In the past, only large corporations could afford the costs associated with Chapter 11 bankruptcy. Fortunately, Chapter 11 has evolved, and large and small businesses can use it to stay open. Individuals who don't qualify for Chapter 13 can file, too. In this article, you'll learn:
Did you know many business owners file for personal bankruptcy to get out from under a personal guarantee? Find out whether you're responsible for business debt and how erasing personal debt can help you keep your business open or move forward after closure.
Businesses turn to Chapter 11 bankruptcy when pinched financially, often due to a temporary downturn. It can help a viable business keep its doors open long enough to regroup and reimagine a future-forward strategy.
It doesn't matter whether the company avoids paying vendors, has difficulty meeting payroll or rent, or struggles with another obligation due. The debt relief afforded by Chapter 11 gets businesses back on track. Here's how it works.
All bankruptcy chapters work by stopping the collection process. Once filed, the "automatic stay" prohibits most creditors from pursuing the individual or business filer, giving the filer, creditors, and the court breathing room to address finances in an organized fashion.
For instance, the stay will temporarily stop:
Unlike other bankruptcy chapters, a bankruptcy trustee isn't in charge of the business and other bankruptcy property. The filer continues to run the everyday functions as a "debtor in possession" during the Chapter 11 bankruptcy.
However, small business bankruptcies filed under Chapter 11, Subchapter V are subjected to more oversight.
The goal of Chapter 11 is to create a financial plan that the filer, creditors, and the court agree will enable the company to remain open and prosper. The plan can include modifying interest, payment due dates, and other terms—it can even discharge (erase) debt entirely.
Most plans require at least some downsizing of the debtor's operations to reduce expenses and free up assets. In some cases, "liquidating plans" shut down the debtor's operations and provide for the orderly sale of its remaining property. However, a debtor can accomplish this in a Chapter 7 business bankruptcy for much less. Learn more about small businesses in Chapter 7 bankruptcy.
If all necessary creditors approve of the plan, it becomes a new contract, and the filer receives the debt discharge immediately. If the court approves the plan without creditor consent, such as in Chapter 11, Subchapter V, the filer must make all required payments before receiving the debt discharge.
When possible, most debtors elect to file for bankruptcy under Chapter 7 or 13 to avoid the time, cost, and risk involved in Chapter 11 proceedings. So your first step should be to learn about personal bankruptcy and bankruptcy options for small businesses.
Find more information about how filing for bankruptcy affects small businesses, qualifying for Chapter 7 bankruptcy, and eligibility for Chapter 13 bankruptcy.
Because most small businesses will benefit more from the straightforward procedures offered by Subchapter V, you'll find a brief explanation of Subchapter V, followed by a Chapter 11 overview highlighting the differences between the two chapters.
For the most part, small businesses and major corporations must follow the same rules and requirements when reorganizing under Chapter 11. However, special provisions help small business debtors move through the Chapter 11 process more quickly while reducing legal fees and other restructuring expenses.
A company qualifies as a "small business debtor" by meeting the small business case requirements under Chapter 11, Subchapter V:
Benefits and special procedures applying to small business Chapter 11 matters include:
No Creditors' Committee. Ordinarily, in Chapter 11 cases, a committee is appointed to represent the interests of unsecured creditors. A creditors' committee can retain attorneys and other professionals at the debtor's expense, significantly increasing the cost of Chapter 11 reorganization. Small business cases don't involve creditors' committees.
Additional Filing and Reporting Duties. Small businesses are subject to some reporting and filing requirements not imposed on other Chapter 11 debtors. A small business debtor, for example, must attach its most recently prepared balance sheet, statement of operations, cash flow statement, and federal tax return to its bankruptcy petition when it files for Chapter 11 relief.
Additional U.S. Trustee Oversight. The United States Trustee's office is the agency that oversees bankruptcy cases on behalf of the Department of Justice. Under bankruptcy laws, small business cases are subject to more oversight by the U.S. Trustee's office than other Chapter 11 proceedings.
Plan Deadline. Generally, there is no deadline for filing a Chapter 11 plan unless set by the bankruptcy court. However, the debtor has only 300 days to propose a Chapter 11 plan in small business cases. The court can extend the 300-day deadline, but only if the debtor proves that it can obtain approval of a plan within a reasonable period.
