Chapter 11 – Understanding How Ch. 11 Bankruptcy Works
Chapter 11 is a legal process that involves reorganizationType A ReorganizationA Type A reorganization is a statutory merger or consolidation, which is classified under Section 368 of the IRC. Type A reorganizations are also … of a debtor’s debts and assets.
It is available to individuals, sole proprietorships, partnerships, and corporationsOtherArticles covering other finance topics ranging from Warren Buffett to hedge fund strategies. These other finance topics are an interesting read. It is most commonly used by corporations.
The reorganization allows the business to continue operations but under supervision, subject to the debtor’s fulfillment of some of his obligations.
Since it is the most expensive of all bankruptcy cases, a business should do a careful analysis of all other bankruptcy alternatives before settling for Chapter 11.
Once a business has filed a Chapter 11 bankruptcy, it is allowed to operate under the management of a debtor, commonly referred to as a debtor in possession.The debtor in possession takes control of the business operations and is tasked with accounting for property, and examining claims and employment of professionals such as accountants, attorneys, and auctioneers.
A trustee supervises the compliance of the debtor in possession with the reporting requirements set by the court.
The Process for Chapter 11 Bankruptcy
A Chapter 11 case starts with the filing of a petition in the bankruptcy court where you are a resident. The petition may be voluntary or involuntary.
A voluntary petition is submitted by the debtor, on condition that no prior bankruptcy petition was dismissed due to the debtor’s intentional failure to appear in court or comply with court orders.
Upon filing the petition, the debtor must submit a schedule of current income and expenditures, assets and liabilities, executory contracts, unexpired leases, as well as a statement of financial affairs.
After the debtor has filed the petition, he automatically assumes the role of ‘debtor in possession’ and takes control of the business operations and assets during the reorganization. An involuntary petition is filed by creditors who meet certain requirements provided by the bankruptcy court.
The voluntary petition includes the debtor’s tax identification number, the location of principal assets, residence, and his intention to file a plan of organization.
When receiving the petition, the bankruptcy court is required to charge a $1,167 filing fee and a $500 administrative fee. The fee is paid to the court clerk in whole, or in installments as the court may decide.
If the court allows payment in installments, the debtor is limited to four installments, with the final payment being not later than 120 days from the date of the case filing.A disclosure statement and a plan of reorganization must also be filed with the court. The disclosure statement contains details about the debtor’s assets, liabilities, and business affairs, sufficient enough to allow the court to make an informed decision about the plan of reorganization.
The plan of reorganization contains a classification of claims and the treatment of each claim. For creditors whose claims are impaired, they vote on the plan of the organization through balloting. Creditors who are unimpaired are deemed to accept the plan while creditors who are impaired are assumed to reject the plan.
After the court has allowed the disclosure statement and tallied the votes, it holds a hearing on whether to confirm the plan of reorganization.
Debtors in Possession
Chapter 11 places the debtor in possession, with a role to perform all functions relating to the business except investigative functions and roles of a trustee.
These functions include examining and objecting to claims, accounting for assets, and filing reports as required by the court.
With the court’s approval, the debtor in possession can employ professionals such as attorneys, accountants, auctioneers, and appraisers to assist in his functions.
The trustee is required to monitor the compliance of the debtor in possession with the reporting requirements set by the court. If the debtor in possession fails to comply with the reporting requirements of the trustee or bankruptcy court, the trustee may file a motion to have the case dismissed or converted to another chapter of the bankruptcy code.
An automatic stay order suspends all judgments, foreclosures, collection activities, and property repossessions by creditors that arose before the petition. The stay against creditors sets in place immediately when the petition is filed. It gives the debtor a chance to hold negotiations in a bid to resolve the financial distress.
In some circumstances, the secured creditors may apply for relief from the automatic stay to foreclose on the assetsFinancial AssetsFinancial assets refer to assets that arise from contractual agreements on future cash flows or from owning equity instruments of another entity.Financial instruments refer to any contract that gives rise to a financial asset to one entity and a financial liability or equity instrument to another entity and apply the sale proceeds to the owed debtsCost of DebtThe cost of debt is the return that a company provides to its debtholders and creditors. Cost of debt is used in WACC calculations for valuation analysis.
