Overview of Chapter 11 Bankruptcy

Overview of Chapter 11 Bankruptcy

Chapter 11 of the Bankruptcy Code is designed to permit a person or business to reorganize while obtaining protection from creditor collection and/or legal proceeding(s). This chapter is designed to provide the business or individual with an opportunity to reorganize its financial obligation and to make essential payments on debts under a Court approved plan. Government tax claims are treated with priority over other types of unsecured debt and are also subject to reduction and dischargeability. Each tax matter is unique, but in most cases substantial reduction can be realized under a plan of reorganization.

A Chapter 11 Bankruptcy filing has no initial qualifying requirements in terms of the amount of debt that a debtor is required to owe or the type of entity that the debtor needs to be. There are various benefits that a debtor gains from a Chapter 11 Bankruptcy filing. A business in serious financial difficulty may continue to operate without danger of immediate closure by its creditors via lawsuits, enforcement of judgments, liens as well as turnover orders. This breathing spell is supposed to provide the debtor with an opportunity to attempt the successful reorganization of its financial affairs. The debtor’s breathing spell lasts until the statutory time to propose a plan of reorganization which is usually 120 days or for a long period of time upon an extension approved by the court.

Chapter 11 Bankruptcy can be an excellent method to deal with the financial problems of companies that may have encountered excessive debts, numerous debt based lawsuits, liquidity problems, temporary down turns in business or even the need to reject certain leases or contracts. Reorganization of business debt under Chapter 11 may at times be a much better option to both the Debtor and its Creditors as opposed to liquidation under Chapter 7.

Secure your company’s financial future


If a company is facing imminent or irreparable financial damage due to the collection efforts of creditors, or simply has hit a few economic bumps but wants or needs to stay in business, there are alternatives to Chapter 11 Bankruptcy. Such options include out of court workouts and settlement arrangements, assignments for the benefit of creditors, as well as receiverships and forbearance agreements. Depending on the facts of a particular case alternatives to Chapter 11 Bankruptcy may be better suited under the circumstances.

Chapter 11 bankruptcies are very complex, time consuming, oftentimes expensive and allow the Court and the creditors to be actively involved in the Debtor's financial affairs. Businesses considering seeking bankruptcy relief under Chapter 11 must utilize an attorney experienced in handling Chapter 11 cases.

1. What is Chapter 11?


Chapter 11 is the chapter of the Bankruptcy Code that permits a person or business to reorganize while obtaining protection from creditors. Chapter 11 of the Bankruptcy Code is entitled “Reorganization.” The Bankruptcy Code is the name given to that portion of the federal laws that deal with bankruptcy.

3. Are there any financial or insolvency requirements for filing under Chapter 11?


No. There are no financial or insolvency requirements for filing a voluntary Chapter 11 case other than the good faith requirement that the case can be filed primarily for purposes of reorganization. A voluntary Chapter 11 Debtor may be solvent or insolvent; its assets may exceed its liabilities by any amount (or vice versa), and its income may be substantial or nonexistent. The only financial restriction is the practical one of whether the cost of the case to the Debtor is justified by the intended benefit. A voluntary Chapter 11 case is a Chapter 11 case filed by the Debtor. An involuntary Chapter 11 case is a Chapter 11 case filed against the Debtor by its creditors.

5. What is a small business Debtor?


A small business Debtor is a Debtor who chooses to be treated as a small business Debtor in a Chapter 11 case. To qualify as a small business Debtor, a Debtor must be engaged in a commercial or business activity (other than one whose primary activity is the business of owning or managing real property and the activities incidental thereto) and the total amount of the Debtors noncontingent liquidated secured and unsecured debts must not exceed $2,490,925 when the case is filed.

7. What are the advantages of being treated as a small business Debtor?


Being treated as a small business Debtor expedites the handling of a Chapter 11 case by dispensing with the necessity of a creditor’s committee, by shortening the period for filing plans, and by simplifying the procedures for obtaining acceptance of a plan.

