Chapter 11 Bankruptcy Basics
- What is Chapter 11 bankruptcy?
Known as a “reorganization” bankruptcy, Chapter 11 bankruptcy allows businesses and individuals to reorganize their debts and repay their creditors over time. While Chapter 11 is the most expensive and complicated form of bankruptcy, Chapter 11 bankruptcy can be a good fit for some businesses because it generally allows business owners to remain open and retain control of their operations as they repay their creditors.
An essential component of Chapter 11 bankruptcy is that debtors must come up with a written plan for how they will repay their debts, and where applicable, continue to operate their businesses. The plan must be approved by a certain proportion of creditors to whom the debtor owes money before being confirmed by the court.
Once a debtor initiates their Chapter 11 bankruptcy by filing their bankruptcy petition, an automatic “stay” or suspension is triggered on all collection activities, foreclosures, and civil litigation against the debtor. The debtor’s pre-bankruptcy debt may be discharged, or forgiven, during the bankruptcy process. All post-bankruptcy debt will not be discharged.
Certain small businesses are eligible to file as small business debtors under Subchapter V of Chapter 11, which allows for faster case processing, lower administrative costs, and other favorable terms for debtors. Please see our FAQs below for more information on whether your business qualifies.
Although businesses commonly file for Chapter 11 bankruptcy, an individual debtor with considerable personal investments, assets, income, or debt may choose to file. Chapter 11 also offers individual debtors additional protections that may be more advantageous than Chapter 13.
- Which parties are involved in a Chapter 11 bankruptcy case?
In addition to the debtor, several other parties are involved in the case.
A United States Trustee is appointed to each Chapter 11 bankruptcy case to oversee case administration and help enforce bankruptcy laws. US Trustees are employees of the United States Department of Justice. Debtors must pay them quarterly fees during a Chapter 11 bankruptcy case to cover their administrative expenses.
The role of a United States Trustee varies from administering the case, appointing creditors’ committees, presiding over creditors’ meetings, collecting quarterly fees, and appointing a trustee for the matter upon the direction of the bankruptcy court. Further, the United States Trustee ensures that all costs are paid, documents and reports are filed, and there are no unnecessary delays in the case. The United States Trustee also collects the financial and operating reports required to be filed by the debtor until a plan is confirmed.
The case also involves a team of advisors to represent the interests of the debtor and the creditors. These professionals may include financial and investment advisors, and attorneys. Attorneys are required to represent business debtors that are structured as partnerships, limited liability corporations (LLCs), and corporations.
A United States Trustee must not be confused with a trustee. A trustee is generally an attorney or certified public accountant (CPA) appointed by a United States Trustee to take control of the debtor’s business and property only under extraordinary circumstances in Chapter 11 cases. Because a business debtor has a duty to act in the best interest of their creditors and stakeholders, trustees are only appointed in Chapter 11 cases when parties to the bankruptcy can provide clear and convincing evidence that a debtor is incompetent and has committed wrongdoing. Once appointed, the trustee has mostly the same obligations as the debtor, which include running the business and creating a reorganization plan.
Finally, one of the most important parties in a Chapter 11 bankruptcy case are the creditors. These are all the lenders and vendors to whom the debtor owes money. Creditors play an important role in approving a debtor’s reorganization plan.
- What is the general timeline of a Chapter 11 bankruptcy case?
While it is not always feasible, debtors should plan their bankruptcy far enough in advance to gather the data for their bankruptcy petition and better ensure the success of their case.
After filing their Chapter 11 bankruptcy petition, business debtors can continue to operate. During this pre-confirmation phase, debtors work on developing their reorganization plan that details how and when they will be able to repay their creditors. In the case of business debtors, the plan will also detail how they will continue to operate their business. This phase lasts for six to twelve months and depends on factors such as the type of plan proposed, condition of the debtor, and plan acceptance by creditors.
The second phase begins once the plan has been confirmed by the court and the debtor begins repaying their creditors and other components of their plan. For business debtors, any qualifying debt is discharged once the plan is confirmed. This phase can last from three to five years or more, depending on the duration of the plan.
- What are the court costs in a Chapter 11 case?
Debtors must pay a filing fee for Chapter 11 cases to the bankruptcy court clerk at the time of filing. Additionally, debtors owe a quarterly fee ranging from $250 to $10,000 per quarter to the United States Trustee that manages the case. This quarterly fee varies based on the total disbursements made by the debtor to creditors during the quarter.