Learn the formula and methods to calculate cost of debt for a company yield to maturity, tax rates, credit ratings, interest rates, coupons, and.
Confirmation of the Reorganization Plan
The bankruptcy court requires the debtor to propose a plan within 120 days from the date of filing the bankruptcy petition.
If the debtor proposes a reorganization plan within the stated period, the court grants another 180 days to allow the debtor to obtain confirmation of the plan.
The plan designates classes of claims for treatment in the reorganization. Also, the plan lists the creditors in order of priority, with secured creditors topping the list.
Chapter 11 dictates that the entire class of creditors is deemed to have accepted the reorganization plan if it is accepted by creditors with at least two-thirds in amount and at least one-half of the number of allowed claims in the class. Also, the plan must be approved by at least one class of creditors who hold impaired claims. The holders of unimpaired claims are deemed to have accepted the plan.
If at least one class of creditors vote to object, the plan can still be confirmed as long as the requirements are met. The basis of this confirmation is that the plan must be fair and equitable, and should not discriminate against that class of creditors.
If no objections are filed, the court must be satisfied that the plan has complied with all the requirements for confirmation. The court must also find that the plan is feasible, it is proposed in good faith, and that the plan and its components have complied with Chapter 11.The plan then becomes binding and identifies how debts will be treated for the plan duration.
If the reorganization plan is not accepted, the court can either convert the case to a Chapter 7 bankruptcy or dismiss it in its entirety. Rejecting the plan returns things to the status quo before the petition filing. Creditors can then opt for a non-bankruptcy law to protect their interests.
Thank you for reading CFI’s guide to Chapter 11 bankruptcy. To further your financial education, we offer the following free resources.
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- Tax Free ReorganizationTax-Free ReorganizationTo qualify as a tax-free reorganization, a transaction must meet certain requirements, which vary greatly depending on the form of the transaction.
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Chapter 11 Bankruptcy Overview
Most businesses, especially large businesses, that file for bankruptcy file under Chapter 11.
Although there are some individuals with very large debts that also file under Chapter 11, because Chapter 11 has no debt limitations for eligibility, Chapter 11 was mainly designed as a means for big businesses to reorganize so that they can operate profitably again, which saves jobs.
Furthermore, much of the property held by the business often cannot be efficiently put to other uses. Such was the case of railroads that required a lot of capital to build, and for which there were no alternate uses for the property. Chapter 11 allows the business to continue operating and to use its property for which it was designed.
Reorganization is mainly accomplished by allowing businesses to reject burdensome contracts, to pay secured creditors the value of their collateral instead of the amount of their debt, and to pay unsecured creditors less than what they are owed. Without the option of reorganizing, most businesses would continue losing money until they would be forced to liquidate, thereupon ceasing to exist.
Chapter 11 Administration and Oversight
Chapter 11 was designed to allow the debtor and its creditors the maximum amount of flexibility in reorganizing the business through negotiation, but it also has rules that can force dissenting creditors to accept a plan in what is called a cramdown. The court serves to resolve disputes and to make sure that the bankruptcy is meeting statutory requirements.
Under Chapter 11, un other chapters of bankruptcy, no trustee is appointed—the debtor acts as a debtor in possession (DIP), who not only continues to operate the business, but also has the powers usually exercised by trustees, such as being able to avoid liens, or to reverse fraudulent transfers or preference payments.
This arrangement is necessary because a trustee, in most cases, does not have the expertise or the time to run the debtor's business. However, a United State Trustee does monitor the DIP and ensures that the bankruptcy moves forward. The U.S.
Trustee also forms the creditors' committee to represent creditors and possibly a committee representing equity holders, such as stockholders.
