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Chapter 11 Bankruptcy

Chapter 11 Bankruptcy Overview

Chapter 11 Bankruptcy is designed for businesses seeking to reorganize their financial affairs and restructure their debts. It provides a way out of leases and contractual obligations while the business continues to operate. The bankruptcy code requires that all major business decisions must be approved by the court while the company is undergoing the bankruptcy procedure. Like other forms of bankruptcy, Chapter 11 bankruptcy grants the filer an "Automatic Stay" which prohibits creditors from carrying out any collection procedures after the company has filed for bankruptcy.

Chapter 11 Filing Requirements

Chapter 11 Bankruptcy can be filed by all types of businesses.

In order to be eligible for Chapter 11 Bankruptcy, the debtor company needs to fulfill the following criteria:

  • The debtor must file a schedule of assets and liabilities, current income, current expenses, a schedule of contracts and leases, and a statement of financial affairs.
  • If the debtor has failed to appear in court, comply with court orders, or had a prior bankruptcy filing dismissed during the preceding 180 days, then the debtor cannot file for bankruptcy.

Does Chapter 11 Bankruptcy risk personal assets?

Whether the owner's personal assets are at risk from the business's creditors depends on the type of business and the business entity's code of the state they are incorporated or registered in.

  • Corporations: The board of directors and majority stockholders will only be personally liable for the company's debts if it can be proved that they have committed some form of fraud. Minority stockholders will never be personally liable. Therefore, personal assets are unreachable by creditors
  • Limited Liability Company (LLC): Often times called "Limited Liability Corporations", these businesses are a hybrid between a sole proprietorship and a corporation that provides the owner with limited liability for the debts of the company. Unless the owner has committed fraud or is using the business as an alter-ego, they remain personally unreachable by the business's creditors. Stockholders' personal assets are always unreachable.
  • Limited Partnerships (LP): There are two types of partners in an LP, general and limited partners. General (sometimes called managing partners) partners can be held personally liable for the partnership's debts during bankruptcy. Limited partners, if they are reachable by the partnership's creditors, are only liable to the extent of their investment.
  • Limited Liability Partnership (LLP): LLPs exist in some states that have not chosen to adopt Limited Partnerships. Personal partner liability for the company's debts depends on state law. Non-partner members of the firm remain unreachable by the firm's creditors.
  • Partnership: Partners, like sole proprietors, are personally liable for all the obligations of the partnership, and therefore a creditor of the partnership may reach a partner's personal assets unless state law exempts those assets from being reached.
  • Sole Proprietorship: Because a sole proprietorship is not a separate legal entity from the owner, the owner remains personally liable for all the business's obligations and their personal assets are reachable by the business's creditors.

Chapter 11 Procedure

Businesses that file for Chapter 11 Bankruptcy assume the role of "debtor in possession". It means businesses must account for their property, examine claims made by creditors, and file all reports requested by the court. The "debtor in possession" can also seek the help of a lawyer to protect its interests.

Every Chapter 11 Bankruptcy case is assigned to a Trustee who oversees the bankruptcy procedure and the company's major business decisions. The trustee also conducts a meeting between the creditors and the representatives of the debtor to inquire about the financial state of the company.

If the creditors can convince the court that it is in their best interest to convert the Chapter 11 case to a Chapter 7 case, then the business may be liquidated. However, liquidation of the business is typically used as a last resort.

The prime focus of Chapter 11 is to adjust and reorganize the debtor's obligations to keep the business running so it can repay all its obligations.

Usually, the debtor files the reorganization plan, but if the debtor fails to file the plan or get it approved, then creditors can file a reorganization plan on the debtor's behalf.

A company can choose a courtroom close to their headquarters. So, it'll be easier for a company to file for Chapter 11 bankruptcy. "Current federal law allows companies to file for bankruptcy protection - enabling them to close locations, sell operations, renegotiate union contracts and cut debt - either where they are incorporated or where they operate with much smaller affiliates." [ Source]

Reorganization Plan

The debtor must file a reorganization plan within 120 days of filing for bankruptcy. The bankruptcy court may allow the debtor to delay the plan filing for up to 18 months.

The plan is generally approved within 180 days of filing. Approval of the plan can be delayed for up to 20 months by the court.

Liquidation can also be proposed as part of the plan if management believes it is in the company's best interest. Chapter 11 provides more flexibility than Chapter 7 for the liquidation of assets.

The court will confirm the reorganization plan only if the following requirements are met:

  • The plan should be feasible.
  • The plan must be proposed in good faith.
  • The plan must comply with all provisions of the Federal Bankruptcy Code.

The debtor is required to make all the payments as required by the reorganization plan. The discharge is not finalized until and unless all payments are made to the creditors in accordance with the plan.

Additional Resources

Bankruptcy Laws overview | Faqs on Bankruptcy | Bankruptcy Terms

US State Bankruptcy Laws

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