Most people have a general familiarity with chapter 7 and chapter 13 bankruptcies, which are the most common types of bankruptcy filed by individuals, but they may not know much of the lesser heard of Chapter 11 bankruptcy. When we do hear about Chapter 11 bankruptcy, it is generally in reference to a large corporation, like the bankruptcies for General Motors, KMart, and United Airlines. However, most Chapter 11 bankruptcies are filed by companies that you haven’t heard of and will most likely never become household names. Chapter 11 bankruptcy is sometimes filed by individuals who exceed the debt limits for chapter 13 bankruptcy.
Chapter 11 bankruptcy tends to be expensive, time consuming, complicated, and potentially risky. It is also the only bankruptcy option available for small businesses that are owned by a partnership, limited liability company, or corporation to restructure and continue in operation. Once the Chapter 11 bankruptcy is filed, the debtor, be it an individual or a business, becomes the debtor in possession and has the majority of the rights and responsibilities of a bankruptcy trustee.
These rights and responsibilities include obtaining loans for the debtor, accepting or rejecting contracts, and other powers exercised with court approval. If it is believed that the debtor in possession is not working in the best interest of the bankruptcy estate and creditors, they may be replaced with a bankruptcy trustee.
At the beginning of Chapter 11 bankruptcy proceedings is the formation of a creditors’ committee to represent the majority of the unsecured debt’s creditors. This committee’s role is to negotiate the best payment options for them. Large-scale cases may have multiple creditors’ committees, each representing different groups and factions of the creditors.
Stockholders can also form a committee. These committees may retain the services of attorneys or other professionals at the debtor’s expense. In the case of small businesses, the bankruptcy court may order that no creditors’ committee be formed.
In a Chapter 11 bankruptcy, debts are reorganized and repaid through a plan approved by the bankruptcy court. This restructuring of debt generally involves a reduction of obligations and modification of payment terms. These changes allow the company to balance income and expenses, providing a way to return to profitability.
While under Chapter 11, a company can only make the usual sales and purchases that are part of its standard business operations. That means that it can’t buy out another company or sell off a division of the company without approval from the court. Chapter 11 bankruptcy proceedings allow debtors to cancel or renegotiate certain other contracts, such as union contracts, leases, and supplier contracts. The debt restructuring and repayment must be approved by the creditors’ committee and the bankruptcy court and may include layoffs, closing of locations, and more.
Once the restructuring plan is approved, it is generally executed by a third party. For example, if the plan requires $30,000 to be paid toward creditors every month, that payment is made to a plan agent who will disburse the funds to the creditors. Once the terms of the plan of restructuring have been fulfilled, the bankruptcy is discharged by the court.