Is your business in financial trouble? Do you owe money to creditors, rent and suppliers and have no way to pay? Filing for Chapter 11 bankruptcy under the Bankruptcy Code may be your solution. In this article we tell you everything you need to know about this measure: how to apply, requirements, advantages, disadvantages and, most importantly, what your company’s situation will be like once you pass bankruptcy.
At Ortiz & Ortiz, our New York bankruptcy lawyers have more than 30 years of experience serving the community. If you are having difficulty meeting your financial obligations or those of your business, tell us about your case and we can guide you.
Chapter 11 Bankruptcy definition: Main characteristics
If you have a business or company and you are having difficulty making payments for rent, suppliers, workers, among others, you should know that there are options. One of them is to file for Chapter 11 bankruptcy. This type of bankruptcy is, rather, a financial reorganization of the company. And, while Chapter 11 bankruptcy can be used for individuals, it is most commonly used for businesses.
Chapter 11 bankruptcy gives debtors time to reorganize their debts and come up with a repayment plan. During the bankruptcy process, a court helps the company restructure its finances and, while that happens, the business remains open and operational.
Characteristics of Chapter 11 bankruptcy:
- Debtors filing for Chapter 11 can do so in their personal capacity or on behalf of a company. While both options are available, this type of bankruptcy is more commonly used by businesses.
- Entities that file for Chapter 11 bankruptcy do so because of financial problems due to a temporary recession.
- This measure gives companies financial relief while they reorganize their situation. That’s why Chapter 11 bankruptcy can put a company back on track.
- Businesses filing for Chapter 11 bankruptcy can be a corporation, sole proprietorship or partnership.
- This bankruptcy allows the debtor to reorganize its debts.
- In the interim of the restructuring process, the business can remain open and operating.
- However, during the process, many of the company’s decisions must be made under the supervision of a court.
- Chapter 11 bankruptcy gives the debtor a fresh start. However, the terms of this new phase will depend on the debtor’s self-imposed limits in the debt reorganization.
- In the event that you as the debtor do not have a plan to propose the structuring of the debt, it is the creditors who can perform that task.
- This is the most complex bankruptcy process and also the most costly. As such, it is recommended that you explore other options before deciding on Chapter 11 bankruptcy.
- In order to file for Chapter 11 bankruptcy, an administrative fee of $1,717 must be paid. The same fee will be paid if you wish to reopen a dismissed case. If the fees are not paid on time, the case is dismissed.
Who is eligible for Chapter 11 bankruptcy?
First of all, you should know that any business or individual who meets certain requirements can file for Chapter 11 bankruptcy. However, as we mentioned a few lines earlier, this type of bankruptcy is mainly used by businesses.
1. Large Businesses
In general, this type of bankruptcy is used by large businesses. It does not matter if it is a corporation or a sole proprietorship.
2. Small companies
Since February 2020 it has become a more affordable process for small businesses. This, precisely, since the Small Business Reorganization Act of 2019 (SBRA) which added Subchapter V to Chapter 11 of the Bankruptcy Code. This Chapter became effective in 2020 and is reserved for small business debtors.
What is Subchapter V about?
- This subchapter is reserved for small businesses only.
- The purpose is to make the bankruptcy process faster and to economically resolve small business bankruptcy cases.
- It was created for businesses that have less than approximately $2.7 million in debt and meet other criteria.
- It imposes shorter deadlines to complete the bankruptcy process and gives them greater flexibility in restructuring the business with creditors.
- In addition, a trustee is provided who will work on the preparation of a reorganization plan.
It is common to see this type of bankruptcy used by businesses, but as surprising as it may seem, it can also be used by individuals.
Individuals file for this type of bankruptcy when:
- Debts exceed the limits allowed for filing Chapter 13.
- They have not had a recent bankruptcy case, i.e., within the last 180 days, that has been dismissed for failure to appear or comply with the court.
- Have received credit counseling within the last 180 days.
Note: Also review what other types of bankruptcy exist in the United States. Specifically, read about Chapter 7 bankruptcy and filing for Chapter 13 bankruptcy. Also read our article on Consolidating debt versus filing bankruptcy.
What happens to the business during the Chapter 11 bankruptcy process?