If the U.S. Trustee has reason to believe that the DIP is unreliable or untrustworthy, then a case trustee will be appointed to take the place of the DIP. Usually, the case trustee will hire someone to run the business.
However, this usually takes more time and costs more money than if the debtor itself continued running the business, since any new operator would have to learn the details of that particular business and its recent transactions in order to run it efficiently.
In some cases, an examiner will be appointed to investigate the DIP and to more closely monitor the DIP's progress, reporting to the U.S. Trustee. Sometimes the examiner will also carry out duties that the DIP is forbidden by the court to do.
Chapter 11 Petitioner
The Chapter 11 petitioner—the one who files the pleading to initiate the bankruptcy—is usually the debtor, and the debtor may be a corporation, partnership, or individual.
In rare cases, the petitioner may be the debtor's creditors who plead an involuntary bankruptcy for the debtor. There are specific provisions that apply only to certain debtors.
The most notable of these special debtors is the small business debtor and individual debtor.
Small Business Debtors
The small business debtor is a business entity that has noncontingent, liquidated secured and unsecured debt of less than $2,490,925 (adjusted for inflation; next adjustment: April 1, 2016) and one for which the U.S.
Trustee has not formed a creditors' committee. The lack of a creditors' committee greatly simplifies the Chapter 11 process, but it does require that the U.S.
Trustee take a more active role in monitoring the small business debtor.
Another simplification is that a standard form can be used for the disclosure statement, and court approval and the distribution of the disclosure statement is simpler.
Chapter 11 has several statutes that apply only to individuals debtors, making it more Chapter 13, which is only available for individual debtors. Both chapters require evidence of credit counseling from an approved credit counseling agency and the petitioner must submit any budget developed as the result of the counseling in the bankruptcy petition.
And if the debtor failed to do so and a creditor objects, the debtor must commit all projected disposable income during the bankruptcy to pay creditors. However, projected disposable income is calculated by subtracting the debtor's necessary living expenses from his income.A debtor with income above the state median is not required to use the means test to determine disposable income.
Un for business entities, the debtor does not receive a discharge at confirmation but only after the payment plan is completed and, if applicable, all domestic support obligations have been paid.
Chapter 11 Petition—Voluntary and Involuntary Petitions—Order for Relief
The Chapter 11 petition has much the same information as the petition under any other chapter of bankruptcy, which includes extensive information about the debtor, schedules of its assets and liabilities, income and expenses, executory contracts, including unexpired leases, and a statement of financial affairs, which summarizes the financial status of the debtor.
A Chapter 11 bankruptcy can be voluntary or involuntary. A voluntary bankruptcy is filed by the debtor and the order for relief is automatic with the filing.
An involuntary bankruptcy can be filed by the debtor's creditors, if certain requirements are met. The court will then determine, after notice and a hearing, whether to approve the bankruptcy.
If it is approved, then the order for relief is granted on the date that the bankruptcy is approved.
Whether the commencement is voluntary or involuntary, the debtor's property becomes the bankruptcy estate and the automatic stay prevents creditors from trying to collect on their debts. Un Chapters 12 and 13, postpetition property and income do not become part of the bankruptcy estate, which is necessary for the debtor to continue doing business.
The bankruptcy petition provides information about the DIP's assets and liabilities, income and expenses, executory contracts, a statement of financial affairs, and a list of its creditors, including the amount of their claim. A copy of the petition is sent to each creditor so that they can evaluate the petition. Creditors do not need to file a claim if they are listed in the petition unless they disagree with it, such as the amount of the claim.
Simply to file a Chapter 11 case costs $1,000 plus a $39 administrative fee.However, the administration of the case requires a lot more money, especially for a large business that always employs many professionals specifically for the bankruptcy, such as lawyers and accountants.
For instance, the bankruptcy of Lehman's Brothers was reported to cost $1.4 billion dollars, and even for individual debtors, attorney fees can range from $10,000 to $30,000.
Plan Formulation—Creditors' Committees
A reorganization plan must be formulated that will allow the DIP to run the business profitably. The DIP has an initial exclusive right for 120 days to file the plan, but the creditors get to vote on whether to accept or reject the plan.
