What is Chapter 11?

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Definition:

Chapter 11 is a type of bankruptcy that primarily businesses use to restructure their debts in order to make them more manageable.

🤔 Understanding chapter 11

When people or companies can’t pay their bills, declaring bankruptcy can help them manage their debt. Chapter 11 is a type of bankruptcy that lets debtors reorganize their finances and restructure their debts while continuing to operate. Rather than eliminating debt altogether, Chapter 11 can help make payments manageable by extending due dates, reducing the amount owed, or making other changes to terms. While Chapter 11 is available to individuals and businesses, individuals rarely opt for this type of bankruptcy. Companies that want to stay open can go for Chapter 11, while those that want to liquidate their assets and shut down usually choose Chapter 7 bankruptcy.

Example

In 2017, Toys “R” Us filed for Chapter 11 bankruptcy. The toy retailer had $4.9B in debt, including $2.1B in interest payments due in the next two years. It was the third-largest retail bankruptcy ever at the time.

After the bankruptcy, the company closed many of its stores and tried to use its remaining locations to generate enough revenue to repay its debts. After a weak holiday season, the company moved to liquidate the remaining assets in its US business, so it could pay what debts it could with the proceeds.

Takeaway

Chapter 11 is like rebuilding a house of cards…

When a business uses debt to expand or pay for other expenses, it can be like building a house of cards. If something unexpected happens, the company may not be able to pay the money back, which can knock the cards over and ruin the business. Chapter 11 lets companies take down the house of cards and rebuild, hopefully using sturdier materials that are better able to withstand unexpected events in the future. Restructuring existing debts, perhaps by reducing monthly payments or extending their terms, can prevent a company from defaulting on its loans entirely.

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What is Chapter 11?

Bankruptcy provides relief to people and businesses who cannot pay their debts. Depending on the type of bankruptcy, courts can either eliminate or reorganize those debts to allow the debtor to start fresh.

Chapter 11 (named after the place it falls in the bankruptcy code) is a reorganization bankruptcy, usually for corporations or partnerships that want to stay in business. It doesn’t eliminate debts — Instead, it helps debtors restructure their debts and financial affairs to help them repay some or all of their obligations. Individuals or companies that plan to liquidate their assets usually use other forms of bankruptcy.

Either a debtor or creditors can file a petition for Chapter 11 bankruptcy in federal court. The debtor typically files a voluntary petition when the person or company wants to restructure the business and their debts. Creditors usually file an involuntary petition after multiple missed payments as part of an attempt to recoup losses.

One important aspect of Chapter 11 bankruptcy is that the debtor usually keeps control of his or her assets while going through reorganization. An outside trustee is only rarely appointed. That means that a business declaring Chapter 11 bankruptcy can usually continue running itself rather than having an outsider take over management of the company.

Who is eligible to file a Chapter 11?

Virtually any person or business with debts they cannot pay may file for bankruptcy, but Chapter 11 bankruptcy has a few other requirements:

  1. The filer cannot have had a bankruptcy case dismissed in the past 180 days due to an intentional failure to appear or comply with court orders.
  2. The filer cannot have had a bankruptcy case voluntarily dismissed after creditors sought relief from the court.
  3. Filers must provide the following documentation:
  • A list of assets and liabilities
  • A list of current income and expenses
  • A list of existing contracts and leases they have to abide by
  • A statement of their other financial affairsIndividuals or married couples must also file:
  • A certificate of credit counseling
  • A copy of any repayment plan developed during counseling
  • Evidence of payments received from employers in the past 60 days
  • A statement of net monthly income and expected increases in income or expenses
  • A record of any interest the debtor has in federal or state education and tuition accounts
  1. Filers need to pay $1,167 plus a $550 administrative fee, either when filing or in installments within 120 days.

Typically, individuals don’t file for Chapter 11 bankruptcy unless they have significant amounts of debt.

What is the difference between Chapter 11 and Chapter 7 bankruptcy?

With a Chapter 11 bankruptcy, a business can restructure its debts and business affairs. That means that the company continues operating and has the chance to pay its debts over time. If things go well, a business can survive the bankruptcy proceedings.

In Chapter 7 bankruptcy, the filer does not want to continue running the business. Instead, the process involves liquidating the company, selling most of its assets, and using the proceeds to pay creditors based on bankruptcy regulations. The business owner isn’t responsible for the liquidation. Instead, the court appoints a trustee to handle the sale of the business and repayment of debts. This is different from Chapter 11, where the business owner can typically retain control of the company while working to pay off debts.

Businesses and individuals typically use Chapter 7 more frequently than Chapter 11. If an individual files for Chapter 7 bankruptcy, the debtor’s must liquidate most assets, excluding:

  • Cars, up to a specific value
  • Necessary clothing (not luxury or designer clothing)
  • Reasonable household goods and furniture
  • Appliances
  • Pensions
  • Professional tools, up to a set value

Individuals may choose Chapter 11 if they want to avoid the liquidation process, for example if they own a small business and want to keep it running.

What is the Chapter 11 bankruptcy process?

To start the Chapter 11 bankruptcy process, either the debtor or creditors must file a petition.