- What types of relief can a debtor obtain under Chapter 11?
Once a debtor files a Chapter 11 case, all foreclosures, civil litigation, and creditors’ collection actions against the debtor and their property are automatically stayed or suspended, except under limited circumstances with the bankruptcy court’s approval.
Creditors may not contact the debtor to collect on debt once the Chapter 11 case is filed. Debtors do not need to make payment on debts while the case is pending, which can take anywhere from a few months to a few years. This provides much-needed relief for business debtors to improve cash flow and reorganize their businesses.
Additionally, once a bankruptcy case is filed, a business debtor may find it easier to raise capital with debtor-in-possession (DIP) financing. DIP financing can enable businesses to fund their ongoing operations, reorganize, and prepare to pay off debts.
Another benefit of Chapter 11 is that business debtors also get the chance to reject their executory contracts, such as commercial leases, when it is in their best business judgement to do so. The rejected contracts will still get a claim in the bankruptcy proceedings.
Once a plan is confirmed in a Chapter 11 business bankruptcy case, all the debtor’s dischargeable debt is forgiven. In the case of individual bankruptcy cases, dischargeable debt is only forgiven after the debtor completes all their payments under the reorganization plan.
The only matters that can continue while a Chapter 11 bankruptcy case is pending are the following types of legal proceedings:
- Those brought by governmental agencies to enforce police powers.
- What is a plan of reorganization under a Chapter 11 bankruptcy?
Debtors have the right to create and submit their own bankruptcy reorganization plan to the court. A Chapter 11 reorganization plan restructures a business’s or individual’s debts so that they:
- Have more time to repay their debts.
- Can retain their assets.
- Can continue to operate their business (for business debtors).
Many businesses also plan to reorganize their business operations to fix the systemic issues that led to the bankruptcy in the first place. Generally, businesses filing for Chapter 11 bankruptcy opt to scale back their operations to both reduce expenses and free up assets to repay creditors.
Businesses generally have four months to come up with a debt reorganization plan after filing for bankruptcy, but that length of time can be extended up to 18 months with court approval. If debtors do not submit a reorganization plan, sometimes their creditors will submit one instead.
Chapter 11 plans must be approved by creditors holding at least two-thirds of the total debt and more than half of the total number of claims. Under certain circumstances, a bankruptcy judge may approve a plan without this measure of support under a “cramdown.”
- How long are plans of reorganization?
Chapter 11 plans do not have a specific time limit, but they should be long enough for the court and creditors to believe that the debtor is making a good faith effort to repay most of their debt. Generally, a Chapter 11 plan is set between three to five years for small businesses.
- Which debts are discharged during a Chapter 11 bankruptcy case?
Certain debts are discharged, or forgiven, by court order during Chapter 11 bankruptcy cases. This means that debtors are no longer liable to pay these debts, unless otherwise specified in their Chapter 11 plan. Courts grant discharges to business debtors after their reorganization plan is confirmed by the court, and to individuals only after they have made all payments under their plan.
Whether debts are dischargeable varies depending on whether the debtor is an individual or business, and for business debtors, whether their confirmed bankruptcy plan is for reorganization or liquidation.
For business debtors with reorganization plans, all debt that occurred before the Chapter 11 bankruptcy plan was confirmed will be discharged without exceptions. Business debtors that file liquidation plans and do not engage in business after the plan is confirmed will not receive any debt discharge.
For individual debtors, all pre-confirmation debts are dischargeable, except those that would not be dischargeable in a Chapter 7 case filed by the same debtor:
- Most unsecured debts are dischargeable, such as credit card debt.
- Many secured debts are dischargeable, but debtors need to surrender the collateral that backs the loan if they stop paying the debt. This includes things like mortgage and car loans.
- Non-dischargeable debts include student loans, certain tax debts, lawsuit judgements, and other debts.
- What is a Chapter 11 liquidation?
Most businesses file for Chapter 11 bankruptcy to avoid liquidation of their assets and continue operating their business as normal. However, liquidation may be allowed under a Chapter 11 bankruptcy under certain circumstances.
Under liquidation, a debtor’s assets are sold, and the resulting funds are used to repay creditors. For businesses, this means their operations will stop for good. Businesses may opt for Chapter 11 liquidation to secure a better economic outcome than they would get from a Chapter 7 liquidation case.
Who Can File for Chapter 11 Bankruptcy?