Hence, much of the initial stages of the bankruptcy require formulating a plan, negotiating with creditors to secure their votes, then getting the plan confirmed by the court.
Sometimes, in what is called a prepackaged bankruptcy, the debtor will negotiate with its creditors before filing so that the debtor will already have an acceptable plan, allowing it to emerge from bankruptcy sooner. Once the plan is confirmed, then all parties in interest, including those who voted against the plan, are bound by it.
To facilitate the negotiation with creditors, a creditors' committee is formed by the United States Trustee that is composed of representatives of the business debtor's 7 largest creditors.
The debtor must negotiate with the creditors' committee to arrive at a reorganization plan that will allow the debtor to survive at the least possible cost to the creditors.
The plan will detail what assets to sell, which executory contracts will be rejected, and how creditors are classified and how much each class will be paid as a percentage of their claim.
The debtor is given 120 days to file a plan and 180 days to confirm it. If the debtor fails to either provide a plan or get a plan confirmed, then the creditors may submit a plan.The time limit motivates the DIP to formulate a desirable plan that will be acceptable to its creditors, because if it doesn't, the creditors will be allowed to submit a plan that may be less desirable for the DIP.
Creditors' committees are not usually formed for most small businesses and individual debtors filing under Chapter 11, since there is usually a lack of interest from creditors in participating in a committee. In these cases, the U.S. Trustee takes a more active role in shaping the plan.
The DIP must negotiate with the creditors' committee for an acceptable plan. Since the creditors vote on whether to accept the plan or not, the DIP must send the creditors a disclosure statement that is approved by the court, after notice and a hearing, which contains adequate information so that creditors can evaluate it and make an informed decision.
For a big business, the disclosure statement is much a prospectus for an investment, since the same types of information must be disclosed.
Generally, the disclosure statement will provide a history of the business and its transactions, the details of its plan to emerge from bankruptcy, possible alternatives to the plan, and the financial information that creditors need to evaluate the probable success of the plan.
Solicitation and Voting
When the court approves of the disclosure statement, it also sets a time to collect all votes. Creditors receive ballots in which they choose to either accept or reject the plan. The ballots must be returned by the prescribed time, or their vote is not counted.
The Chapter 11 Code has specific rules about who can vote and how the votes are counted. Creditors and equity holders are placed in classes, according to the type of collateral or the priority of their claims.
For instance, secured and unsecured creditors would be in separate classes, as would be preferred and common stockholders.
Often, all unsecured claims of little value are also placed in a class separate from other unsecured creditors to reduce administration expenses.
Since creditors and equity holders vote as a class, how they are classified will affect their voting rights. Although the DIP classifies the creditors and equity holders, to prevent classification schemes designed to manipulate votes, the classification must have a reasonable basis and the court must approve of the classification.
The plan must describe how the creditors will be classified, particularly which classes will be impaired, since they will be the only ones voting on the plan. An impaired class is one whose rights are being altered under the plan from nonbankruptcy law, which, in most cases, means that they are getting less than the full amount of their claim.
Unimpaired classes are deemed to accept the plan, since their nonbankruptcy rights are not altered, except that the debtor has the right to cure defaults and to decelerate loans by compensating the class for the delay in payment. An impaired class who is getting nothing under the plan is deemed to reject the plan. Hence, only impaired classes who are getting something get to vote on the plan.
Although each member of an impaired class gets to vote, only the class vote matters.Under §1126(c) of the Bankruptcy Code, an entire class of claims is deemed to accept a plan if the plan is accepted by creditors that hold at least 2/3 in amount and more than ½ in number of the allowed claims in the class.
Those creditors who rejected the plan are at least entitled to receive the present value of what they would have received under a Chapter 7 liquidation.
For those holding interests in the debtor, such as shareholders, a class of interests is deemed to have accepted the plan if at least 2/3 of the class voted in favor of the plan.
