Chapter 11 is a form of bankruptcy that is usually filed by a corporation or partnership that needs time and assistance to restructure and pay off their debts. Normally, this type of bankruptcy is utilized by businesses not allowed to file under Chapter 13 or by individuals with debts too large for Chapter 13. Chapter 11 is considered one of the most complex types of bankruptcy cases and can be the most expensive type to file. It should only be considered after an organization has researched all other alternatives and completed a careful financial analysis.
How Chapter 11 Works
If a company determines that their long-term revenues will be higher than the liquidation value of their assets, they may decide to file for Chapter 11. Once a company has filed for Chapter 11 bankruptcy, an “automatic stay” is created which stops creditor actions including foreclosure, repossession, bank account garnishment and creditor harassment.
Chapter 11 is designed to help creditors get more of their owed money back because it gives the business time to continue operations under a reorganization. Reorganization efforts can include adhering to an agreed-upon payment plan; offering stock to creditors, closing stores, laying off employees or renegotiating union contracts. A major provision of Chapter 11 allows a business to void many of its contracts, including real estate leases and those with unions and suppliers.
A creditors' committee is created in Chapter 11 proceedings, and this group represents the majority of the unsecured creditors and works to negotiate payment options from the company that has filed for protection. Some cases may have multiple creditors' committees and stockholders can also form a committee.
The Chapter 11 Process
After filing for Chapter 11, the business becomes what is called a “debtor in possession,” which means they continue regular operations, still have ownership of the company and can maintain control over their assets. No trustee is named at this point.
The business can also avoid some purchases or payments under Chapter 11 protection that happened in the period leading up to the bankruptcy, normally 90 days. Payments or gifts made to friends, family or company insiders typically have a one-year limit and some payments can be returned to the debtor and become subject to the terms of the reorganization plan. This system works to keep businesses from manipulating their assets and giving preference to certain creditors.
There are many steps a company is required to take once they are in Chapter 11 status including creating lists that disclose all of its assets and all the debts that it is seeking protection from. This is called the “creditors’ right to question the debtor,” which is a major part of bankruptcy law. For large companies that make millions or billions of dollars, this step alone can be very time consuming and complex.
Once the debtor submits a reorganization plan, the creditors and the company's stockholders vote on it. Even if the stockholders vote down the plan, the court can go ahead with it if the creditors have approved it. Once the court has approved the plan, the Chapter 11 bankruptcy is certified and confirmed and the company must comply and make the proper payments to the creditors (or to the trustee, if one has been appointed).
Investigating to determine if there has been any fraud or gross mismanagement on the part of the company seeking Chapter 11 protection is part of the court’s process. If this is found, the court will appoint a trustee, who will take over operations for the duration of the proceedings. This means the Chapter 11 business can continue with regular operations, but the original owner is no longer in control.
If federal bankruptcy courts are in charge of the proceedings, the Department of Justice will also assign a U.S. Trustee to oversee the bankruptcy case.
While under Chapter 11, a company can only make the usual sales and purchases that are part of its standard business operations. Examples of things the company cannot do without court approval includes buying or selling property or major equipment, selling off a division or undergoing expansion efforts.
Unfortunately, during the reorganization period, the company's stock value will likely be much less than initial purchase price. If the business begins operating normally after the terms of the Chapter 11 bankruptcy, those stocks may increase in value.
There are several potential consequences if company does not comply with their court-approved Chapter 11 plan including appointing a trustee or conversion into a Chapter 7 bankruptcy.
Experienced Chapter 11 Counsel
Chapter 11 bankruptcy requires the assistance of highly competent legal counsel. Contact us at Newland & Newland, LLP and we will be dedicated to the details of your case to ensure all proceedings are managed as efficiently as possible.