9. Does a person have to be engaged in business to qualify for Chapter 11 relief?


A person does not have to be engaged in business in the traditional sense to obtain Chapter 11 relief. A consumer is legally eligible to file under Chapter 11. As a practical matter, however, the person filing under Chapter 11 must have something to reorganize, rehabilitate or liquidate before Chapter 11 relief can be granted.

11. What type of long-term relief may a Debtor obtain under a Chapter 11?


Long term relief in the form of either a reorganization of the Debtor’s business or an orderly, debt-controlled liquidation of the Debtor’s assets may be obtained under Chapter 11. If the Debtor’s business is reorganized, it may continue to function either in its present form or in a revised form, and its present creditors will be permitted to satisfy their claims only to the extent provided in the Debtor’s plan of reorganization. A reorganization may consist of anything from an extension of time for the repayment of debts to a total restructuring of the business.

13. When does the Debtor receive a discharge in a Chapter 11 case?


In the Chapter 11 case filed by a corporation, limited liability company, or other nonindividual, the Debtor receives a discharge when the plan is confirmed by the Court. The order of the Court that confirms the plan also contains the Debtor’s Chapter 11 discharge. In a Chapter 11 case filed by an individual (i.e., a natural person), a discharge is granted by the Court separately, after the completion of payments under the plan. A discharge is a Court order relieving the Debtor from liability for certain debts. A debt that is discharged is a Debtor for which the Debtor is no longer liable, except as provided in the Chapter 11 plan.

15. Is a Chapter 11 discharge valid if the Debtor later fails to carry out the plan?


The validity of a Chapter 11 discharge granted to a nonindividual Debtor is not affected by the subsequent failure of a Debtor to carry out the plan. As long as the order of confirmation is not revoked by the Court, (which seldom happens), the discharge received by a Debtor of this type is valid even if the Debtor later fails to fulfill its obligations under the Chapter 11 plan. However, under certain circumstances an individual Debtor who has not completed payments under the plan must also receive a Chapter 11 discharge.

17. Where is a Chapter 11 case filed?


A Chapter 11 case is filed with the clerk of the bankruptcy Court in the district where the Debtor either resides, has its principal place of business, or has its principal assets.

19. Does a person or business filing under Chapter 11 have to continue paying its debts after the case is filed?


Most Chapter 11 Debtors receive a moratorium on the payment of most of their general unsecured debts for the period between the filing of the case and the confirmation of a plan. This period usually last for six to twelve months. During this period, however, it may be necessary to pay secured creditors whose property, goods, or services are needed to continue the Debtor’s business.

21. What is an interest holder and what is its role in a Chapter 11 case?


An interest holder is the holder of an equity interest in the Debtor. In Chapter 11 cases interest holders are often referred to as equity security holders. A shareholder is an interest holder of a corporation and a member is an interest holder of a limited liability company. If the rights of interest holders are dealt with in a Chapter 11 plan, interest holders are treated like creditors and are permitted to file proofs of their interests, vote on the acceptance or rejection of a plan, and participate in distribution under the plan. However, most plans in small business Chapter 11 cases deal only with creditors and do not deal with the rights of interest holders.

23. Is the Debtor permitted to operate its business during a Chapter 11 case?


Unless a trustee is appointed, the Debtor may continue to operate its business during a Chapter 11 case as a Debtor in possession. In operating its business during a Chapter 11 case, the Debtor, as a Debtor in possession, must abide by the requirements of Chapter 11 and orders of the bankruptcy Court.

25. May a Debtor incur new debts and obtain new credit during a Chapter 11 case?


Yes, unless the Court orders otherwise, the Debtor, as a Debtor in possession may obtain unsecured credit and incur unsecured debt in the ordinary course of business during a Chapter 11 case without Court approval. Further, the unsecured credit or Debtor obtained or incurred is payable as an administrative expense in the case, which means that those creditors get paid ahead of all other unsecured creditors. Court approval is required prior to obtaining or incurring any other type of credit or debt during the case. Thus, secured credit or unsecured credit not in the ordinary course of business may be obtained during the case only with the prior approval of the bankruptcy Court.

