What is Chapter 11 Bankruptcy?

Under the United States Bankruptcy Code, filing a petition for chapter 11 bankruptcy is basically a request for reorganization, and chapter 11 is therefore often called a "reorganization" bankruptcy. Chapter 11 bankruptcy is open to individuals, sole traders, partnerships and corporations, although in reality it is mainly used by corporations as the amounts involved are usually in excess of the Bankruptcy law cap for chapter 13, and their affairs are complicated.

Chapter 11 bankruptcy is not usually used by individuals as proceeding is usually complicated and expensive - chapter 7 or chapter 13 are usually the preferred options.

Exemptions

As with other chapters of US bankruptcy law, chapter 13 has certain conditions which may prevent a debtor, (known in chapter 11 as a "debtor in possession") from filing. These are:

1. If the debtor in possession has had a bankruptcy petition dismissed for failing to appear before the bankruptcy court or comply with an order from the court, or has had a voluntary dismissal due to creditors with liens attached to the debtor in possession's property obtaining relief from automatic stay to recover said property, and this is within 180 days prior to filing the bankruptcy petition, chapter 11 cannot be filed, nor can bankruptcy be filed under any other chapter (11 U.S.C. §§ 109(g), 362(d)-(e)).

2. The bankruptcy petition may be dissmissed under chapter 11 or any other chapter of the Bankruptcy Code if the debtor in possession has not undergone a credit counselling course from an approved credit counsellor within 180 days of filing ( 11 U.S.C. §§ 109, 111).

The term "debtor in possession" is used because the debtor retains control of the business and its assets while the reorganization takes place, without the appointment of a case trustee. A trustee is rarely appointed in a chapter 11 case.

How to File a Petition under Chapter 11

A chapter 11 bankruptcy petition has first to be filed at the bankruptcy court in the area where the debtor is domiciled. The petition can be a voluntary or involuntary petition (11 U.S.C. §§ 301, 303).

Voluntary petition

The debtor must file chapter 11 bankruptcy using Form 1 of the official forms proscribed by the Judicial Conference of the United States. Unless the court agrees to the contrary, the debtor must also file a schedules concerning assets and liabilities, current income and expenditure, executory contracts and unexpired leases and a statement of financial affairs (Fed. R. Bankr. P. 1007(b)).

If the debtor is an individual or husband and wife, then an approved credit counselling course must be attended and a certificate gained on completion. Failure to undergo credit counselling may result in the case being dismissed, as it is compulsory under the Bankruptcy Abuse Prevention and Consumer Protection Act 2005. They must also any records of payments received 60 days prior to filing and details of their current net income and projected future income and expenditure increases after filing chapter 11. A husband and wife petition may be individual or joint (11 U.S.C. § 302(a)).

Fees

Fees must be paid when filing bankruptcy to the clerk of the court, and are $1039, made up of a $1000 filing fee and a $39 "administrative fee". If the debtor obtains permission of the court, the fees may be paid in 4 instalments (28 U.S.C. § 1930(a)), with the total amount paid no later than 120 days after filing, (Fed. R. Bankr. P. 1006(b)), although the court may extend this in special circumstances so that the final instalment is paid no later than 180 days after filing (Fed. R. Bankr. P. 1006(b)).

Only one set of fees is payable for a joint petition. Failure to pay the fees may lead to dismissal of the case (11 U.S.C. § 1112(b)(10)).

Chapter 11 - The Process

Chapter 11 bankruptcy is often referred to as "corporate reorganization" and allows otherwise viable companies to continue trading under the protection of the bankruptcy court, otherwise known as "automatic stay", in that once filed, all creditors may no longer pursue the debtor for payment, other than through the court.

Once the chapter 11 bankruptcy petition is filed, the debtor becomes the "debtor in possession" as explained above. The debtor in possession had control of the business and assets of the business while undergoing the reorganization. Usually the debtor in possession performs the duties of a case trustee. They remain debtor in possession until the reorganization plan is confirmed, the case converted to a chapter 7 liquidation or dismissed, or a chapter 11 trustee is appointed. Upon filing a voluntary petition for relief under chapter 11 or, in an involuntary case, the entry of an order for relief, the debtor automatically assumes an additional identity as the "debtor in possession." 11 U.S.C. § 1101. The term refers to a debtor that keeps possession and control of its assets while undergoing a reorganization under chapter 11, without the appointment of a case trustee. A debtor will remain a debtor in possession until the debtor's plan of reorganization is confirmed, the debtor's case is dismissed or converted to chapter 7, or a chapter 11 trustee is appointed. The appointment or election of a trustee occurs only in a small number of cases. Generally, the debtor, as "debtor in possession," operates the business and performs many of the functions that a trustee performs in cases under other chapters. 11 U.S.C. § 1107(a).

