Filing bankruptcy can help a debtor who cannot keep up with lenders' demands to make a plan to repay their debts or to have debts discarded.
A debtor must file a petition to open a bankruptcy case with the federal bankruptcy court.
The filer can be an individual, a corporation, another type of organization or even a municipality. Federal courts handle bankruptcy cases according to the U.S. Bankruptcy Code depending on the debtor’s circumstance, there are different types of bankruptcies, which are referred to by chapter.
What is Chapter 11 Bankruptcy?
Chapter 11 bankruptcy is a form of bankruptcy typically used by incorporated businesses that want to reorganize their finances.
It is often called a “reorganization bankruptcy.” This is because the debtor uses the period between their bankruptcy filing until the court’s confirmation of a debt repayment plan to reorganize their finances.
If a debtor does not reorganize and get their debt repayment plan approved, it is likely that the Chapter 11 case will be converted to a Chapter 7 case. A small business debtor will file for relief under two special categories of Chapter 11 that streamline reorganization processes and reduce costs.
Who Qualifies for Chapter 11 Bankruptcy?
An individual, a married couple or a business can file for Chapter 11 bankruptcy. In order to continue to qualify for Chapter 11 bankruptcy, a person or entity must not incur additional liabilities. A business that files for Chapter 11 bankruptcy must show the court that it can meet all of its financial obligations going forward.
This includes paying federal income and payroll taxes. An individual may need to make higher withholding and/or estimated tax payments.
Chapter 11 Bankruptcy Rules
When a debtor files for Chapter 11 bankruptcy, they typically remain in possession of their business, although the assets of the debtor comprise the bankruptcy estate.
The debtor has the powers and duties of a bankruptcy trustee, a person with the power to take responsibility for the financial affairs of a bankruptcy estate. The debtor may distribute assets of the bankruptcy estate to creditors.
A debtor may continue to operate their business. With the court’s approval, they can also borrow new money. A Chapter 11 bankruptcy plan typically lasts between six months and two years. It usually remains on a debtor’s credit history or report for between seven and 10 years after the case has closed.
Process for Chapter 11 Bankruptcy
The basic steps of a Chapter 11 bankruptcy include:
- The proposal of a reorganization plan
- A vote on the plan by creditors whose rights are affected
- A confirmation of the plan by the court
The court will confirm the plan only if it gets the required number of creditor votes and satisfies certain legal requirements.
Initial Steps for Chapter 11
The first step is the debtor’s filing of a petition with the bankruptcy court in the area where the debtor has a permanent dwelling place, has a residence or that is the company or organization’s principal place of business.
A petition may be voluntary, meaning that the debtor files it, or involuntary, meaning that creditors file it. An automatic stay against creditor or lender actions such as collections goes into effect when the bankruptcy petition is filed.
Next, a committee of creditors is appointed by the U.S. trustee, the individual that the court makes responsible for monitoring the Chapter 11 case.
The committee ordinarily is made up of unsecured creditors who hold the seven largest unsecured claims (for which there is no collateral) against the debtor. Then the debtor, except for a small business debtor, has a 120-day “exclusivity period” to file a reorganization plan.
The court may extend or reduce this period. The period, including all extensions, may not be longer than 18 months.
Middle Steps for Chapter 11
After the exclusivity period has expired, a creditor or the case trustee can file a competing plan.
A Chapter 11 case can last for years unless the court, the U.S. trustee, the committee of creditors or another party in interest takes an action to make sure the case resolves in a timely manner.
The debtor or any entity that proposes a plan is required to file and get the court’s approval of a written disclosure statement about the bankruptcy estate before there is a vote on the reorganization plan. The disclosure statement must contain “adequate information” about the affairs of the debtor to enable the holder of a claim to make an informed judgment about the proposed plan.
Final Steps for Chapter 11
After the court approves the disclosure statement, the plan proponent is required to mail the plan to the U.S. trustee, all creditors and equity security holders.
An equity security is a share, interest or right. Examples of equity security holders include a person with a share in a corporation, a limited partner with an interest in the limited partnership, and an entity with a right to sell a security in a corporation.
Then the court confirms the plan of reorganization. This event triggers discharge, meaning the debtor is released from debts that arose before the date of confirmation. The debtor must make payments under the plan. They are bound by the provisions of the reorganization plan.
After confirmation and before “substantial consummation” of a plan, any plan proponent may modify the plan. The modified plan must meet certain Bankruptcy Code requirements. A court may revoke the confirmation order if the confirmation was procured by fraud.
What Are Adversary Proceedings?
A debtor who retains possession of the bankruptcy estate usually files a lawsuit called an adversary proceeding to recover money or property for the estate. These proceedings can take the form of lien avoidance actions or actions to avoid fraudulent transfers.
A creditor may also initiate adversary proceedings by filing a complaint to determine the validity of priority of a lien. A creditor’s adversary proceeding may also have the purpose of revoking the court’s confirmation of a reorganization plan, determining whether a debt can be discharged or subordinating another creditor’s claim.
Subordination involves the other creditor’s claim being ranked lower in priority than the creditor filing the complaint.
What Is a Claim?