27. What is a disclosure statement?


It is a document prepared by the proponent of a Chapter 11 plan that discloses financial and other information about the Debtor and the proposed plan to the Debtor’s creditors. A disclosure statement must contain information that is sufficient to enable creditors to make an informed decision on whether to accept or reject a proposed plan. A disclosure statement must be approved by the Court before it is distributed to creditors. In a small business case, the Debtor’s Chapter 11 plan may also serve as the disclosure statement if it contains adequate information about the Debtor and the plan.

29. How are secured creditors dealt with in a Chapter 11 plan?


Much depends on whether a creditor is fully secured or undersecured. The claim of a fully secured creditor must be paid in full in cash, and if deferred cash payments are made on the claim, interest must be paid to the creditor for not receiving its cash immediately. An undersecured creditor may elect to have its claim treated as being fully secured, and if such an election is made, the claim must be paid in full in cash, but if deferred cash payments are made, interest does not usually have to be paid on the claim. If an undersecured creditor does not elect to have its claim treated as being fully secured, the secured portion of its claim must be paid in the same manner as a fully secured claim, while the unsecured portion may be paid as an unsecured claim.

31. How does a priority unsecured claim differ from a nonpriority unsecured claim?


A priority unsecured claim is an unsecured an unsecured claim that is given priority of payment under the Bankruptcy Code. Priority unsecured claims include the following types of claims: the administrative expenses of the Chapter 11 case, wage claims of up to $12,475 per employee, wage benefit claims of employees up to certain limits, consumer deposit claims of up to $2,775 each, most divorce related claims, and tax claims. Administrative expenses include the fees of the Debtor’s attorney and unsecured debts incurred in the ordinary course of operating the Debtor’s business during the case. A nonpriority unsecured claim is a general unsecured claim against the Debtor prior to the filing of the Chapter 11 case. The claims of most trade creditors are nonpriority unsecured claims.

33. When do the creditors vote on whether to accept or reject a Chapter 11 plan?


Voting on a plan begins after the Court approves or conditionally approves a disclosure statement prepared by the party proposing the plan. Each eligible creditor is mailed a ballot for voting on the plan. The ballot is accompanied by a copy of the disclosure statement and a copy or summary of the proposed plan. The Court sets a deadline for voting on the plan, and a creditor’s ballot must be filed with the Court prior to the voting deadline in order to be counted.

35. What happens when a plan is confirmed by the Court?


To become legally effective, a plan must be confirmed by the bankruptcy Court. A plan is confirmed by the bankruptcy Court when the bankruptcy judge signs an order approving the plan and ruling that the Debtor and all creditors and interest holders are bound by the provisions of the plan.

37. What happens if the Court does not confirm a Chapter 11 plan?


If the Court decides not to confirm a Chapter 11 plan, it will usually permit the party proposing the plan to modify the plan so that it can be confirmed. If a Chapter 11 plan is modified, it is usually necessary to hold another confirmation hearing on the modified plan. If the Court refuses to confirm any plan, the Chapter 11 case must either be dismissed or converted to a Chapter 7.

38. What happens after a Chapter 11 plan has been confirmed by the Court?


After a Chapter 11 plan if confirmed by the by the Court, the plan must be implemented and carried out, wither by the Debtor or by the successor to the Debtor under the plan. If the plan calls for the Debtor to be reorganized or for a new corporation to be formed, this function must be carried out first. If the plan calls for property to be transferred or for liens to be created or modified, this must also be done. And of course, the claims of creditors must be paid in the manner specified in the plan.

39. For how long a period may a Chapter 11 plan run?


There are no specified limits on the length of a Chapter 11 plan. A Chapter 11 Plan must be long enough to convince the Court and creditors that the Debtor is making a good faith effort to pay as much of its debt as is realistically possible. On the other hand, the plan must not be so long that it does not appear feasible to the Court. Typically, it takes from three to five years to carry out and consummate the Chapter 11 plan of a small business Debtor.