- Who is permitted to file for bankruptcy under Chapter 11?
Any business, individual, or consumer can file for Chapter 11 bankruptcy if:
- They can afford the related expenses of the filing.
- The cost of filing justifies the intended financial results.
- The purpose of the filing is reorganization, rehabilitation, or liquidation.
There is no minimum revenue requirement for businesses that file for Chapter 11, and eligible entities include Limited Liability Corporations (LLC), S and C Corporations, Partnerships, and Sole Proprietors.
Individuals who file for Chapter 11 bankruptcy must also receive credit counseling from an approved credit counseling agency within 180 days before filing, either in a group or individual setting.
- Who cannot file for Chapter 11 bankruptcy?
Individuals or businesses cannot file for bankruptcy under Chapter 11 if they have had another bankruptcy case dismissed within the previous 180 days.
Certain entities are ineligible to file for Chapter 11 bankruptcy, including governmental agencies, estates, nonbusiness trusts, stockbrokers, commodity brokers, insurance companies, banks, and Small Business Administration (SBA) licensed small business investment companies.
- Does Chapter 11 have any financial or insolvency requirements?
There are not any financial or insolvency requirements for debtors filing a voluntary Chapter 11 case. Voluntary debtors who file under Chapter 11 may:
- Be solvent or insolvent.
- Have assets or liabilities that exceed each other.
- Have nonexistent income.
The Role of Creditors in Chapter 11 Bankruptcy
- How does a creditor become entitled to payment in a Chapter 11 case?
A claim is a right to repayment during bankruptcy proceedings. If a creditor’s claim is listed on the debtor’s schedules, and it is not is not disputed, contingent, or unliquidated, then creditors do not need to take additional action. This means that the creditor’s claim matches the amount and priority listed on the debtor’s schedules.
A proof of claim is required for a creditor to get paid during bankruptcy proceedings if they are not listed in the debtor’s schedules, or their claim is disputed, contingent, or unliquidated. A creditor can file a proof of claim in bankruptcy with the court to register their right to, or claim against, assets in a bankruptcy estate. A proof of claim details how much money is owed to a creditor on the date of the bankruptcy filing, and any priority status, if applicable. The bankruptcy estate may accept or reject the claim.
Once the claim is filed and has no objections, the creditor should continue to monitor the case for a final payment plan confirmation.
Debts are repaid in order based on whether a creditor’s bankruptcy claim is fully secured, undersecured, or unsecured. Unsecured creditors are further prioritized based on whether their claims are priority or nonpriority.
- What is a fully secured creditor?
A fully secured creditor holds a bankruptcy claim that is secured by property or collateral that equals or exceeds the total amount of the claim. Generally, if a borrower agrees to guarantee payment of a debt using collateral, the creditor will be fully secured. Fully secured creditors must be paid in full during bankruptcy proceedings, in cash. They are also owed interest for deferred cash payments.
- What is an undersecured creditor?
An undersecured creditor holds a claim which is secured by collateral or property that is worth less than the total amount of the claim. These creditors are entitled to protection for the secured part of their claim. The remainder of their claim that is not secured by collateral is treated as an unsecured claim. Undersecured creditors are generally not entitled to interest on delayed payments.
- What is the difference between a priority unsecured claim and a nonpriority unsecured claim?
Priority unsecured claims are not secured by collateral but are given priority for bankruptcy payments because the repayment of these debts benefits the public. These may include wage claims, consumer deposit claims, administrative expenses of the Chapter 11 case, divorce claims, and tax claims. A nonpriority unsecured claim is paid at the end of bankruptcy proceedings, after all other priority secured and priority unsecured claims are paid. Nonpriority unsecured claims may include credit card debt, judgements from lawsuits, and trade credit debt, or debts to vendors that a business has not yet paid.
- How does a priority or nonpriority claim affect an unsecured creditor?
Unsecured creditors do not have the right to collateral from the debtor to back the value of their claim. Their claims are paid in order of whether they are priority, priority tax claims, or nonpriority.
- Priority claims are debts that are not dischargeable in bankruptcy proceedings, meaning the debtor must repay these debts. Priority claims must be paid first before other debts after a Chapter 11 bankruptcy is confirmed. These payments must be made in cash, unless a creditor agrees to or chooses another method of payment. All priority claims that are not tax claims are paid at the time that a bankruptcy plan is confirmed or based on an agreement between the parties.
