Basics of Chapter 11 Bankruptcy

Most people in the United States have heard of Chapter 7 and Chapter 13 bankruptcy, but know very little about Chapter 11 bankruptcy. But if you need to file for bankruptcy and don’t qualify under Chapter 7 or 13 of the U.S. Bankruptcy Code or you need more control over the bankruptcy process than those forms of bankruptcy offer, then filing under Chapter 11 may be your best option, and you need to understand what it’s about. This article will cover the basic elements of a Chapter 11 bankruptcy very broadly. Upcoming articles will address specific aspects of this form of bankruptcy in more detail.

Who Can File for Chapter 11 Bankruptcy?

Chapter 11 bankruptcy is most often used by large corporations who often don’t qualify for Chapter 13, whose financial structures require the greater flexibility offered by Chapter 11, and whose creditors will get more of their money by letting the business continue operations rather than liquidating it. However, Chapter 11 is available to any business or individual whose debts exceed their ability to pay.

Individuals who use Chapter 11 usually do not meet the income and debt limitations for Chapter 7 and Chapter 13, or they have a complex situation that requires more options than offered by other forms of bankruptcy. For most individuals, though, Chapter 11 costs too much and is too complicated to be worthwhile. Usually, only people with significant wealth organized into a complex array of business structures and trusts or people with unusual strategic goals are able to utilize Chapter 11 rules to their advantage.

What is the Goal of Chapter 11 Bankruptcy?

The goal of Chapter 11 bankruptcy is to payoff and discharge debts and reorganize the finances or operations of the debtor so that they are once again financially solvent. When creditors are likely to get more of their money by letting the debtor continue operating than by selling the debtor’s assets or selling off company divisions, i.e. the whole is worth more than the sum of its parts, Chapter 11 is often a good option. Sometimes Chapter 11 is used to liquidate a debtor company by selling off its various divisions without shutting down operations or dismissing management personnel because more money can be obtained for creditors that way.

How Does Chapter 11 Differ from Chapter 7 or 13 Bankruptcy?

Whereas Chapter 7 bankruptcy results in liquidating (selling off) all of the debtor’s assets and using the proceeds to pay creditors as much as possible with remaining debts being discharged, Chapter 11 bankruptcy is a reorganization process, similar to Chapter 13, so the debtor can regain financial footing without having to sell assets or close the business. However, Chapter 11 doesn’t have the same limitations and restrictions that Chapter 13 does. There is no ceiling to the amount of debt or income the debtor has as long as the debtor is unable to stay current with payments to creditors. Because of the flexibility of Chapter 11, it is sometimes used as a way to sell a company as a going concern.

Chapter 11 also gives the debtor greater control over the process, often determining how long the reorganization plan will take and determining how creditors will be paid. In some cases a debtor can even force a reorganization plan on creditors even if some creditors object to the plan. Because the debtor retains ownership of assets and control of financial decisions, Chapter 11 is known as a “debtor in possession” bankruptcy. However, if a debtor acts fraudulently, deals unfairly with creditors, or grossly mismanages the business or assets, the bankruptcy court may appoint a trustee to oversee operations.

The Absolute Priority Rule

Another main difference between Chapter 11 bankruptcy and other forms of bankruptcies is the Absolute Priority Rule. This rule requires that all creditors be paid in full if an individual debtor or the owners of a business debtor are going to retain ownership of assets or business interests. If any creditors do not get paid in full, then the debtor can retain any assets or business interests. However, in some cases, an experienced and sophisticated bankruptcy attorney can take advantage of other bankruptcy rules to allow a debtor to retain business interests even when some creditors don’t get paid in full. This is called “the new value exception” to the absolute priority rule. Also, there is some dispute across the country about how the rule is to be applied to individual debtors, making it another place where an experienced and skilled attorney can make a significant difference in the outcome of a bankruptcy proceeding.

More Details on Chapter 11 Bankruptcies Coming Up

It is impossible to cover all the details of Chapter 11 bankruptcies in a single article. In future articles we’ll be covering different aspects of Chapter 11 filings in more detail, including what to think about before filing, the Chapter 11 process, explanation of the “cram down” option, and more details about the Absolute Priority Rule.

If you’re located in Maryland and want to know whether a Chapter 11 bankruptcy is the best option for you, bankruptcy attorney John Burns and his firm can evaluate your situation and advise you on whether to file for bankruptcy under Chapter 11. Mr. Burns can also assist in protecting your rights during bankruptcy proceedings and negotiate with your creditors. Call our office at 301-441-8780to schedule an appointment.