Section 1129(a) of the Bankruptcy Code lists the requirements for confirmation, including:
- the plan must be lawful and proposed in good faith;
- impaired claims and interests who have rejected the plan must receive at least as much as they would have gotten under a Chapter 7 liquidation;
- all impaired classes must have accepted the plan;
- all priority claims must be paid in full;
- and the plan must have a good chance of success.
When the reorganization plan is confirmed, the business debtor receives a discharge of most of its debts. It then must effectuate the plan to completion, after which, the court will issue a final decree.
Under §1129(a)(10), if there are impaired classes of claims, the court cannot confirm a plan unless it has been accepted by at least one class of non-insiders who hold impaired claims. Even if this is satisfied, however, if there are any impaired classes that have rejected the plan, then the plan can only be confirmed by cramdown under §1129 (b), which requires that:
- all the requirements listed in §1129(a) must be met except for subsection (8), which requires the approval of all impaired classes;
- the plan does not discriminate unfairly and is fair and equitable against impaired classes who have rejected the plan.
Discharge and the Final Decree
When the plan is confirmed the business debtor receives a discharge at the time of confirmation and the property of the bankruptcy estate vests with the debtor. However, an individual debtor must complete the plan before receiving a discharge.
The debtor must continue reporting to the U.S. Trustee until the plan is completed, after which, the court issues a final decree and the case is closed.
- Chapter 11. Reorganization Under the Bankruptcy Code
Chapter 11 Bankruptcy: An Overview
Chapter 11 is a section of the bankruptcy code that permits individuals and businesses to either liquidate or reorganize debt. Distinct from Chapter 7 and Chapter 13 bankruptcy cases, Chapter 11 typically involves greater sums of money regarding the assets and debts of the individual or business.
Who Can File for Chapter 11 Bankruptcy?
Chapter 11 is available for both individuals and businesses. As an individual debtor, you can reorganize the debts that are in your name in an effort to restructure your finances and protect your assets. If you file as a business, you can still reorganize the debt but you are limited to debts of the business.
Typical Chapter 11 Cases Filed by Individuals
Chapter 11 cases are seldom filed by individuals. However, when individuals do file for Chapter 11, it's usually for one of two reasons: real estate investment reorganization or reorganizing unsecured debts that are too high to qualify for Chapter 13 relief.
Real Estate Investors May Use Chapter 11 to Rewrite Mortgages
Chapter 11 is a powerful tool that allows real estate investors to rewrite mortgages. For example, if you own a property worth $50,000 but you owe $100,000 on the loan, Chapter 11 will allow you to reduce the principle balance of the mortgage to the value of the property. This would reduce the mortgage from $100,000 to $50,000.
Not only that, but Chapter 11 will also allow you to reduce the interest rate and extend the term of repayment, often times to another 360 months (30 years). This results in a lower monthly mortgage payment and allows the property to become profitable again.
Using Chapter 11 to Reorganize Large Amounts of Unsecured Debt
Most individuals use Chapter 13 bankruptcy to reorganize and pay back debt under a repayment plan. However, Congress has limited the amount of debt you may have to qualify for Chapter 13. The current debt limit for a Chapter 13 debtor is $360,475 for unsecured debts. If your total unsecured debt is more than this, you could file for Chapter 11 bankruptcy instead.
A Chapter 11 allows you to restructure and pay back your unsecured debt in a manner similar to Chapter 13. You will have a regular monthly payment to each of your creditors and once you have completed repayment according to your court-approved plan, the judge will give you a discharge absolving you of any future liability on most debts.
Typical Chapter 11 Business Cases
Most chapter 11 business cases deal with the restructuring of multiple types of debt including: priority tax debt, secured debt, unsecured debt, and leases, while also seeking to protect the business assets.
Priority Tax Debt
Chaper 11 can be a useful tool to reorganize past due taxes that your company has incurred.
Debts such as property taxes, income taxes, and payroll taxes can be restructured to allow you to continue to operate the business but also meet your tax obligations at the same time.
