Also known as a “reorganization bankruptcy”, Chapter 11 can be seen as a last chance for many firms to keep afloat when deeply in debt. As the name suggests, this entails restructuring the business under court supervision in order to afford paying creditors while still in operation. For the most part, the debtor retains control over day to day activities but he has to receive approval for a number of transactions and associations, which we will detail further bellow.
How does a Chapter 11 case start?
Most of the times, the debtor is the one to take initiative for commencing the proceedings by applying for bankruptcy relief, generally to the court where the business is incorporated. All partnerships, limited liability companies, and incorporated businesses are eligible for Chapter 11, as well as individuals with significant assets.
If his petition is approved, then he will have to submit all relevant documents concerning the firm’s financial situation to the court, and allow these to be consulted by creditors. The cost of the preceding will also fall under his responsibility, and this can amount to quite a lot, as the case can take anywhere from a couple of months to over two years to complete.
Submitting a reorganization plan
In broad strokes, the objective of the debtor in a Chapter 11 bankruptcy is to have a re-organization plan approved by both the court and creditors. The plan details all the changes he proposes to have enacted to his business, which can range from downsizing and cutting expenses to liquidation of certain assets.
The final say on whether or not a proposed plan can go forward rests with the courts and for this to happen the debtor’s propositions must meet with the following demands:
- It must be feasible, with the debtor required to prove that he will be able to raise sufficient funds to cover all expenses and debts.
- It must be in good faith.
- It must reflect the best interest of the creditors, meaning they would have to receive at least as much under the plan as they would under a liquidation bankruptcy (Chapter 7). However, it is only rarely that the sum owed is paid in full, and the court can be satisfied when the plan covers only a fraction of the total debt.
- The fair and equitable test refers to the exact sum to be returned. If they vote against the proposed plan, secured creditors, meaning those that hold a collateral are to be paid at least the value of the mortgage.
Decisions controlled by the court
Businesses often prefer re-organization over liquidation because it offers them a new lease on life, as well as a good amount of freedom over how the company is run. People opt for Chapter 11 if they have a high degree of faith in the potential of their company and their own ability to manage it out of debt. If incompetence, fraud, or dishonesty is suspected, then the court can appoint a trustee that takes over for the creditor until the proceedings are completed.
Otherwise, the owner or an affiliate gains the title of debtor in possession and continues to operate as usual, with a few limitations, when decisions must be approved by the court:
- Sales of property and real property, except for inventory items if the debtor happens to be in retail.
- Leases of personal property.
- Borrowing money after the case is filed, entering a mortgage and other secured arrangements.
- Expanding operations or shutting down certain departments.
- Entering partnership agreements with unions and vendors, as well as modifying contracts with third parties.
- Paying legal representatives.
Conclusions
Chapter 11 is not something a business owner or representative should decide on lightly. It can get more expensive than outright liquidation, can drag on for a number of years, and the chances of success are somewhat small. According to studies, only 10-15% of cases end with a successful reorganization, with a majority being either thrown out or converted into Chapter 7.
About the writer: The Law Offices of Kevin S. Neiman are located in Denver, Colorado but have a national reach. They often take complicated cases of a financial nature, including Chapter 11 and Chapter 7 bankruptcies, representing the interests of either creditors or debtors.
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