In addition, if a case trustee is appointed, they may in turn form a "creditors committee". This committee is comprised of the seven major unsecured creditors (11 U.S.C. § 1102), who act as a safeguard as to the performance of the business by taking an active interest in the running and financial position of the business. As a consequence they may be involved with drawing up the plan of reorganization, or filing a competing plan with the debtor in possession.

The debtor in possession must file a disclosure statement with the court, detailing assets, unsecured and secured creditors etc, along with a plan of reorganization, so that the bankruptcy court may properly determine if any reorganization plan is feasible in the overall light of the debtors current financial position.

Any third party who has an interest in the business by way of an equity stake may file a proof of interest, as opposed to a proof of claim. If an equity security shareholder's interest is not scheduled as disputed, contingent or unliquidated has to file a proof of interest so that they can be treated as a creditor and therefore have voting rights as regards the plan of reorganization and any distribution rights that apply (11 U.S.C. § 1111).

Provided that the debtor is not a debtor in possession, the initial petition was voluntary and that the chapter 11 petition was not the result of a conversion from another chapter other at the debtor's request, the debtor may convert the case to a chapter 7 straight liquidation case as a onetime absolute right.

Under 11 U.S.C. § 1121(b) has 120 days to file the plan of reorganization exclusively. The court may extend this, but the absolute maximum is 18 months. After that, a competing plan may be filed by a creditor or the case trustee. The US trustee may not file a plan.

It is in the interests of the debtor to file the plan in a timely manner so that confirmation can be granted by the court, rather than delay and give the creditors an opportunity to file a competing plan. In this case the court will consider all plans put forward.

Confirmation of a plan means that the court has to be satisfied that all the requirements of the Bankruptcy code have been satisfied. This includes an acceptance that the plan is (a) feasible, (that there will be no liquidation under chapter 7 or necessary further restructuring) (b) proposed in good faith and (c) that both the plan and its proponent are in compliance with the Bankruptcy Code.

Features of Chapter 11 Bankruptcy

Chapter 11 bankruptcy is often referred to as "corporate reorganization" and allows otherwise viable companies to continue trading under the protection of the bankruptcy court, otherwise known as "automatic stay", in that once filed, all judgments, collection activities, foreclosures, and repossessions of property must cease, and any further representations concerning these matters must be directed at the bankruptcy court judge (11 U.S.C. § 362(a)).

However, a secured creditor can seek an order of relief from stay from the court if the debtor has property which is not necessary for the reorganization and the debtor has no equity in it, to allow the creditor to foreclose on said property (11 U.S.C. § 362(d)).

Under chapter 11, the court oversees a "restructuring" of both the contractual and debt obligations of the company, and can grant either complete or partial relief from the same, allowing the company to make a fresh start.

Given that a corporation is a legal entity in itself, the stockholder's personal assets are not at risk, however, if the debt burden of the company exceeds its asset value, the stockholders, on completion of bankruptcy, have their rights and interests terminated, and ownership of the company passes to creditors, on the assumption or hope that any future profits of the company will serve to offset their financial losses.

In the case of sole traders however, there is no protection from liquidation of personal assets, as they are the legal entity themselves and not a corporation and therefore separate from the business.

Under chapter 11 bankruptcy, the court asks the debtor to present a plan of reorganisation for the court's approval. If the debtor fails to do this, the court may take into consideration suggestions from the creditors. If no plan is approved, the court may decide to convert the case into a Chapter 7 case, or may dismiss the case altogether.

Section 507 of the bankruptcy code lays down priority of claims, with secured creditors such as banks, having higher priority on the proceeds of any sale of company assets.

If the company's stock has been traded on either the New York or American Stock Exchanges, a chapter 11 filing results in the letter "Q" being added to the stock's symbol, and trading is automatically transferred to the NASDAQ.

How Long Does It Take?

The time from filing for chapter 11 bankruptcy to "emerging" from bankruptcy can take from several months, to several years, depending on the complexity of the case.

In this age of globalisation and companies sometimes straddling several continents, it can be difficult to determine which branches or subsidiaries are involved. Indeed, assets can be transferred offshore or hidden deep within an organisation's infrastructure, making unravelling time consuming and complex.

It is possible for individuals to file under chapter 11 bankruptcy laws, but due to the complexity and costs involved, most choose either chapter 7 or chapter 13.