While most tax obligations usually get paid off during a five-year period, Chapter 11 allows you to renegotiate repayment terms between your business and the taxing authority on grounds mutually acceptable to both parties.
Chapter 11 permits a business debtor to reorganize secured debts in a similar manner to individual cases.
You identify which secured debts and corresponding collateral will contribute to the profitability of the business.
Then, just in the individual Chapter 11, you may seek to pay the current value of the property as opposed to what you actually owe on it. Examples of collateral include real estate, business equipment, and vehicles.
For example, if you have a fleet of 20 work trucks that are worth approximately $200,000 but you owe $500,000 on them, you can ask the court to allow you to pay only what the collateral is worth as opposed to what is owed. This allows your business to reduce its monthly operating expenses in order to become more profitable.
Debts such as company credit cards, signature loans, or other general unsecured loans can help with upstart and ongoing operating costs, but frequently act as a major burden on future profit margins.
Chapter 11 allows you to restructure your unsecured debt and pay towards it with the company’s profit either in a lump sum at the conclusion of your case or in periodic payments over a term of years. Ideally, you and your class of unsecured creditors will agree upon how much and when you pay.
If an amicable agreement cannot be reached among the parties, then the judge will decide what is fair and you will be bound by his or her decision.
Lease or Executive Contract Debt
Chapter 11 permits you to accept or reject your leases and executive contracts. For example, imagine you are a hotel owner and previously contracted with a cleaning service for the next five years. You find you can now obtain similar services for half the price, thus increasing the profitability of the business.
Chapter 11 will allow you to sever the contract with the current cleaning service. You may then ask the court to allow you to seek a new, more affordable service.
As long as you can show that the new contract and corresponding service will contribute to the profitability of the business, the judge will authorize the new contract.Another example would be if your company leased office space. That same office space may be leasing for twice as much since you originally signed the lease.
The bankruptcy code requires you to affirm your intent to retain that lease within a certain number of days after filing or you are automatically deemed to have rejected it.
Failure to act may cause you a great deal of time and money and the bankruptcy judge will be powerless to help you correct your mistake.
How to Succeed in Chapter 11 Bankruptcy
A Chapter 11 bankruptcy can be ned to a very contentious election. Each class of creditors (priority, secured, and unsecured) are entitled to vote to accept or reject your proposed treatment of them in your bankruptcy plan.
After the initial hearings, the court will authorize you to start soliciting votes. Ideally, you get a vote of acceptance from every creditor and the judge approves the plan on this basis.
You will ly have to negotiate various terms of treatment with the individual creditor to obtain acceptance so be prepared to compromise.
In the event you have a creditor who rejects the plan, the creditor’s non-acceptance may be a major impediment to court approval of your plan.
If all negotiations fail, you will have to ask the judge to approve your case over the objection of the non-accepting creditor.
This request is referred to as “cram down” because you are asking the judge to cram the terms of the plan down the non-accepting creditor’s throat.
As long as you successfully negotiate the treatment of each participating creditor in your bankruptcy, you should be able to restructure your individual or business debt in a way that allows you to emerge from bankruptcy lean and profitable.To learn about typical procedures in a Chapter 11 case, see Chapter 11 Bankruptcy: Timeline and Process.
Chapter 11 vs. Chapter 7 Bankruptcy
Depending on the type, or “chapter,” of bankruptcy, debts are treated differently. In Chapter 11 bankruptcy, debts are restructured in a way that debt repayment becomes more achievable.
In Chapter 7 bankruptcy, which is the most common form of bankruptcy, many debts are forgiven, and a variety of personal assets are sold — liquidated — to repay as many remaining debts as possible.
In general, Chapter 11 bankruptcy is utilized by corporations and other business owners, while Chapter 7 bankruptcy is favored by individuals.