As we said a few lines earlier, the company that is going through the Chapter 11 bankruptcy process will be able to continue to operate as usual. However, there are some points to keep in mind:
- The company will not be able to make some decisions without the permission of a Court.
- Decisions that depend on the Court: Sale of assets other than inventory, initiating or terminating a lease, and stopping or expanding business operations. In addition, there are decisions related to hiring and paying lawyers, as well as decisions related to contracts with suppliers and labor unions. The court must approve of any professionals you wish to employ.
How does Chapter 11 bankruptcy work?
While all bankruptcy processes, whether Chapter 7, 13 or 11 are more or less similar, there are a few things that make a difference. Let’s review step by step how Chapter 11 bankruptcy works.
1. Filing Bankruptcy
- The Chapter 11 bankruptcy filing must be made in the state where the business is registered.
- The petition for bankruptcy can come voluntarily from a debtor or involuntarily from a creditor.
- If the petition is filed by the debtor, it must include documents such as: financial statements, most recent balance sheet, most recent federal income tax return, lists of debts and their respective creditors, and proof of credit counseling.
2. Automatic stay
- Once the bankruptcy petition is filed, the automatic stay begins to apply.
- As with the other chapters of the bankruptcy, this means that all collections from creditors and lenders are automatically stopped.
- The automatic stay ends calls, visits and bills for the duration of the bankruptcy process.
3. Debtor in Possession
- The debtor, which can be an individual or a business, becomes a debtor-in-possession once the Chapter 11 bankruptcy petition is filed.
- Debtor-in-possession means that the debtor will retain its property and, in the case of the business, the business continues to operate for the duration of the bankruptcy process.
- Creditors and lenders or the court may request that a bankruptcy trustee be appointed. This is for the purpose of replacing the debtor in possession if they believe it is in the best interest of the bankruptcy estate and the creditors. Such a situation usually arises when the debtor in possession is thought to be mismanaging the assets.
4. Chapter 11 Bankruptcy Process
- The first thing is that once the bankruptcy petition is filed, the schedules are filed.
- A meeting is held with the creditors.
- The debtor begins to make a reorganization plan to repay his debts.
- This debt reorganization plan must be approved by the court and the creditors.
Within this part, there are a few steps to keep in mind:
#1 Disclosure Statement.
- The debtor must draft a disclosure statement.
- The disclosure statement consists of a document describing the structure of the business and how the debtor manages it.
- This document should contain sufficient information for creditors and lenders to determine if a plan of reorganization is possible.
- The disclosure statement must be approved by the court. This approval must take place before the next step which is confirmation.
- Upon approval of the disclosure statement, the debtor proposes a plan of reorganization to the creditors and lenders.
- The debtor’s proposed plan may focus on reducing costs, seeking new sources of income, temporarily postponing payment to creditors, or other ideas to generate greater returns.
- After the initial bankruptcy filing, the debtor will have 120 days to propose the reorganization plan. After that period, creditors may submit a competing plan. There is also the possibility that the court may reduce or extend the 120-day exclusivity period by up to 18 months.
- All creditors and lenders will be divided into groups based on the type of debt.
- Creditors vote on the proposed plan.
- After the vote, and for the reorganization plan to be valid, it must be approved by the judge.
- The plan must also be approved by impaired creditors, i.e., creditors who will be paid less than what they are owed.
What must be in the reorganization plan for the judge to approve it?
- It must be workable. The bankruptcy court must consider the proposed plan as feasible and with a high probability of success. Key to this will be the debtor’s ability to demonstrate that it has the capacity to earn sufficient income to cover expenses and, in addition, payments to creditors.
- Good faith. The proposed plan must be bona fide and not circumvent or evade the law.
- Best interest of creditors. The “best interest” test requires that creditors receive the same or more than they would receive if the debtor were to file under Chapter 7 of the Bankruptcy Code where all assets would be liquidated.
- Fair and equitable. This means that secured creditors must be paid at least the value of their collateral.
#3 After confirmation
- The plan of reorganization is proposed by the debtor. It may be executed by the debtor or a trustee may be appointed as in Chapter 7 and 13.
- In either case, there will be a trustee to ensure that the debtor does what is required and carries out the proposed reorganization plan.
