What Is Chapter 11 Bankruptcy?

How Does Chapter 11 Bankruptcy Work? 

Chapter 11 bankruptcy is a legal process that allows a business to reorganize its debts and continue operating while working out a plan to pay back creditors over time. Most individuals who file bankruptcy would not use Chapter 11. Instead, they'd typically file Chapter 7 or Chapter 13.

A Chapter 11 bankruptcy starts the same way as all other types of bankruptcy. The bankruptcy filers submits a petition to their local bankruptcy court. The court assigns a case number and teh automatic stay takes effect. Then, the court schedules the meeting of creditors .

Depending on the filer’s situation, a Chapter 11 can work either as a reorganization — similar to a Chapter 13 — or a liquidation, similar to a Chapter 7. 

What Is a Chapter 11 Reorganization Bankrupcy?

Chapter 11, often called "reorganization bankruptcy," allows a business to restructure its debts while keeping the business running. Instead of shutting down, the business works with creditors to create a repayment plan that fits its financial situation.

This plan may involve reducing the debt, extending payment terms, or selling some assets. The goal is to help the business recover financially while still paying back what it owes. It's mostly used by larger companies, but small businesses can also file for Chapter 11.

How Does a Chapter 11 Reorganization Plan Work?

When you file for Chapter 11 bankruptcy, you need to create a plan to repay your debts. This plan outlines how you’ll handle your financial obligations and may involve renegotiating terms with creditors. The goal is to give you time to reorganize and stabilize your business while still paying off what you owe.

To make it fair, creditors are grouped into different classes based on the type of debt they hold:

• Secured creditors: They have a lien on your property, like a mortgage or car loan.

• Unsecured priority claims: These debts, such as certain taxes or employee wages, are given priority for repayment.

• Non-priority unsecured claims: These debts, like credit card balances or medical bills, are paid after priority claims.

If you’re a business, stockholders or partners might also be classified as equity security holders.

Only you, as the filer, can propose a reorganization plan within the first 120 days of filing. If you're a small business, this period extends to 180 days. After this window, creditors can submit their own plans if yours hasn’t been accepted.

Before creditors vote on your plan, they must receive a disclosure statement. This document gives them enough information about your financial situation to make an informed decision. In small business cases, the court might decide the plan itself provides enough details, so a separate disclosure statement isn’t needed.

Who Gets Paid First in Chapter 11 Bankruptcy?

The order in which creditors get paid is crucial. Generally, secured creditors and those with priority claims are at the front of the line. Non-priority unsecured creditors are next and may sometimes receive partial payments or none at all. If your business has equity security holders, they’re typically paid last, if at all.

Creditors can object to their classification and the proposed payment plan. To move forward, at least one class of creditors with impaired claims—those not being paid in full—must approve the plan. The plan needs two-thirds of the total dollar amount and over half of the number of claims in that class to vote in favor for it to be accepted.

What Is Chapter 11 Plan Confirmation?

Once your reorganization plan is drafted and approved by creditors, the court will hold a confirmation hearing. The court checks to make sure the plan follows bankruptcy laws, was proposed in good faith, and meets all necessary requirements. If the court confirms your plan, your Chapter 11 case can be closed temporarily until you've completed the plan, which helps you save on fees.

Who Oversees a Chapter 11 Case?

In most Chapter 11 cases, there's no bankruptcy trustee appointed. Instead, you act as the "debtor in possession," meaning you keep control over your business or financial affairs during the bankruptcy process. Your duties include managing assets, filing tax returns, and objecting to claims.

The U.S. Trustee, a government official, monitors your case to ensure you're meeting your responsibilities. If you prefer, or if the court finds you’re not capable of managing your case properly, a bankruptcy trustee can be appointed to take over these duties.

Can Chapter 11 Bankruptcy Be Used for Liquidation?

Yes, Chapter 11 bankruptcy can also be used to liquidate a business. In a liquidating plan, the business shuts down, and its assets are sold off to pay creditors. This process can sometimes be more favorable than Chapter 7 liquidation because the business owner (acting as the debtor in possession) and the creditors have more control over how the liquidation is handled.

Just like in a reorganization under Chapter 11, a bankruptcy trustee might be appointed, but it’s not always necessary. The decision depends on the specific circumstances of the case.

How Is a Chapter 11 Different From a Chapter 13?

While both Chapter 11 and Chapter 13 are forms of bankruptcy, they serve different purposes and have distinct requirements. Here’s a quick comparison of the main differences:

• Who Can File: Chapter 11 is for businesses, individuals, and married couples, while Chapter 13 is only for individuals and married couples.

• Income Requirement: Chapter 11 doesn’t require regular income, but Chapter 13 does to ensure the filer can make regular monthly payments over the course of the 3–5 year repayment plan.

• Plan Flexibility: Chapter 11 offers flexible plans for reorganization or liquidation, whereas Chapter 13 plans are structured to last 3–5 years.

• Plan Details: Chapter 11 requires a detailed plan and disclosure statement, while Chapter 13 plans are less detailed and don’t need a disclosure statement.

• Plan Proposals: In Chapter 11, creditors can propose a plan if the filer doesn't, but in Chapter 13, only the filer can submit a plan, usually with the help of a bankuptcy attorney.

• Trustee Involvement: Chapter 11 allows the filer to act as the debtor in possession, while Chapter 13 cases are always managed by a bankruptcy trustee.

• Debt Limits: Chapter 11 has no debt limits, but Chapter 13 has strict debt limits that must be met to qualify. The current debt limit for Chatper 13 is $2,750,000. This means your combined secured and unsecured debts can't be greater than that number.

How Is Chapter 11 Bankruptcy Different From Chapter 7?

Chapter 11 and Chapter 7 serve different purposes within the bankruptcy process. Here’s a quick comparison to help you understand the key differences:

• Reorganization vs. Liquidation: Chapter 11 focuses on reorganization, allowing businesses to restructure debts and continue operating. Chapter 7 is a form of liquidation bankruptcy becuase any assets that aren't protected by exemptions can be sold off. (Though this is very rare.)

• Control Over Operations: In Chapter 11, the filer typically retains control over the business during reorganization or liquidation. But in Chapter 7, a trustee takes control.

• Liquidation Process: Chapter 7 liquidation is straightforward, following the Bankruptcy Code with no separate plan needed. Chapter 11 liquidation follows a court-approved plan and can involve more flexible strategies.

• Flexibility and Decision-Making: Chapter 11 offers more control and flexibility for the filer and creditors in deciding how to liquidate assets. Chapter 7 follows a more rigid, trustee-led process.

• Cost and Complexity: Chapter 11 comes with higher costs, more reporting requirements, and complex steps toward plan confirmation. Chapter 7 is generally quicker and less expensive.

Let's Summarize...

The majority of people file for personal bankruptcy protection under Chapter 7 bankruptcy or Chapter 13 bankruptcy. It's rare for an individual or married couple to file Chapter 11 bankruptcy. In reality, Chapter 11 is not for the typical consumer. Most often, Chapter 11 cases are filed by businesses looking to restructure debts or liquidate assets and property. 

Learning about your debt relief options is a good place to start if you're unable to pay your debts as they become due. Consider meeting a bankruptcy attorney for a free consultation and take our bankruptcy screener to see if you’re a fit for Upsolve's free web app.