40. What happens if the Debtor is unable to comply with or carry out the provisions of a plan after it has been confirmed by the Court?


If the Debtor, or the successor to the Debtor under the plan, is unable to comply with the provisions of a confirmed plan, the plan may be amended so that it may be complied with, if sufficient grounds exist for such an amendment. Otherwise, the Chapter 11 case may be dismissed or converted to Chapter 7. If the Debtor, or the successor to the Debtor under the plan, fails to carry out its obligations under the plan, creditors may sue, or foreclose on the property of, the Debtor or its successor either in the bankruptcy Court or in other Courts.


2. Who may file under Chapter 11?


Legally, anyone except a governmental agency, an estate, a nonbusiness trust, a stockbroker, a commodity broker, an insurance company, a bank, or an SBA-licensed small business investment company may file under chapter 11. An individual may not file a chapter 11 if he or she has had another bankruptcy case dismissed upon certain grounds within the last 180 days. As a practical matter, chapter 11 is available to virtually any business or person able to afford the expenses of the case.

4. What is a Debtor?


A Debtor is a person or business concerning whom a case under the Bankruptcy Code has been commenced. A person or business who files a Chapter 11 case is referred to as a Debtor. A Debtor who qualifies may be treated as a small business Debtor in a Chapter 11 case.

6. How does a Debtor get to be treated as a small business Debtor?


A qualifying Debtor who checks the appropriate box on the Chapter 11 petition will be treated as a small business Debtor unless and until the Court orders otherwise.

8. Are there any restrictions on the size or type of business that may file under Chapter 11?


No. A business filing under Chapter 11 may be very large, very small or anywhere in between. Under Chapter 11, a business may be a sole proprietorship, a partnership, a limited liability company or a corporation of any size.

10. What type of relief from creditors may a Debtor obtain by filing under Chapter 11?


The filing of a Chapter 11 case automatically stays all foreclosures, collections actions, civil litigation, and creditor action of any kind against the Debtor or the Debtor’s property. The only significant proceedings not stayed by the filing of a Chapter 11 case are criminal proceedings against the Debtor, divorce-related proceedings, and proceedings by governmental agencies to enforce police or regulatory powers. All other proceedings and acts against the Debtor or the Debtor’s property, whether in or out of Court, are stayed. Even telephone calls or the sending of letters or bills to the Debtor, if for the purpose of collecting a prepetition debt, are precluded by the automatic stay. An act or proceeding that is stayed is held in abeyance, and no further action may be taken in the matter without the approval of the bankruptcy Court. The automatic stay that accompanies the filing of a Chapter 11 case normally gives the Debtor a moratorium of several months on the payment of many of its debts.

12. How long does a Chapter 11 case last?


A Chapter 11 case must be broken down into two phases: the pre-confirmation phase and the post-confirmation phase. The first phase, which is the phase prior to the confirmation of a plan, normally lasts from six to twelve months, although the time may vary depending on the condition of the Debtor, the type of plan proposed by the Debtor, and the reaction of the creditors to the plan. The second phase, which is where the confirmed plan is implemented and carried out by the Debtor, normally lasts from three to five years, although it, too, may vary in duration. See answer to question 39 below.

14. What debts are discharged by a Chapter 11 discharge?


The debts discharged in a Chapter 11 case depend on whether the Debtor is an individual (i.e., natural person) or a nonindividual (i.e., a corporation, partnership, etc.). The discharge received by an individual Debtor in a Chapter 11 case discharges the Debtor from all pre-confirmation debts except those that would not be dischargeable in a Chapter 7 case filed by the same Debtor. The discharge received by a nonindividual Debtor in a Chapter 11 case depends on whether the plan confirmed is a plan of reorganization or a plan of liquidation. The discharge received in the confirmation of a plan of reorganization discharges a nonindividual Debtor from al scheduled pre-confirmation debts without exception. However, if the plan confirmed is a plan of liquidation and if the Debtor does not engage in business after consummation of the plan, a nonindividual Debtor does not receive a discharge.

