Chapter 11 Reorganization & Business Bankruptcies
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Chapter 11 is the chapter of the United States Bankruptcy Code that governs the process of business reorganization under the bankruptcy laws of the United States. Alternative, Chapter 7 governs the process of a liquidation bankruptcy. The purpose of a Chapter 11 bankruptcy case is generally to permit the rehabilitation and reorganization of the debtor’s business. One of the principal benefits of a Chapter 11 bankruptcy is that it allows a debtor to keep all or a portion of its assets, as it elects, unlike Chapter 7 that permits the retention of only a limited amount of the debtor’s “exempt” property. Rehabilitation of the debtor’s business is accomplished through the creation of a Chapter 11 Plan that provides for the treatment of all claims against the debtor and the terms that will govern reorganization of the debtor’s financial structure and operations. In most instances, the debtor’s Chapter 11 Plan will be the result of a consensual arrangement between the debtor and its creditors and equity security holders. However, Chapter 11 does have certain provisions that allow the debtor to impose its Chapter 11 Plan on dissenting claimants in certain circumstances.
In Chapter 11 reorganization, certain debts may be cancelled or reduced, and the debtor can elect to terminate certain contracts and lease. Typical debts and contracts cancelled in a Chapter 11 bankruptcy include unsecured loans, union contracts (when cancellation would be financially favorable to the company), supply or operating contracts (involving both vendors and customers), and long-term real estate leases.
The process of filing a Chapter 11 and obtaining confirmation of the debtor’s Chapter 11 Plan can be quite complex and costly. Accordingly, most Chapter 11 bankruptcy cases are filed by business entities. However, individuals are not precluded from seeking Chapter 11 relief, and in appropriate cases, usually involving individuals with large liabilities or engaged in complex business dealings, Chapter 11 bankruptcy may be the best solution for an individual with financial problems.
If a business finds itself unable to pay its obligations as they mature, it can file (or be forced by its creditors to file) for bankruptcy protection under either Chapter 7 or Chapter 11. A Chapter 7 bankruptcy filing is intended to result in the orderly liquidation of the debtor’s assets, and the distribution of asset sale proceeds in a manner set forth in the Bankruptcy Code. In a Chapter 7 case, the debtor ceases operations and terminates its business existence. A Chapter 11 filing, on the other hand, is an attempt to stay in business while a bankruptcy court supervises the "reorganization" of the company's contractual and debt obligations. The court can grant complete or partial relief from most of the company's debts and its contracts, so that the company can make a fresh start. In many cases involving large business enterprises or publicly held companies, the result of the Chapter 11 reorganization is the transfer of all or a substantial portion of the company’s equity ownership from its prior owners (stockholders) to its bond holders and other creditors. In those cases, the company's creditors accept ownership of the company in lieu of payment on its claims in the hopes that it will eventually succeed financially and provide them with compensation for their losses.
The theory of Chapter 11 bankruptcy is that the value of a typical business as a reorganized going concern is substantially more than the value its assets if sold individually. For that reason, Chapter 11 allows a troubled business to continue operating running, cancel some of its debts, and transfer some or all of the newly reorganized company to the creditors whose debts were cancelled. If the company is reorganized, rather than liquidated, jobs may be saved, assets are retained, and the remaining creditors and equity participants may have smaller losses than if the company is dismantled. Accordingly, a party seeking confirmation of a Chapter 11 plan is required to demonstrate that because of the plan, the company’s creditors will end up with more money than they would in Chapter 7 liquidation.
All creditors can have their opinion heard by the court in a Chapter 11 proceeding and the court is responsible for determining whether the Chapter 11 plan of reorganization complies with the purposes of the bankruptcy law and provides for fair and equitable treatment of all parties in interest. Priority of claims is determined by Section 507 of the Bankruptcy Code, but as a general rule secured creditors, often times institutional creditors, such as banks and bondholders, have a higher-priority claim on the proceeds of the sale of corporate assets than unsecured creditors and trade creditors who have not been paid for products previously delivered to the company. Once a business files a Chapter 11 petition constituting an order for relief, the “automatic stay” immediately stops creditors from taking collection action without obtaining permission from the bankruptcy court.
Under some circumstances, the creditors or the United States Trustee can ask the court either to convert the case to liquidation under Chapter 7, or to appoint a trustee to manage the debtor's business. Generally, the court will only approve a motion to convert a case to Chapter 7 or appoint a trustee to run the business if it believes that one of these actions will be in the best interest of all creditors. Appointment of a trustee requires some wrongdoing or gross mismanagement on the part of existing management and is relatively rare).
After filing a Chapter 11 and obtaining plan confirmation, the company may "emerge" from bankruptcy. Sometimes this takes only a few months, sometimes several years. At times the process can be long and complex, and at times the reorganization fails and the company is liquidated, but the goal of Chapter 11 is to preserve the ongoing value of the business enterprise, preserve jobs and assets, and to result in a new “reorganized” healthy business.