Longer Exclusive Period to Propose Plan. In some cases, creditors file competing Chapter 11 plans. Chapter 11 plans filed by creditors typically provide for the liquidation or takeover of the debtor's assets and business. The debtor usually has the exclusive right to propose a Chapter 11 plan for 120 days. In small business cases, the exclusivity period is 180 days. The extended exclusivity period reduces the debtor's risk of the business closing while litigating competing plans.
No Disclosure Statement. Ordinarily, in Chapter 11, the debtor must prepare a disclosure statement, submit it to the bankruptcy court for approval, and circulate copies to creditors and other parties in interest. Disclosure statements in Chapter 11 cases are similar to prospectuses for stock offerings. They must provide extensive information about the debtor and proposed plan and are often expensive to prepare. The bankruptcy court can waive the disclosure statement in small business cases to significantly expedite the reorganization process and reduce legal and other costs.
A Chapter 11 case begins with filing a petition in bankruptcy court. Generally, Chapter 11 cases are voluntary, and the debtor takes the initiative and seeks bankruptcy relief. Occasionally, however, creditors will band together to file an involuntary bankruptcy petition against a defaulting debtor.
Business debtors can file bankruptcy where they are located or are "domiciled" (incorporated or otherwise organized). For instance, companies incorporated in Delaware sometimes choose Delaware instead of their home states.
There is no absolute limit on the duration of a Chapter 11 case. Some Chapter 11 cases wrap up within a few months, but it's more usual for it to take six months to two years for a Chapter 11 case to come to a close.
While the debtor ordinarily continues running the business as a debtor in possession, the bankruptcy court must approve:
Creditors, shareholders, and other parties in interest may support or oppose actions that require bankruptcy court approval. The bankruptcy court will consider input from creditors and other parties when deciding how to proceed. However, formal votes by creditors and equity holders are taken only in connection with proposed Chapter 11 plans.
Unsecured creditors participate in the Chapter 11 case through a committee appointed to represent their interests. The unsecured creditors' committee can retain attorneys and other professionals to assist at the debtor's expense.
The filer must fully disclose background information so that a creditor can make an informed decision about the feasibility of the proposed plan. The fact that creditors can object to the disclosure statement and the actual plan creates two rounds of costly litigation. After approving the disclosure statement, the court sets dates for plan objections and creditor voting.
Ordinarily, the debtor has the exclusive right to propose a reorganization plan for the first four months. However, the court can extend the debtor's "exclusivity period" to 18 months after the petition date. This provision is one of the reasons why Chapter 11 is so costly.
Once the exclusivity period expires, the creditors' committee or other parties can propose alternate reorganization plans. But more often, creditors or other parties dissatisfied with the debtor's progress will move to dismiss or convert the case to Chapter 7.
Creditors can vote on whether they accept a proposed Chapter 11 plan. At least one class of "impaired" claims must vote in favor of a Chapter plan. An impaired claim is an obligation the plan won't pay in full upon plan confirmation or when originally due.
In reality, the debtor and creditors can agree to any plan. However, if a creditor objects to the plan, the court will consider factors, including:
Feasibility. The bankruptcy court must find that the proposed plan is feasible or likely to succeed. The debtor must prove the ability to raise sufficient revenues to cover expenses and creditor payments.
Good Faith. The plan must be proposed in good faith and not seek to further an agenda forbidden under the law.
Best Interests of Creditors. The "best interests" test ensures the proposed plan pays the creditor at least as much as the creditor would have received if the debtor had filed a Chapter 7 liquidation and the Chapter 7 trustee sold the debtor's property and distributed the proceeds.
If the debtor has a lot of assets, the "best interests" test could require the debtor to pay creditors in full. However, most Chapter 11 debtors are financially underwater and meet the "best interests" test by paying creditors only a fraction of what they owe.
Fair and Equitable. The plan also must be "fair and equitable." Under the "fair and equitable" test:
Counsel must represent all businesses that file for Chapter 11. A bankruptcy attorney will be in the best position to explain your options and the specific procedures you can expect in your case.
Did you know Nolo has been making the law easy for over fifty years? It's true—and we want to make sure you find what you need. Below you'll find more articles explaining how bankruptcy works. And don't forget that our bankruptcy homepage is the best place to start if you have other questions!
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