16. How is a Chapter 11 case commenced?


A voluntary Chapter 11 case is commenced by filing a voluntary petition with the clerk of the bankruptcy Court requesting relief under Chapter 11 of the Bankruptcy Code. A number of other documents are usually filed with the petition. However, if it is necessary to file the case before the other documents can be prepared, most of the other documents may be filed within 14 days after the petition is filed. The filing fee must usually be paid when the petition is filed, although an individual Debtor may pay the filing fee in installments. As a practical matter, however, Debtors who are unable to pay the filing fee when a Chapter 11 case is filed seldom succeed a Chapter 11.

18. Is the public informed of the filing of a Chapter 11 case?


When a Chapter 11 case is filed, all of the Debtor’s creditors, shareholders, partners and other persons directly involved with the Debtor are notified. Notice of a Chapter 11 case is not normally published in newspapers or trade journals unless the filing of the case is considered newsworthy by the newspaper or journal. Generally, only the creditors, owners and employees of a small business Debtor are aware that the Debtor has filed a Chapter 11 case.

20. How does a Chapter 11 case proceed after it has been filed?


After a Chapter 11 case has been filed, the Debtor must file documents with the Court listing the names and addresses of its creditors and owners, describing all of its property and other assets, and disclosing its financial condition. The Debtor, as a “Debtor in possession,” is usually permitted to continue to operate its business during the course of the case, but must comply with the requirements of Chapter 11 and the bankruptcy Court in doing so. A creditor whose collateral is threatened may apply to the Court for relief from the automatic stay or for adequate protection of its security interest. The Debtor must prepare a Chapter 11 plan and file it with the Court, usually within 180 days after the case is filed if the Debtor is a small business Debtor. The Debtor must also prepare, file, and obtain Court approval of a disclosure statement that adequately informs its creditors and interest holders of its financial condition and of its reorganizational plans. After the disclosure statement has been approved by the Court, copies of the statement and Chapter 11 plan are distributed to creditors and interest holders, who may vote on whether to accept or reject the Debtor’s plan. If the plan is accepted by at least one class of creditors whose claims are impaired (i.e., not paid in full, see question 45 below) under the plan, the plan may be confirmed by the Court. After the completion of voting, a confirmation hearing is held wherein the Court must decide whether to confirm the plan. If the plan is confirmed by the Court it becomes effective and must be carried out and consummated by the Debtor. After the plan has been consummated, a final report is filed and the case is closed.

22. What is a “Debtor in possession” and what is required of it in a Chapter 11 case?


A “Debtor in possession” is the Debtor in a Chapter 11 case in which a trustee has not been appointed. As a Debtor in possession, the Debtor is legally charged with rights, duties, and obligations as a trustee in dealing with the Debtor’s property and operating the Debtor’s business for the benefit of its creditors and interest holders. As a Debtor in possession, the Debtor must abide by the rules and standards of Chapter 11 and the orders of the bankruptcy Court. The failure of a Debtor in possession to perform its obligations and duties may result in the appointment of a trustee, a Court order terminating the Debtor’s business, the conversion of a case to Chapter 7, or the dismissal of the case. A Debtor ceases to be a Debtor in possession when a plan is confirmed by the Court.

24. What limitations are placed on a Debtor’s right to use, sell or lease its property during a Chapter 11 case?


For purposes of use, sale, or lease during a Chapter 11 case, a Debtor’s property is divided into two categories: cash collateral and all other property. Until a plan is confirmed, the Debtor, as a Debtor in possession, may not use, sell, or lease cash collateral unless each creditor secured by the cash collateral consents to the proposed use, sale, or lease, or unless the Court approves the proposed use, sale or lease. Unless the Court orders otherwise, the Debtor may use, sell or lease any of its property except cash collateral in the ordinary course of business during the case without prior notice to creditors or Court approval. The Debtor may use, sell, or lease property other than cash collateral outside the ordinary course of business during the case only after notice to any affected creditors and a Court hearing.

