What is Chapter 11 Bankruptcy?

Chapter 11 is a reorganization of finances in bankruptcy of a formal business entity such as a corporation or limited liability company (LLC). Individuals, however, sometimes must file under Chapter 11 if they want to reorganize and the individual’s debts exceed the limits of Chapter 13.

As of this writing (August, 2010), an individual debtor has to file under Chapter 11, if his unsecured debts equal or exceed $360,475 or his secured debts equal or exceed $1,081,400. Debtors with homes in expensive parts of the country, including some areas of the District of Columbia, Maryland and Virginia, may find they have to file a Chapter 11 case to reorganize.

Reorganization and Restructuring

In a bankruptcy reorganization the debtor has the opportunity to restructure the finances of the business (or the individual) with the goal, usually, of preserving the enterprise as a “going concern.” An orderly liquidation or sale of the business (at a better price than could usually be achieved in a Chapter 7 quick sale) are often effectuated, also, through Chapter 11.

If reorganization is elected, the restructuring can be achieved through a variety of mechanisms including modifying secured loans, discharging or paying selected unsecured debts, rejecting or assuming leases, and selling selected assets.

Directing the restructuring, in most cases, is the debtor himself, who, upon filing the case is vested with a new title, “Debtor in Possession” (DIP), and a new role, trustee running the enterprise and seeking to maximize the value for all creditors. The DIP, however, is subject to removal for failing to perform his duties and obligations. Also the case itself can be dismissed or converted to a Chapter 7 liquidation (particularly when there are valuable assets) if the case is not showing progress toward a viable reorganization.

Creditors and Plan Confirmation

Plan confirmation varies from Chapter 13 in one major way. The plan is confirmed by the court, but in addition, the creditors have a say in that they must be allowed to vote on the plan.

Creditors are divided into classes having similar interests. For example, most unsecured creditors will be in one class. Each secured creditors usually will be put into one class consisting only of that creditor.

A class will be considered to have voted for the plan when it garners, of the creditors who actually vote, more than one–half in number, and more than two–thirds in dollar amounts, of the creditor’s claims.

At least one impaired class of creditors (a class whose rights have been proposed to be altered by the plan) will have to vote in favor for the court to be able to confirm the plan, and then only if it meets special requirements for a Chapter 11 plan “cram down.”

Other significant obligations of the debtor in Chapter 11 include monthly financial reports on operations to the creditors and the court, quarterly fees to the US Trustee based on disbursements, and a detailed “disclosure statement” to the creditors accompanying the plan when votes are solicited which gives the creditors sufficient information to make an informed decision on whether or not to accept the plan.

Chapter 11 provides the debtor with great flexibility to structure a plan. Likewise, the flexibility requires more time and effort from counsel and the principals of the debtor to cut the various deals to make the plan workable.

Also, Chapter 11 tends to have much more participation from creditors than other chapters, and sometimes can be quite adversarial with many motions and opposition by creditors, particularly if the relationship between debtor and creditor is a hostile one.

As a consequence, Chapter 11 is much more complex, expensive, and the most unpredictable of the various types of bankruptcy, more akin to litigation than the more administrative Chapter 7 and lightly adversarial Chapter 13.