Business owners and sole proprietors sometimes take on more debt than they can handle, leading to bankruptcy, which can lead to financial hardships for the owners personally. This can happen to individuals as well. The cause can be anything from poor management to a global recession.
As business slows and cash runs short, too much leverage can feel like quicksand. If you want to try and salvage the business, you can use Chapter 11 to restructure debt and the business. This holds creditors at bay while you work. It’s complex, slow, and expensive, and not for the impatient.
A company in Chapter 11 has years to repay its debts, which can be a lifesaver for struggling firms.
Even individuals and sole proprietors may file Chapter 11 cases to restructure debt. That said, corporations make up the majority of filers.
In Chapter 11, creditors sometimes play an active role in negotiating the outcome.
Under the Bankruptcy Code, the debtor (you or your company) “reorganizes” or “restructures” the business under Chapter 11, a type of bankruptcy described as a ”reorganization bankruptcy”. Chapter 11 allows you to keep possession of the company while you seek financing to restructure it and your debts. Usually the company continues to operate during the process, although not always.
Chapter 11 companies are called ”debtors in possession” because you are in possession of the company and responsible for running it. There is no trustee in charge of the company. Rather, there may be a trustee to monitor the case to report on your compliance with certain laws, like timely payment of employees and important outside parties. It’s typical that the trustee requires regular reports about the business’ condition.
Part of the plan is usually downsizing the company’s property, operations, and staff to cut costs and free up assets.
Unlike other bankruptcies, a committee of your top unsecured creditors (loan with no collateral like a building) helps make sure your case is handled fairly for everyone.
Holdout creditors who will not be paid back in full for amounts owed in the plan are ”impaired”. They get to vote on the plan, and if they vote it down the court can override it. This is a ”cram down”. In cram downs, the judge will usually confirm the plan if they find it fair and equitable.
The goal is to sort out financial knots and give you a fresh start. It is mainly used by large businesses that need time to get out of heavy debt. The cost of Chapter 11 plus the years it can take to resolve one are why smaller companies and individuals often choose Chapter 13 or Chapter 7 bankruptcy instead.
Because of cost and the drawn-out process, small business owners may file instead under Subchapter V or a ”Small Business Case”. These are streamlined, do not usually require formation of a creditors’ committee, and involve the oversight of a trustee. Eligibility for a Small Business Case depends on debt limits and other rules.
Chapter 11 is expensive, starting with $1,167 to file. You will also pay $571 to the court, plus a quarterly trustee fee that begins at $325 and rises depending on the amount you disburse to creditors, to as much as $30,000 in a quarter. After that come the copying fees, document retrieval fees, document amendments, drafting the plan, and the attorneys that you will need to help you manage this. No, that’s not all. This only covers the start of the process.
You start your case by filing a petition for bankruptcy in the bankruptcy court. Your case is called ”voluntary” if you file it. It is ”involuntary” if your creditors (who must meet certain requirements) file against you.
The debtor is usually required to provide a complete financial disclosure to the creditors and bankruptcy court. These may include:
- Schedules of Assets and Liabilities
- Budget (income & expenses)
- Schedule of Executory Contracts and Unexpired Leases
- Statement of Financial Affairs (SOFA)
Individuals must include proof of required credit counseling and a debt repayment plan.
At the petition, an automatic stay goes into effect as it does with Chapter 7 and 13. This halts creditors, which cannot start or continue collection, eviction, or foreclosure actions.
In certain circumstances, a court can allow a secured creditor to get around the automatic stay. They can ask the court to let them foreclose and sell collateral that the debtor does not need and in which it has no equity. As you can see, the stay is not absolute.
The debtor’s attorneys and trustee who are handling the case may ask to be paid every three months. In very large cases, where the debtor is continuing to operate its business, professionals may file fee applications more often.
Reorganization Plan
As a company prepares to file for Chapter 11 bankruptcy, along with the disclosures it must file a reorganization plan, so it has to map out its recovery before it ever files. As hard as it seems, it is a good exercise for every company, as it forces you to focus on all aspects of the business.
The plan may include selling unneeded properties, layoffs, and promising to seek new sources of funding. The debtor must sort claims into classes. Each class gets its own treatment in the plan, be it repayment plans, changes to interest rates, or the debt being discharged.
Examples of the order in which claimants are repaid:
- Secured creditors: lenders who have an interest in the company’s property
- Priority unsecured claims
- General unsecured creditors: they hold no collateral
- Equity security holders: shareholders
A Chapter 11 debtor has to explain their bankruptcy plans to creditors in a disclosure statement, and the court must approve it before creditors vote on it. After the votes are in there is a confirmation hearing. Once discharged, the business still has to keep repaying its debts.
For owners, the personal cost of Chapter 11 depends on how their business is organized. A corporation is a separate legal entity from the shareholders, and they usually are not responsible for its debts. But the stock may have little or no value left. In proprietorships, the owner will take the full brunt of the hit to credit.
Whatever the structure, the bigger the case, the longer it takes to unwind.
One of the main advantages of the filing is that the debtor has the chance to break leases, contracts, and other costly arrangements that were eating into profits. They can also explore better financing opportunities. Other debtors have used the process to sell assets to raise cash.
Your creditors are not going to give up their investments without a fight. Creditors are working for money, too, and they’re not happy to let a big debt go for nothing. Debtor and creditor will negotiate intensely while the court weighs the best options for both. Dealings can drag on and take years.
In a Chapter 11 reorganization case, the company may seek to sell off parts or all of the business. Unlike a Chapter 7 liquidation, creditors may get more of a say in sale terms and how proceeds will be used than they would in a liquidation.
At its best Chapter 11 can help salvage a failing firm that might otherwise have to close. It has rescued General Motors, American Airlines, and J.C. Penney. That said, Chapter 11 is complex, is drawn out, and can be very expensive.
In the end, full reorganizations are rare. How many Chapter 11 cases end in a successful reorganization? Debt.org estimates that only 10% to 15% end in a reorganization. Depending on the circumstances and how the case is handled, a Chapter 11 filing can do long term damage to customer relationships, your market reputation, and company brand.
About Delancey Street
Delancey Street is a premier, and award winning, business debt settlement company that helps business owners nationwide. Our goal is simple: help you escape debt in a safe and legal manner. Based out of New York, we can help in 49 of 50 states. We tell you how it is; because your business and future is on the line.