There are 4 types of bankruptcy filings in the Federal Bankruptcy Code (Title 11 of the United States Code):
- Chapter 7 – Liquidation
- Chapter 11 – Reorganization (or Rehabilitation bankruptcy)
- Chapter 12 – Adjustment of Debts of a Family Farmer with Regular Annual Income
- Chapter 13 – Adjustment of Debts of an Individual with Regular Income
The main difference between Chapter 7 and Chapter 11 bankruptcy is that under a Chapter 7 bankruptcy filing, the debtor's assets are sold off to pay the lenders (creditors) whereas in Chapter 11, the debtor negotiates with creditors to alter the terms of the loan without having to liquidate (sell off) assets.
|Reorganization or Rehabilitation Bankruptcy||Liquidation Bankruptcy|
|No||Yes (certain assets are exempt; so they are not sold)|
|To work with the debtor to develop a repayment plan for all outstanding loans||To oversee the securing of the debtor's assets, the liquidation (sale) of these assets and the repayment of creditors in the order of priority (secured debts repaid first)|
|No. Terms of the loan are changed.||Yes. Debt may be forgiven to the extent that sale of assets does not cover all loans.|
|Businesses, individuals, married couples||Businesses, individuals, married couples|
Bankruptcy is an option for those who feel they will be unable to repay their debts. Even so, bankruptcy should be considered only as a last resort, as it has long-term, negative consequences on credit rating.
Other Ways to Discharge Debt
Often creditors sell their unsecured debts to collection agencies, who then adopt aggressive tactics to collect on the debt, or as much of it as they can.
There are ways to use the Fair Credit Reporting Act to get these unsecured debts voided, especially because collection agencies often lack the necessary documentation for legally enforcing debt obligations.
This forum post has some good information on how to do that.
Who Should File for Chapter 11 or Chapter 7?
In most cases, individuals will want to file for Chapter 7 or Chapter 13 bankruptcy.
Chapter 7 bankruptcy, in particular, is meant for individuals who are seeking a “fresh start,” but corporations may also file for Chapter 7 (and commonly do).
This form of bankruptcy focuses on discharging as many debts as possible and liquidating assets to pay off a variety of remaining debts that cannot be discharged.
A minimum amount of debt is not required for someone to file either Chapter 11 or Chapter 7 bankruptcy. However, to file for Chapter 7 bankruptcy, individuals need to pass a “means test,” usually by having a large amount of unmanageable debt and/or a low income that hinders debt repayment. Those who have a lot of disposable income are less ly to have their Chapter 7 filing approved.
Chapter 11, which is more expensive than Chapter 7, is typically intended for medium- to large-sized businesses, but smaller businesses and sole proprietors may also want to consider this type of bankruptcy.
Un Chapter 7, Chapter 11 does not liquidate assets, only restructures debts. This allows a debtor to protect an important asset, such as a business, from liquidation.
In the case of sole proprietorships and similarly small businesses, Chapter 11 bankruptcy affects both business and personal assets.
Credit Counseling and Debtor Education
Prior to filing either type of bankruptcy, individuals must attend at least 60 minutes of credit counseling and at least two hours of a debtor education course. The U.S. Trustee Program provides a list of government-approved credit counselors and debtor education courses.
During credit counseling, a financial advisor helps a debtor create a budget and look for any possible alternatives to bankruptcy. Debtor education is more of a general educational course that teaches an individual how to properly manage money and credit; the course is intended to help the debtor learn how to avoid bankruptcy in the future.
Upon successful completion of these programs, individuals receive a certificate from program providers. These certificates are part of the evidence required for debtors to file for bankruptcy.
How to File
With the advent of the electronic filing processes, individuals are able to file for bankruptcy without the help of a bankruptcy attorney. Form B200 contains checklists for each type of bankruptcy.
However, Chapter 11 and Chapter 7 bankruptcies are very complex for individuals who are unfamiliar with the U.S. Bankruptcy Code, and failing to submit the right information or paperwork may result in a court's rejection of a filing.Worse, inaccurate information in a bankruptcy filing may be considered criminally fraudulent.
