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What is Chapter 11 Bankruptcy?

chapter 11 bankruptcy
Businesses generally choose to file for Chapter 11 bankruptcy when their long-term revenue potential is greater than the amount it could be liquidated and sold for.
Credit: forestpath | Shutterstock

While available to individuals, Chapter 11 bankruptcy is the type of filing used most often by businesses — corporations, sole proprietorships or partnerships.

Chapter 11 bankruptcy is commonly referred to as reorganization or rehabilitation bankruptcy. It gives businesses, and sometimes individuals, the opportunity to come up with a plan to restructure finances so they can eventually pay off some, or all, of their debt. In addition, businesses that file for Chapter 11 bankruptcy are allowed to remain in operation during the repayment period.

Businesses generally choose to file for Chapter 11 bankruptcy when their long-term revenue potential is greater than the amount it could be liquidated and sold for. Creditors prefer this option because it offers a chance to get a greater share of the debt owed to them. While rare, individuals can file for Chapter 11 bankruptcy, and often do so when their debt exceeds the limits of those in Chapter 13 bankruptcy.

The key aspect of Chapter 11 bankruptcy is the reorganization plan, which spells out how much money creditors will receive and when. For the plan to go into effect, it must be approved by a majority of the creditors. Typically, businesses will use the plan to get a reduction in the amount owed, and a longer period of time to pay it. Specifically, the plan divides the creditors into different classes based on the type and size of debt. The plan then determines which, if any, classes will be paid in full and which ones will only receive a reduced portion of the debt owed. The plan must be approved by at least two-thirds of each class. Once the plan is approved, that becomes the new debt terms, replacing the outstanding ones. Businesses or individuals who fail to get their reorganization plan approved often end up liquidating the business through Chapter 7 proceedings.

Chapter 11 vs. Chapter 7

While Chapter 11 is most often used by businesses and rarely by individuals, the opposite is true for Chapter 7 bankruptcy. Commonly known as liquidation bankruptcy, filing for Chapter 7 puts the debtor's assets at risk of being liquidated to pay off portions of the debt.

The largest difference between Chapter 7 and Chapter 11 bankruptcies is what happens to the debts. Under Chapter 11, the debts are not negated as they are under Chapter 7. Instead, the terms of the loan are altered to make it easier for the debtor to pay it off. Another main distinction between chapters 7 and 11 bankruptcy is the time the filingtakes to complete. While Chapter 7 proceedings are often completed within four to six months, going through Chapter 11 bankruptcy often takes years.

Filing for Chapter 11 is also significantly more expensive. It takes more than $1,000 to file a Chapter 11 case, as opposed to just $300 for a Chapter 7 case. Attorney fees also are much more expensive because Chapter 11 cases require considerably more work.

Chapter 11 vs. Chapter 13

One of the main differences between Chapter 11 and 13 bankruptcies is who is eligible. Chapter 13 is an option only for individuals who owe less than $360,475 in unsecured debt and $1,081,400 in secured debt. These amounts do change periodically based on the Consumer Price Index. When it comes to businesses, corporations and limited liability companies are ineligible to file for Chapter 13 and only have the option of filing for Chapter 11 if they want to enact a payment plan.

Besides eligibility differences, Chapter 11 and 13 bankruptcies also differ in how the repayment plans are approved by the creditors. Under Chapter 11, creditors are able to vote on whether or not they want to accept the plan. In Chapter 13, the plans are automatically approved as long as they meet the required legal standards. The length of the repayment plan can also differ. While Chapter 11 payment plans generally last between three and five years, a court can approve a longer plan. There are no circumstances, however, in which a Chapter 13 plan can be extended longer than five years.

Filing for Chapter 11 bankruptcy

While not mandatory for individuals, businesses set up as corporations and partnerships must be represented by an attorney. The U.S. Court system also highly recommends individuals use the services of a lawyer, because Chapter 11 proceedings are often complicated and lengthy.

With the assistance of the attorney, the first step for the debtor is to file a Chapter 11 bankruptcy petition with the bankruptcy court that serves the area where they live or where their business is located. The proper and necessary filing forms can be found online at the U.S. Court system's website. In addition to the bankruptcy petition, the debtors – either individuals or businesses – must provide the court with a host of other financial documents, including a list of assets and liabilities, a schedule of current income and expenditures and a statement of financial affairs. In addition, individuals filing for Chapter 11 must provide proof that they completed a credit counseling class within 180 days before filing their petition.

After the proper paperwork is filed, the debtor assumes the role of "debtor in possession," which – in the case of a business – means they can continue to operate the business in a regular manner. While the debtor in possession can make simple day-to-day decisions, the court must approve any actions that aren't considered regular business activity. The debtor than has 120 days to submit a reorganization plan, which details a plan for repayment of debts. Once the plan has been submitted, the creditors must approve it.

In the reorganization plan, the creditors are divided into groups based on the type and size of debt. In order to be confirmed, the plan must be approved by two-thirds of each group of creditors. Once the plan is officially approved, the debtor is required to make scheduled payments and is bound by the provisions of the payment plan, which replaces any pre-bankruptcy contracts. Once the plan has been adhered to, the court will issue a final decree closing the case.

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