- Priority tax claims are also not dischargeable. These claims are repaid in cash installments, plus interest, over a period of five years or less after the case is filed.
- All priority claims must be repaid first before any nonpriority claims are paid. Creditors with nonpriority claims must receive at least as much as they would under a Chapter 7 bankruptcy filing. Payments can be made in cash, property, or securities of the debtor or the successor. Most trade creditors, or suppliers who have provided goods or services to the debtor and have not yet been paid, have nonpriority claims.
- What is a creditors’ committee?
A creditors’ committee is appointed by the United States Trustee and is designed to represent the interests of creditors in a case. This committee must be appointed in a Chapter 11 case and is usually composed of the seven largest unsecured creditors that are willing and able to serve on the committee.
Creditors’ committees may enlist the help of professionals, such as attorneys, whose fees are paid by the debtor’s estate. They also may negotiate with debtors and other creditors to ensure a fair and equitable reorganization plan is developed.
Plan Voting and Confirmation
- Can creditors discuss and vote on the plan?
The court first approves or conditionally approves a disclosure statement, which lists the assets, liabilities, and business affairs of the debtor. Creditors can then discuss the proposed payment plan internally before voting on the plan. Each eligible creditor is mailed a ballot, a copy of the disclosure statement, and a copy or summary of the proposed plan. The court sets a deadline for voting on the plan, by which all creditors’ ballots must be filed with the court.
- Which creditors can vote on the plan?
A creditor is eligible to vote on a Chapter 11 plan if their claim is allowed by the court. Except for certain priority claims, a court puts each claim into a class as part of a Chapter 11 bankruptcy plan. To be eligible to vote on a plan, a class of claims must:
- Be impaired by the plan, or not paid in full.
- Receive something under the plan.
Classes of claims that are paid in full under the plan, or unimpaired, are considered to accept the plan. Classes of claims that do not receive any funds are considered to reject the plan. Creditors in either of these classes do not have the ability to vote on the Chapter 11 bankruptcy plan. All other classes of creditors are eligible to vote on the plan.
- How is a plan accepted or rejected by creditors?
Each class of creditors vote on the Chapter 11 plan. A court can confirm a plan if it is accepted by at least one class of creditors with impaired claims. A plan is considered accepted by a class of creditors when it is accepted by creditors that hold at least one-half of the claims in the class and at least two-thirds of the class’s claims in dollar value.
- What is a plan confirmation?
After creditors and interest holders vote on a Chapter 11 plan, the bankruptcy court will hold a confirmation hearing to determine whether to confirm the plan. At this hearing, the debtor or other party proposing the plan must provide evidence that the plan meets Chapter 11 confirmation requirements. If the plan is confirmed, a bankruptcy judge signs an order to approve the plan. The debtor and all creditors and interest holders are then legally bound to follow the plan.
- What is a “cramdown” versus a regular method of confirmation?
The court can confirm a plan under the regular method of confirmation when:
- All classes of impaired claims approve the plan.
- The debtor proves that the plan complies with Chapter 11 confirmation requirements.
When one or more classes of impaired claims have voted against the plan, and at least one of these classes has voted for it, the court can confirm the plan under a cramdown. The debtor must show that the plan:
- Meets Chapter 11 confirmation requirements.
- Is equitable and non-discriminatory toward all classes of claims that rejected or did not accept the plan.
Creditors are required to accept the terms of a cramdown.
- Can a court reject a Chapter 11 bankruptcy plan?
If a court chooses not to confirm a Chapter 11 plan, it will usually give the party proposing the plan the opportunity to modify the plan. Once the plan is updated, the court holds another confirmation hearing. If the court does not want to confirm any plan, the Chapter 11 bankruptcy case will either be dismissed or converted to Chapter 7 bankruptcy. Chapter 11 is usually a debt reorganization bankruptcy, while Chapter 7 is a liquidation bankruptcy. Under Chapter 7, debtors must liquidate their assets to repay as many creditors as they can.
- What happens after plan confirmation?
Once a plan is confirmed, it must be executed by the debtor or the successor to the debtor as laid out in the plan. If the plan requires the debtor to be reorganized or to form a new corporation, this must happen first. Then, as specified by the plan, the debtor or successor must transfer property, create or modify liens, and pay creditors.
- Once the debtor complies with the terms of the plan, how is the case closed?