Once the debtor files for Chapter 11 bankruptcy, the person or business becomes a "debtor in possession." This is a legal designation that lets the debtor retain control over his or her assets, even while undergoing the bankruptcy process. The person or entity remains the debtor in possession until the court confirms a plan of reorganization, dismisses the case, converts it to a Chapter 7 bankruptcy, or appoints a Chapter 11 trustee.

Filing also creates an automatic stay, which protects the filer from collection activities, foreclosures, and judgments during the bankruptcy process.

A debtor in possession has a number of duties, including, “accounting for property, examining and objecting to claims, and filing informational reports as required by the court and the US trustee or bankruptcy administrator.” He or she also has to file tax returns and other reports.

A Chapter 11 trustee is a third party responsible for monitoring a Chapter 11 bankruptcy case. The trustee oversees the debtor’s actions and has the power to question the debtor under oath about his or her efforts to run the business. The trustee can also set requirements for the debtor in possession, forcing the debtor to report financial information regularly or organize financial accounts a certain way.

The debtor in possession pays the trustee a fee, ranging from $325 to $30,000 per quarter. If the debtor fails to pay the trustee or meet requirements, the trustee can file a motion asking the court to convert the case to a different type of bankruptcy or dismiss it.

After a debtor files for Chapter 11 bankruptcy, creditors form a creditors’ committee. The trustee appoints the members, usually choosing the seven creditors holding the most unsecured debt (debt without collateral). The committee provides additional oversight and helps the debtor in possession create a reorganization plan.

Once the court confirms the reorganization plan, typically the debtor is freed from any debts incurred before this date. Instead, the person or company must now make payments as outlined in the plan.

If the business or person follows the plan and fully settles all debts and payments, he or she completes the bankruptcy process. The bankruptcy court issues a final decree and closes the case.

What is a reorganization plan?

Once debtors file for Chapter 11 bankruptcy, they have the exclusive right to submit a reorganization plan within 120 days (plus another 60 days with a court-approved extension). After that time period, creditors may file a competing reorganization plan.

The reorganization plan outlines the borrower’s current debts and creditors. It also describes how the debtor plans to change business activities and sell assets to pay the debts. The reorganization plan can request that some or all of the creditors settle for less than the full amount owed or ask to amend repayment terms.

Once the debtor submits the plan to the court, each lender whose claims against the borrower are altered (or impaired) by the plan votes to confirm or deny it. They can also counter with a different plan.

The debtor also files a disclosure statement, which includes:

  • A description of the business
  • An explanation of why it is filing for bankruptcy
  • A description of its assets, debts, and other financial information
  • Historical financial statements
  • A liquidation analysis
  • A description of post-confirmation management staff, including their salaries
  • A disclosure of professional fees paid or to be paid
  • A statement regarding any insider transactions or claims
  • A description of any pending or contemplated litigation
  • Tax consequences (like capital gains, if property is sold)

The court then holds a hearing to decide whether to confirm or deny the proposed course of action.

What elements must be included in a Chapter 11 reorganization plan?

Chapter 11 reorganization plans have to include the following information:

Classification of each creditor’s claim (secured creditors, unsecured creditors, etc.). Those classes will later help determine the order in which creditors get paid.

Details on how the program treats claims in each classification. Each claim in the same class must receive the same treatment unless the creditor agrees otherwise.

Explanation of how the debtor plans to implement the plan by describing:

  • The assets the debtor will sell
  • Which debts the debtor wants to cancel or modify, and how
  • Any alternative forms of payment, such as paying debtors in stock or other properties

Plans must also be:

  • Feasible
  • Submitted in good faith
  • Equitable to all the creditors involved
  • In the creditors’ best interest

For individuals filing Chapter 11, the plan must also include a provision outlining a percentage of future income they must use to pay creditors.

How long does a Chapter 11 bankruptcy last?

Chapter 11 bankruptcy can take anywhere from months to years to play out. The length of the bankruptcy depends on the complexity of the filer’s financial affairs and the amount of debt they have. A small business that files for bankruptcy will typically spend less time on the process than a multi-billion dollar corporation.

One time-based limit on Chapter 11 bankruptcy is that, for individuals, the court may not confirm a plan if a creditor objects, unless the debtor commits all disposable income over the next five years to debt payments.

Can a company survive Chapter 11?

The goal of a Chapter 11 bankruptcy is for a business or individual to reorganize their affairs and survive the process. This is different from other types of bankruptcy, like Chapter 7, which liquidate all of the filer’s assets. Many companies make it through. For example, Delta Airlines, filed for Chapter 11 bankruptcy in 2005 and continues to operate today. United Airlines and Texaco are other companies that have survived Chapter 11 bankruptcy.

Still, it can be difficult for a business to make it through Chapter 11. In many cases, attempts at reorganization fail, and companies end up liquidating all or some of their assets.

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Sign up for Robinhood and get your first stock on us.Certain limitations apply

The free stock offer is available to new users only, subject to the terms and conditions at rbnhd.co/freestock. Free stock chosen randomly from the program’s inventory. Securities trading is offered through Robinhood Financial LLC.

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