- There is also the possibility of the court appointing a bankruptcy trustee if there are good reasons for doing so, such as fraud or incompetence on the part of the debtor-in-possession.
5. Chapter 11 Discharge
- Upon confirmation of the reorganization plan by creditors and subsequently by a court, the debtor will receive a discharge of debts.
- The discharge of debts will occur after payments to creditors are completed.
Chapter 11 as a liquidation
- A liquidation plan is also possible in Chapter 11.
- The liquidation plan would close the operations and sell all assets with the goal of paying creditors the debts or at least part of the debts.
Advantages and disadvantages of filing for Chapter 11 Bankruptcy
- The main advantage of this Chapter 11 bankruptcy is that the business can continue to operate normally while it is in the bankruptcy process and reorganization occurs.
- The fact that the company continues to be active will allow for cash flow that can, at the same time, assist in the process of repaying creditors.
- As in other Chapters, the automatic stay is in effect and will keep creditors at bay.
- Creditors are receptive to Chapter 11 because the reorganization plan will allow them to get their money back, or at least a large part of it.
- It will allow you to improve the things that are going wrong.
- In general, it avoids total liquidation of the business.
- It is the most complex bankruptcy process compared to the other chapters of the Bankruptcy Code.
- It is the most expensive of the bankruptcy processes.
- The reorganization plan must be perfectly structured and manageable over time. This considering that it will be approved by the bankruptcy court.
Note: Learn more about the consequences of filing bankruptcy and also review how you can fix your credit score after bankruptcy.
Chapter 11 Bankruptcy Questions and Answers
1. What happens to the owner’s personal assets if the business files for bankruptcy?
- If the business is a corporation, the personal assets of the shareholders are not at risk. What is at risk is the investment made in the company’s stock.
- In the case of a sole proprietorship, this means that the owner is the debtor and therefore does not have a separate and distinct identity from the owner of the company. In that context, a bankruptcy will include the business and personal assets of the debtor-owner.
- If it is a partnership, i.e., it exists separately from its partners, the bankruptcy case may affect the personal assets of the partners in some cases. In order for them not to be affected, they must be adequately protected.
2. Differences between Chapter 7 and Chapter 11 Bankruptcy
- Chapter 7, also known as liquidation bankruptcy, is when the bankruptcy court appoints a trustee to conduct the sale of assets to pay amounts owed to lenders. And in that type of bankruptcy, unsecured debt such as credit card debt is wiped out. However, other types of debts such as tax, student loan or child support debts remain and must be paid to creditors.
- Chapter 11 is a reorganization of a debtor’s debts and assets.
- The main difference between the two types of bankruptcy is that in Chapter 11, the debtor retains full control of its operations and is not required to liquidate assets. It is the debtor who makes a tailored plan.
- The Chapter 11 discharge can take years, while in Chapter 7 it can take only a few months, specifically 4 to 6.
3. Difference between Chapter 13 and Chapter 11 Bankruptcy
- Chapter 11 bankruptcy can be filed by individuals, married couples, corporations, partnerships, small businesses and other types of business entities. Chapter 13 will be filed by individuals and married couples.
- Chapter 13 bankruptcy is a debt adjustment for individuals with regular income and a monthly payment plan. In Chapter 11, a plan of reorganization or liquidation is made.
- Chapter 13 lasts 3 or 5 years. Chapter 11 may last less or more than that.
Note: If you are considering filing for Chapter 11 or other bankruptcy, read our articles on what happens after bankruptcy. How to buy a house after bankruptcy, How to buy a car after bankruptcy and Can I refinance my house after bankruptcy.
New York Chapter 11 Bankruptcy Attorneys
The decision to file for bankruptcy may have been on your mind for a few weeks or months. We know it is a complicated decision, involving many changes. However, it can also bring you relief and allow you to reorganize your debts and, therefore, the financial situation of your company.
In that sense, our business bankruptcy lawyers in New York are ready and willing to analyze your case and offer you the best options:
- They will be able to help you make a thorough analysis of your financial situation and see how serious it is.
- They will be able to advise and guide you through the process of filing for bankruptcy. Represent you at all times, whether in court or before creditors.
- Our attorneys will advise you in order for you to make the best decision regarding your situation.
For these and other services contact us today.