26. May a Debtor break its contracts or leases in a Chapter 11 case?


Yes, under a Chapter 11, the Debtor, as a Debtor in possession, may, at its option and without the consent of the other party, reject, assume, or assign most contracts or leases under which the Debtor is obligated. This may be done either by motion during the Chapter 11 case or as part of the Chapter 11 plan.

28. What is a Chapter 11 plan?


It is a written document that states the terms of how the Debtor will deal with its creditors and, if necessary, interest holders. A Chapter 11 plan may be simple or complex, but it must comply with the legal requirements of Chapter 11. Most Chapter 11 plans are plans of reorganization, but a Chapter 11 plan may also be a plan of partial or complete liquidation, if desired.

30. How are unsecured creditors dealt with in a Chapter 11 plan?


The answer depends on whether a creditor has a priority or a nonpriority claim. Priority claims must be paid in full in cash under a Chapter 11 plan, unless a creditor agrees otherwise. Further, all priority claims except tax claims must be paid when the plan is confirmed or shortly thereafter, unless a particular creditor agrees to accept payments under the plan. Tax claims may be paid in regular cash payments with interest over a period not exceeding 5 years from the date the case is filed. An unsecured creditor with a nonpriority claim must be paid at least as much as the creditor would have received had the Debtor filed under Chapter 7, and the payments need not be in cash. Nonpriority claims may be paid in cash, property, or securities of the Debtor or the successor to the Debtor under the plan.

32. What must a creditor do to become entitled to payment in a Chapter 11 case?


For a creditor to be entitled to payment in a Chapter 11 case, the creditor’s claim must be filed and allowed by the Court. If a creditor’s claim is listed on the schedules filed by the Debtor in the case, and is not listed as being disputed, contingent, or unliquidated, then the claim is considered to be filed in the case in the amount and priority listed on the Debtor’s schedules. Otherwise, a creditor must file a document called a “proof of claim” in order for its claim to be filed. Once a claim is filed, either by virtue of being included in the Debtor’s schedules or by the filing of a “proof of claim,” the claim is automatically allowed by the Court unless someone files an objection to the allowance of the claim, in which case the Court must hold a hearing to determine whether to allow the claim. If a creditor’s claim is correctly listed in the Debtor’s schedules and if no one files an objection to the claim, the claim will automatically be allowed in the case, even if the creditor does nothing. It is up to the creditor, however, to check and insure that its claim is correctly listed on the Debtor’s schedules.

34. How is it determined whether a plan is accepted or rejected by creditors?


All voting on the acceptance or rejection of a plan is by class. The creditors in each class of impaired claims vote on whether the plan will be accepted by that class of claims. To be accepted by a class of claims, a plan must be accepted by creditors holding at least two-thirds in dollar amount and one-half in number of claims in the class that actually vote on the acceptance or rejection of the plan. At least one class of impaired claims must vote to accept the plan before the plan can be confirmed by the Court.

36. When and under what circumstances may a plan be confirmed by the bankruptcy Court?


After creditors and interest holders have votes on whether to accept or reject a proposed Chapter 11 plan, the bankruptcy Court will hold a hearing for the purpose of determining whether to confirm the plan. This hearing is called the confirmation hearing. At the confirmation hearing, the party proposing the plan, which is usually the Debtor, must present evidence showing that, the plan complies with the Chapter 11 confirmation requirements. A plan may be confirmed by the Court either through the regular confirmation method or through what is called a “cramdown.” The regular method of confirmation is used when the plan has been accepted by the holders of every class of impaired claims and interests. The cramdown method of confirmation is used when the plan has been rejected by the holders of one or more classes of impaired claims or interests, but has been accepted by the holders of at least one class of impaired claims. A plan that has not been accepted by the holder of at least one class of impaired claims cannot be confirmed by the Court.

41. What happens when all of the provisions and requirements of a Chapter 11 plan have been carried out?


When all of the provisions and requirements of a Chapter 11 plan have been fulfilled or carried out, the plan is said to have been consummated. When a plan has been consummated, a final report and accounting must be filed, and the case will be closed by the Court.