Are you feeling frustrated by sleepless nights due to a failing business and don’t know what to do?
According to statistics published in 2019 by the Small Business Administration (SBA), about 20% of business startups fail in the first year. Nearly half succumb to business failure within five years. By year 10, only about 33% survive.
There is a solution.
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What is Chapter 11 bankruptcy?
A case filed under Chapter 11 of the U.S. Bankruptcy Code is often called a “reorganization” bankruptcy. According to the U.S. Courts website, the debtor remains “in possession,” has the powers and duties of a trustee, may continue to operate its business, and may, with court approval, borrow new money.
Creditors vote on the proposed “plan of reorganization,” and the court may confirm the program if it gets the votes and satisfies specific legal requirements. Chapter 11 usually involves a corporation or partnership. Although it is available to individuals, it is rarely filed by any. The main difference between Chapter 7 and 11 is that the entity filing for bankruptcy remains in control of operations and is not required to liquidate assets.
If an individual files for Chapter 11, it is usually for one of two reasons, a real estate investment reorganization or reorganizing unsecured debts that are too high to qualify for Chapter 13.
How Chapter 11 bankruptcy works
A Chapter 11 case starts with filing a petition with the bankruptcy court serving the area where the debtor has a residence or principal place of business. The petition may be voluntary or involuntary. The debtor files the voluntary petition, and the creditors meet specific requirements.
Unless the court orders otherwise, the debtor also must file with the federal court:
- schedules of assets and liabilities
- a schedule of current income and expenditures
- a schedule of executory contracts and unexpired leases
- a statement of financial affairs
If the debtor is an individual or a married couple filing jointly, there will be additional document filing requirements, including
- a certificate of credit counseling and a copy of any debt repayment plan developed through credit counseling
- evidence of payment from employers, if any, received 60 days before filing
- a statement of monthly net income and any anticipated increase in revenue or expenses after filing
- a record of any interest the debtor has in federal or state qualified education or tuition accounts
An individual cannot file a Chapter 11 or any other chapter if a prior bankruptcy petition was dismissed within the past 180 days due to the debtor’s failure to appear before the court or comply with court orders, or the plea was voluntarily dismissed. In addition, no individual may be a debtor under chapter 11 unless they have, within 180 days before filing, received credit counseling from an approved credit counseling agency.
Chapter 11 and good faith
Before accepting a Chapter 11 filing, the bankruptcy court judge will make certain that the filing has been made in good faith. This requirement is intended to prevent Chapter 11 from being used for anything aside from its original purpose.
One high-profile example of this is the Chapter 11 filing from the National Rifle Association. That filing was dismissed by the judge due to several concerns, including secrecy surrounding the filing and conclusions that the NRA was using the bankruptcy process as a scheme to avoid New York regulations in efforts to relocate its headquarters to Texas.
Cram down and “cram-up” plans
Occasionally in a Chapter 11 filing, the bankruptcy court will approve the reorganization plan despite objections raised by a class of creditors. Less common are so-called “cram-up” plans, where junior creditors accept a reorganization plan, which is then “crammed up” to force objecting senior creditors to accept it as well.
Fees for filing Chapter 11 reorganization
There are costs associated with all bankruptcy filings. The courts will charge a $1,167 case filing fee and a $571 miscellaneous administrative fee but expect to spend at least $10,000 on legal fees. Some have even been known to cost in the millions.
The filer can pay these fees in four installments with the court’s permission. The final installment must be paid not more than 120 days after filing the petition.
According to 11 U.S.C. § 1101, upon filing a voluntary petition for relief under chapter 11 or, in an involuntary case, the entry of an order for relief, the debtor automatically assumes an additional identity as the “debtor in possession.” The debtor keeps possession and control of its assets while undergoing a reorganization under Chapter 11, without the appointment of a case trustee. A debtor will remain a debtor in possession until the debtor’s reorganization plan is confirmed, the debtor’s case is dismissed or converted to chapter 7, or a Chapter 11 trustee is appointed.
Standard documents needed to file
- Chapter 11 Debtor Questionnaire
- Chapter 11 Individual Debtor Questionnaire
- First Day Hearing Agenda
- Forbearance Agreement
- Restructuring Support Agreement
- Restructuring Support Agreement: Joinder
- Board Resolution Authorizing Chapter 11 Filing
- Global Notes for Schedules and Statements of Financial Affairs
Advantages to filing Chapter 11
The most significant advantage is that a business can continue operations during the reorganization process, and creditors are held at bay by an automatic stay. The cash flow generated during this time can help in the repayment process. You can renegotiate certain debts. You get a second chance and extra time to dismiss some debt so your business can get a fresh start. Many creditors are partial to Chapter 11 because there’s a chance for them to recoup more of their money. You can also retain your workforce.