A Chapter 11 plan is complete once all its payments and provisions have been satisfied. The debtor or the trustee must file a final report and account with the court, which details the administrative expenses paid and payments made to creditors. Then the court will close the case.
- What happens if a debtor defaults on a Chapter 11 plan?
If there are sufficient grounds, the court will allow a plan amendment to enable a debtor to comply with the plan’s terms. Otherwise, the Chapter 11 case will be dismissed or converted to a Chapter 7 bankruptcy case. If dismissed, creditors may use collection methods such as filing a lawsuit or foreclosure proceedings to recover their assets.
- If a business debtor fails to carry out their bankruptcy plan, are the discharges still valid?
Yes, for business debtors. Discharges are valid even if a business debtor does not complete the confirmed plan. Courts can revoke bankruptcy plans and invalidate discharges, but this is very rare.
Individual debtors do not receive discharges until after they have completed all payments under their Chapter 11 bankruptcy plan. However, there are limited circumstances when individual debtors may receive a Chapter 11 discharge despite not having completed payments under the plan.
Small Business Debt Reorganization Act (SBDRA), or Subchapter V of Chapter 11 Bankruptcy
- What is the Small Business Debt Reorganization Act (SBDRA)?
The Small Business Debt Reorganization Act of 2019 (SBRA) allows small business debtors the opportunity to reorganize their debt in a faster and more cost-effective manner than Chapter 11 bankruptcy, but with many of the same advantages. SBDRA allows companies to reorganize under Subchapter V of Chapter 11 bankruptcy.
- Who qualifies as a small business debtor under SBDRA/Subchapter V?
A small business debtor can be a sole proprietor, corporation, or partnership that:
- Conducts commercial or business activities, not including owning or operating real estate property.
- Owes $2,725,625 or less in at the time of filing that is:
- Noncontingent: The debtor is currently liable for this debt, not pending an event in the future.
- Liquidated: The debt amount is specific and determinable.
- Secured or unsecured: Secured debt is backed by collateral that is equal to the amount of the loan and may include things like mortgage and car loans. Unsecured debt may include credit card and vendor payments and is not backed by collateral.
Under the Coronavirus Aid, Relief, and Economic Security (CARES) Act of 2020, the debt limit for SBDRA was increased to $7,500,000, effective for one year beginning March 27, 2020.
- How can a debtor choose to be treated as a small business debtor?
Debtors who qualify as small business debtors must check the box indicating this status on their Chapter 11 petition. This will ensure that they are treated as a small business debtor, unless the court orders otherwise.
- What are the advantages to being treated as a small business debtor under Subchapter V?
It is generally more affordable for a small business debtor to file bankruptcy under Subchapter V than under regular Chapter 11 because certain administrative costs are eliminated. For example, debtors under Subchapter V do not have to pay US Trustee’s fees or the expenses of creditors’ committees like they do under Chapter 11. Additionally, the debtor can pay the administrative expenses of the case over the life of their bankruptcy plan.
It is also faster to file for bankruptcy under Subchapter V for a multitude of reasons, including:
- No creditors’ committee is required.
- Plans are due within 90 days, instead of 180 under Chapter 11.
- Plans can be approved without the approval of any class of creditors.
Additionally, the debtor retains more control under Subchapter V. Only the debtor, and not creditors or other interested parties, can file a reorganization plan. Debtors are also the only parties that can modify the plan after it is confirmed. This is an advantage because if, for example, the debtor’s business improves significantly after the petition is filed, a creditor cannot request that the plan be modified to increase the amount of their debt payments.
- What are the drawbacks of Subchapter V for debtors?
Debtors must appoint a trustee in Subchapter V cases. Luckily, trustees generally will not operate the debtor’s business. Instead, trustees assist the debtor with proposing and confirming a plan, making distributions to creditors under the plan, examining proofs of claims from creditors, and other duties.
Additionally, the accelerated schedule of Subchapter V can be difficult for some debtors, and extensions for submitting a plan can be hard to obtain.
Subchapter V also requires debtors to apply their projected disposable income over a three-year period, or its equivalent in property, to creditor payments under their reorganization plan. For some debtors, it can be difficult to project their three-year disposable income due to business fluctuations.
Debtors must include a remedy in their plan for how they will repay creditors if they default on their debt payments. This can include, for example, liquidating their non-exempt assets. Debtors can avoid this requirement by proving that they will be able to make all payments as required under the Subchapter V plan, but this is difficult to achieve.