A claim can be a right to payment or a right to an equitable remedy for failure to perform a contract, like completing a contract as originally agreed. Any creditor whose claim is not scheduled, meaning that the debtor did not list the claim on their schedules filed with the court, must file a proof of claim.
A creditor whose claim is scheduled as disputed, contingent or unliquidated must also file a proof of claim. A creditor must attach evidence documenting the claim in order to be treated as a creditor for purposes of voting on the plan and distribution under it.
Pros and Cons of Chapter 11 Bankruptcy Proceedings
A Chapter 11 bankruptcy can be beneficial if a person wants to maintain their business rather than closing it.
The cons are that a Chapter 11 bankruptcy will negatively affect the debtor’s credit score, as well as the reputation and health of the business. Yet, a business that is financially viable can recover over time.
What Is Chapter 13 Bankruptcy?
Chapter 13 bankruptcy is typically for individuals, wage earners and sole proprietors, or one-person businesses. It is often called the wage earner’s plan because it allows a person with a regular income to form a plan to repay all or part of their debts.
In a Chapter 13 bankruptcy, a debtor proposes a repayment plan to make installments to creditors for between three to five years.
To qualify for Chapter 13 bankruptcy, an individual must:
- Have a regular income
- Have filed all required tax returns for tax periods that ended within four years of their bankruptcy filing
- Meet other requirements in the Bankruptcy Code
An individual whose debt exceeds the maximum limit for Chapter 13 bankruptcy must also file for Chapter 11 bankruptcy.
Debt Limits for Chapter 13 Bankruptcy
On June 21, 2022, the debt limits for Chapter 13 bankruptcy increased to $2,750,000 for a two-year period. The legislation will sunset, or end, if legislation is not signed into law to extend or modify the debt limits.
Length of Plan Depends on Debtor's Income
If a debtor’s current monthly income is lower than the applicable state median income, the plan will be for three years unless the court approves a longer period for cause.
If the debtor’s current monthly income is higher than the applicable state's median income, the plan usually must be for five years. During the time when the debtor pays installments, a creditor may not start or continue collection efforts.
Chapter 11 vs. Chapter 13
This is an option for individuals, married couples, and entities like companies.
This option is available only to individuals.
There is no debt limit.
There is a specific debt limit.
A party filing does not need to have a required income.
An individual must have a stable income.
A debtor makes distributions to creditors over the period of the reorganization plan.
The court appoints a trustee to distribute the debtor's income to creditors for a three- to five-year period.
Is It Better to File a Chapter 11 or Chapter 13?
Choosing between Chapter 11 and Chapter 13 bankruptcy depends on what the debtor wants to accomplish.
- Chapter 11 — A debtor who wants to make payments to creditors themselves in accordance with a reorganization plan should file for Chapter 11 bankruptcy.
- Chapter 13 — A debtor with a stable income under the debt limit who wants a trustee to distribute their income to creditors should file for Chapter 13 bankruptcy.
Chapter 7 Bankruptcy
Chapter 7 bankruptcy, also known as “liquidation,” involves a trustee taking over the bankruptcy estate. The trustee reduces the assets to cash and makes distributions to creditors. The debtor has the right to retain certain exempt property. An individual, married couple or entity like a business can file for Chapter 7 bankruptcy.
A debtor in a Chapter 11 case has a one-time absolute right to convert the case to a Chapter 7 case unless:
- Debtor is not a debtor in possession.
- Case originally began as an involuntary case, initiated by creditors.
- Case was converted to a case under Chapter 11 not at the debtor’s request.
A debtor in a Chapter 11 case lacks an absolute right to have the case dismissed upon request.
Chapter 11 vs. Chapter 7
This option is available to individuals, married couples, and companies.
This option is available to individuals, married couples, and companies.
The debtor retains control over their business as the court monitors their payments to creditors.
The court-appointed trustee liquidates the debtor’s nonexempt assets to pay creditors.
This chapter is preferable for a debtor who wants to continue operating their business.
This chapter may be a better choice for a debtor who wants to close their business.
Bankruptcy Attorneys For Bankruptcy Law and Process
A bankruptcy attorney can assist a debtor with understanding the differences between Chapter 7, Chapter 11 and Chapter 13 bankruptcies, as well as deadlines and paperwork during the bankruptcy process.
A bankruptcy attorney can also represent a debtor in court if the debtor runs into concerns, such as an inability to make payments according to a reorganization plan for a Chapter 11 bankruptcy. In addition, a bankruptcy attorney can represent a debtor in court to address unfulfilled contracts and unexpired leases.
The court typically holds hearings on contested motions before confirming a reorganization plan. If there are significant delays in formulating a reorganization plan, creditors may file motions for relief from the automatic stay to stop collections. A creditor may also file a motion to convert a Chapter 11 bankruptcy case to a Chapter 7 bankruptcy.
A debtor who wants to continue their business rather than close it should consult a bankruptcy attorney to ensure that they have an adequate argument to counter a creditor’s allegations.
Jessica Zimmer is a journalist and attorney based in northern California. She has practiced in a wide variety of fields, including criminal defense, property law, immigration, employment law, and family law.