challenges, Chapter 11 offers some benefits. Here are some of the most important:

• Creditors must stop collection efforts immediately.
• The business keeps operating under current ownership and management.
• As a debtor-in-possession, the business can borrow money on better terms.
• The business can get out from under burdensome leases and other contracts.
• The business may be able to sell previously encumbered assets to raise money.
• Ultimately, the business may be able to emerge as financially healthy.

Chapter 11’s disadvantages include:

• Not shielding sole proprietors from creditors seeking repayment.
• It’s expensive, thanks to the need for legal and other professional advice.
• Cases can take a long time.
• The business may not be able to sell assets, borrow or make other decisions without court approval.
• Chapter 11 may not work, leading to the business being forced to close its doors and liquidate.

Bottom Line

Chapter 11 is not a cheap or easy refuge. Reorganization bankruptcies have a lot of moving parts and can cost far more and take vastly longer than the more straightforward, final remedy of a Chapter 7 liquidation. Chapter 11 doesn’t erase all debts and it’s not suitable for all businesses. But in the right cases, it can be a viable way for financially troubled firms to find a path through a difficult time. Before choosing the type of bankruptcy to file, it’s wise to speak with a bankruptcy attorney and consider all of your options for debt relief.

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