Business Bankruptcy Law
Chapter 11 bankruptcy usually involves a financially-struggling business attempting to reorganize their debts to return to future profitability. In general, companies who choose to file for Chapter 11 seek to alleviate their debt burden and craft a new business plan. While statutory language does not bar individuals from filing for Chapter 11, such cases are extremely rare. This article will break down some common Chapter 11 issues:
Usually, companies that file for Chapter 11 restructure their debts and create a reorganization plan for future financial success.
Chapter 11 bankruptcy is most often used by corporations, partnerships, and limited liability companies (LLCs) to restructure their debt. Individuals may also file for Chapter 11 bankruptcy if they meet the eligibility requirements. However, the vast majority of Chapter 11 cases are filed by corporations and small businesses. If an individual chooses to file for chapter 11 bankruptcy, they will be required to complete mandatory credit counseling within 180 days prior to filing, (11 U.S.C. § 109(h)). Corporations and partnerships do not have to undergo this counseling.
An official bankruptcy petition for Chapter 11 relief can be filed by either the debtor or the creditors of the debtor. Most Chapter 11 petitions are voluntary as it is very rare for creditors to bring an involuntary petition against the debtor. The goal of Chapter 11 bankruptcy is to make the business profitable again. Chapter 11 seeks to restructure debts rather than the all-out liquidation of assets under a Chapter 7.
Once a company files the petition, it is referred to as the “debtor-in-possession” and will usually continue to run the day-to-day business operations. Typically, after a petition is filed, a debtor will have at least 4 months and potentially up to 18 months to propose a plan of reorganization. If the creditors and other parties are unhappy with the proposed plan, they can move to convert the Chapter 11 to a Chapter 7.
The reorganization plan addresses how creditors will be re-paid and the future operation of the company. For businesses in Chapter 11, the end goal is the approval of this plan. Getting the plan approved means either agreement among the various interested parties (creditors, shareholders, etc.) or acceptance by the court if it meets various requirements. Court acceptance means the company can force the plan through against the wishes of certain parties. The debtor can be brought back to court or have its case converted to liquidation under Chapter 7 if it does not follow the terms of the plan.
Chapter 11 cases typically average anywhere between six months to two years to complete.
There is no definitive amount of time for a Chapter 11. The duration of a Chapter 11 case will depend heavily on many different factors. Usually, the shortest Chapter 11 cases involve either total liquidation of assets or agreement among the various committees on the reorganization plan. The longest Chapter 11s may result from drawn out negotiations, meetings, and hearings among the parties with an interest in the case.
Whereas a Chapter 7 shuts down the business and uses asset liquidation to repay creditors, companies in Chapter 11 restructure their debt obligations and chart a course for fiscal success post-bankruptcy.
Occasionally, the end result of a Chapter 11 will be the same as a Chapter 7. This happens when the reorganization plan calls for an immediate shutdown of the business and liquidation of remaining assets. The role of the trustee in a Chapter 7 is much more prominent than in a Chapter 11. A trustee will only be assigned in a Chapter 11 case in specific circumstances. The courts are required to charge much higher fees in a Chapter 11 case compared to a Chapter 7.
A Chapter 11 bankruptcy case officially begins with the filing of a petition for debt relief.
Individuals file the petition with the local bankruptcy court. Business entities can either file the petition with the court that serves their primary place of business or their place of incorporation. For instance, a company might be incorporated (registered) in Delaware, but have their corporate headquarters in San Jose, CA. The following documents should be included with the petition:
As with other chapters of bankruptcy, the court will charge a variety of fees upon filing. However, the court charges significantly higher fees for a Chapter 11 filing than for any other chapter. The bankruptcy court is required to charge:
In general, the fees are due upon filing. However, with permission from the court, special provisions in the law provide for individual debtors to pay the filing and administrative fees in installments. Failing to pay the required fees may result in the court dismissing your case. Once the case has been filed, the debtor becomes the “debtor-in-possession” and in most cases, continue the day-to-day business operations. Lastly, a written disclosure statement containing information regarding business affairs, assets, and liabilities along with a reorganization plan is usually submitted to the court along with the forms and fees.
The reorganization plan is the core of a Chapter 11 case. This plan lays out how the business intends to operate going forward and how creditors will be repaid.
Usually, the plan involves some manner of corporate restructuring, downsizing, reduction of expenses, and/or sale of some assets. Sometimes, a Chapter 11 plan will call for the closure of the business and sale of all assets. This is not very common since a business with no chance of survival will usually file for Chapter 7 instead of Chapter 11 to avoid the exorbitantly higher court fees. Typically, companies going into Chapter 11 will already have been in discussions with creditors prior to the court filing.
For the first four months after filing for Chapter 11, companies have the exclusive right to propose a reorganization plan. They can ask the court to extend this exclusivity up to 18 months. After that time, other parties, such as creditors, may submit competing plans. During the Chapter 11 process, various parties with a stake in the company are grouped into classes. These classes usually include creditors (secured and unsecured), shareholders, employees, and others.
If the company can convince all the classes to agree on its proposed plan, the approval of the plan is usually very quick. On the other hand, with the court’s approval, the company can also force the plan through without consensus via special provisions known as “cram down.” To qualify for a cram down, the company will need to demonstrate to the court that its plan is fair and equitable, in the best interests of creditors, in accordance with the law, and in good faith.
Many Chapter 11 cases are filed by small businesses. There are special provisions in bankruptcy law governing small businesses in Chapter 11. In addition to greater oversight by the U.S. trustee, small business debtors will need to make ongoing filings with the court throughout the bankruptcy process concerning profitability and projected cash receipts. Small businesses will also need to demonstrate compliance with the Bankruptcy Code and prove that all applicable taxes were paid and tax returns filed. The bankruptcy court in a small business case can waive the appointment of creditors’ committees, which, along with other advantages, reduces the financial burden on small business debtors.
In very rare instances, individuals will file for Chapter 11 bankruptcy. Although Congress may not have intended Chapter 11 to be utilized for consumer bankruptcy, the landmark Supreme Court case, Toibb v. Radloff (1991), gave qualifying individuals the right to file under Chapter 11. There are no eligibility criteria concerning amounts of debt or income for individuals seeking to file Chapter 11. For those who do not qualify under the terms of either Chapter 7 (your income is too high) or Chapter 13 (your amount of debt is too high), Chapter 11 bankruptcy is a potential alternative. However, due to the length of the process and the significantly higher court fees, most consumer bankruptcies are filed as either Chapter 7 or 13, rather than Chapter 11.