Disadvantages of Filing Chapter 11
Chapter 11 bankruptcy is the most complex of all bankruptcy chapters. It is expensive and lengthy. A company has to consider filing for a Chapter 11 bankruptcy seriously. The legal costs alone can be a bit onerous. In addition, the reorganization plan must be approved by the bankruptcy court and offer a reasonable expectation that they can repay the debt over time.
Who files chapter 11 personal bankruptcy?
A Chapter 11 personal bankruptcy case is a popular option for real estate investors, celebrities, and pro athletes. It is usually only a viable option for debtors who don’t want to liquidate all of their assets or have too much debt to qualify for a Chapter 13 reorganization.
For real estate investors, it allows real estate investors to rewrite mortgages, reduce interest rates and extend the term of repayment up to 30 years, resulting in a lower monthly payment and enabling the property to be profitable again.
To qualify for Chapter 11, debts can’t exceed $1,184,200 in secured debt and $394,725 in unsecured debt.
Chapter 11 bankruptcy process
You can file a Chapter 11 voluntarily, or three or more creditors can force you to file.
The bankruptcy trustee may be assigned to your case. They are an employee of the Department of Justice that plays a significant role in monitoring the progress of your Chapter 11 case and supervising its administration. The U.S. trustee is responsible for monitoring the debtor in possession’s operation of the business and submitting operating reports and fees. Bankruptcy trustees become the C.E.O. of the debtor, exercising such day-to-day control as they deem appropriate. Their duties include evaluating and making recommendations about various debtor demands under the U.S. Bankruptcy Code.
The business has four months to develop a reorganizational plan, but it can take 18 months. If the time limit surpasses this, then creditors can propose a plan. The creditors have to vote on the approval of the program. They are known as a creditors’ committee, a group of people representing a company’s creditors in a bankruptcy proceeding.
There are three classes of creditors: priority, secured and unsecured. It is a payment hierarchy. The ones highest on the rung, the priority creditors, get paid first. It continues down the chain until all claims are resolved.
Secured claims are guaranteed by collateral such as a mortgage holder, receivables lender, or equipment lender. The priority claimants will be paid ahead of unsecured creditors. These can include employees, tax obligations, suppliers, and investors.
Most repayment plans take six months to two years, but there is no time limit.
What’s the exclusivity period?
The exclusivity period is where debtors have the exclusive right to file a reorganization plan within the first 120 days from filing the bankruptcy petition. The bankruptcy court could extend this time.
Chapter 11 bankruptcy filing costs
As of 2020, you will pay a $571 administration fee and approximately $1738 for the petition fee to file a Chapter 11 bankruptcy but expect to pay at least $10,000 in legal fees.
If you ask to divide a joint case (such as converting a partnership into two business owners filing separately), you will pay another $571 in administration fees. In addition, it will cost another $1,167 to file the new motion with divided cases. It will also cost $1,167 to reopen a dismissed case.
Chapter 11 business bankruptcy
The debtor can continue business operations in a Chapter 11 business filing, but the bankruptcy court will approve any significant decisions. A trustee could also be appointed who will be responsible for managing the property of the Chapter 11 bankruptcy estate, operating the debtor’s business, and, if needed, filing a reorganization plan.
The Bankruptcy Court may order a Chapter 11 trustee to be appointed if it finds fraud, dishonesty, incompetence, or gross mismanagement.
Who can claim subchapter v bankruptcy?
Businesses that qualify for so-called Subchapter V bankruptcy must be pursuing business activities and have a debt of less than $2.75 million. At least 50% of that debt must come from business activities. Only the debtor can file a plan under Subchapter V, and no disclosure statement is required.
Can a sole proprietorship file Chapter 11?
A sole proprietorship is owned by one person and thus will not provide the same liability protection as other businesses. However, an owner of a sole proprietorship or a small business debtor may still file Chapter 11 bankruptcy. If this happens, the owner will be allowed to continue to operate the business, but the owner’s assets will be at risk. There may be better options that offer bankruptcy protection, so I recommend consulting a bankruptcy attorney.
Want to learn more about Chapter 11 filings? Check out this video:
What are the chapters of the U.S. Bankruptcy Code?
There are officially six chapters in the U.S. bankruptcy code, and they address different aspects of the process.
- Chapter 7 (liquidation)
- Chapter 9 (municipalities)
- Chapter 11 (reorganization, usually for businesses)
- Chapter 12 (family farmers)
- Chapter 13 (repayments options), and
- Chapter 15 (international bankruptcies)
Out of all of these, Chapter 7, Chapter 11, and Chapter 13 are the most common.
Chapter 7 vs. Chapter 11 bankruptcy
In Chapter 7, the court appoints a trustee to oversee the sale of an individual’s assets. The trustee will determine how much needs to be sold. Unsecured debt, like credit card debt, is usually erased. However, Chapter 7 won’t forgive any taxes owed, alimony and child support, debts that arise after bankruptcy has been filed, debts incurred six months before the bankruptcy filing, fraudulent loans, and federal student loans. Individuals are allowed to keep particular “exempt” property.
Chapter 11 involves reorganizing the debtor’s business affairs, debts, and assets, sometimes called a reorganization bankruptcy. It is most often used by large businesses, though it’s an option for individuals. The primary difference is that the filer remains in control of operations and won’t be required to liquidate assets.
Chapter 7 is a straight liquidation of personal assets, and there is no reorganization plan or restructuring of debt. Debtors can protect some assets like pensions and jewelry. Your co-signer may still be on the hook to pay all or part of your loan.
Chapter 7 legal fees are usually low, but filers will have to pass a means test to be eligible.
If you are going to file a Chapter 7, filing fees are $338 plus attorney fees that can run you $500 to $3,500. The attorney fees will be dependent on the complexity of your case, where you are based, and the attorney himself.
An automatic stay is total debtor protection provided by bankruptcy law. It gives the debtor breathing room from all collection efforts, harassment and foreclosure actions.
When a bankruptcy petition is filed, a stay of creditor actions against the chapter 11 debtor automatically goes into effect. The automatic stay provides a period in which all judgments, collection activities, foreclosures, and property repossessions are suspended.
Chapter 11 vs. Chapter 13 bankruptcy
Both allow businesses to continue operating under reorganization plans. But both have different costs, eligibility, and time to complete.
Chapter 11 can be done by any business or individual with no debt level limits or required income.
Chapter 13 is a wage earners plan for individuals with stable incomes and specific debt limitations. This chapter also includes a trustee who handles all the payments and distributes them to creditors and takes three to five years to complete.
Areas where bankruptcy won’t help
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, a 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.
Considering bankruptcy? Here are the next steps
Bankruptcy can be a difficult time for any individual or business owner. Here are a few tips to consider before determining a bankruptcy plan:
- Get familiar with each type of bankruptcy chapter to determine the best fit for the debtor’s needs.
- Consult a bankruptcy lawyer. Bankruptcy laws are complicated. An experienced attorney will be familiar with the U.S. bankruptcy code and will be able to advise you on your best course of action.
- Consider the costs. Bankruptcy can be expensive for filers. It may not make financial sense to pay the various fees, depending on your financial situation and your debt.
- Consider other debt-relief options, including a debt consolidation company or taking a loan from your savings or retirement plan.
- Talk to a nonprofit credit counselor to discuss your options.
- Call creditors and try to settle debt amounts, especially for consumer debt like credit cards.
- Prepare for a massive hit from all three major credit bureaus. And expect the bankruptcy filing to stay on a credit report for several years.
- Treat bankruptcy as a last resort. It will affect your credit score for up to 10 years.
The bottom line
A chapter 11 bankruptcy is a complicated, costly, and much longer process than a Chapter 7 liquidation. It may not be a perfect fit for all businesses, and it would be wise for someone considering this type of bankruptcy to consult a bankruptcy specialist.
The Small Business Reorganization Act of 2019 aims to make small business bankruptcies faster and less expensive. Generally, the Act only applies to business debtors with secured and unsecured debts of less than $2,725,625. The Act includes the following provisions: the appointment of a Trustee, streamlining the reorganization process, the elimination of the New Value Rule, modification of certain residential mortgages, delayed payment of administrative claims, and a discharge of limitations.
The New Value Rule eliminates the requirement for equity holders in the small business to affix a “new value” to their equity interests without paying creditors in full.
When a company or individual files for bankruptcy, they must first list all their debts.
While secured debt uses the property as collateral to support the loan, unsecured debt has no collateral attached to it. In secured debt, interest rates are lower with longer repayment terms and typically higher loan limits.
An unsecured claim is a payment request made to the bankruptcy court by a creditor who doesn’t have the right to sell the property to satisfy the underlying debt. Credit card companies, medical bills, gym memberships, most personal loans, and utility companies often file unsecured claims.
The case trustee or the bankruptcy trustee is the person who appears at the 341 meeting of the creditors to inquire about the debtor’s veracity of their bankruptcy. The case trustee liquidates the debtor’s assets in a Chapter 7 bankruptcy and pays the creditors out of the repayment plan in a Chapter 13 bankruptcy. Case trustees are paid a commission from the bankruptcy estate based on its size.
The Attorney General appoints U.S. Trustees, so they work for the Department of Justice. They are responsible for supervising and appointing case trustees to bankruptcy cases, teaching them how to do their jobs. U.S. Trustees are paid out of the United States Trustee System Fund, financed by petitioners’ bankruptcy filing fees. Their primary responsibility is evaluating bankruptcy petitions and pursuing bankruptcy fraud. U.S. Trustees can also file adversary proceedings to revoke debtors’ discharge orders or request the bankruptcy court dismiss their cases.