Individuals cannot file for bankruptcy when they have had a previous filing dismissed in the last 180 days, so it is very important to have all of the necessary evidence when filing.
As soon as any bankruptcy petition is filed, and prior to its approval or dismissal, an automatic stay is placed on all lenders.
An automatic stay restricts creditors from continuing to try to collect payment from the debtor and further restricts creditors from filing lawsuits against the debtor or foreclosing on his home. This provides immediate relief for those seeking bankruptcy.
More than anything, it prevents creditors from using abusive, last-minute tactics to try to make back as much of their money as possible. These protections remain in place throughout the bankruptcy process.
Lenders can petition a bankruptcy court to make an exception to this rule for whatever debt dispute they have with a debtor, meaning that, in some cases, debtors may have to juggle bankruptcy filing and several types of debt repayment at the same time.
First Meeting of Creditors and Bankruptcy Court
Barring when creditors dispute a discharge, few must attend a hearing in a bankruptcy court for a personal bankruptcy filing.
Instead, there is a “First Meeting of Creditors,” which is a meeting that takes place around 30 to 40 days into the filing process.
As the name suggests, creditors may attend this meeting, but they rarely do; instead, they tend to have their attorneys work with the debtor's attorney(s) — another reason it is wise to hire an attorney for the bankruptcy process.This meeting is not overseen by a bankruptcy judge, but by a bankruptcy trustee, a person who is in charge of managing an individual's bankruptcy. Trustees are usually appointed by the U.S. Department of Justice. In some Chapter 11 filings, a chief restructuring officer is used in place of a trustee.
In either type of filing, the person seeking liquidation or reorganization swears an oath to truthfully answer a trustee's questions. Most of the time, this meeting is very short unless the trustee or chief restructuring officer is confused or suspicious about certain information the debtor has provided.
One major difference in a Chapter 11 filing comes with the reorganization of businesses, which the trustee takes over during the bankruptcy process. (There are some exceptions to this; see debtor in possession.
) If a business is ly to make money in coming years, the business will often be allowed to continue operations, and income earned from the business will go toward debt repayment.
If the business has more debt than it does assets or revenue, however, it is ly the business will be sold to creditor(s) as part of Chapter 11's reorganization process.
Debt Forgiveness vs. Debt Reorganization
Debt forgiveness is the common term for what is legally known as a bankruptcy discharge, a core component of a Chapter 7 filing that is also used to a lesser degree in Chapter 11 filings.
Unless a creditor disputes a particular discharge request, most discharges are automatically approved. A bankruptcy court then mails a copy of discharge orders to all applicable creditors.
Under a discharge order, the creditor(s) must “forgive” the debts listed by no longer seeking repayment. In the eyes of the law, discharged debt is no longer owed.
This is a different process from debt reorganization, which is used in a Chapter 11 filing. Under debt reorganization, debts are not discharged or forgiven.
Instead, loan terms are altered in a way that a debtor will hopefully be able to repay his debt more successfully.
For example, debt APR or interest rates may be lowered, or the length of time a debtor has to repay a loan may be extended.
Unsecured debt, such as credit card debt, is more ly to be forgiven than secured debt, such as a home or auto loan. And student loan debt is never discharged in bankruptcy.It is worth noting that any debt discharges are issued at different times in Chapter 11 and Chapter 7 filings. For Chapter 11 bankruptcy, any debt forgiveness is typically granted after all reorganized debts have been paid in full.
In Chapter 7 bankruptcy, however, there are set periods of time when a creditor can petition to make a debt ineligible for discharge; following this period of time — usually about two to four months into the Chapter 7 filing process — all eligible debts are automatically discharged.
In Chapter 7 bankruptcy, individuals will often be allowed to have some assets exempted from the liquidation process.
What can be exempted from liquidation varies by state, but usually exempt property includes assets such as retirement plans, 401(k)s, a family car, and some savings.
A few states, Texas, are quite lenient when it comes to property exemptions. Others, however, only allow filers to keep a very small amount of cash by the time the process is over.
Mortgages are very rarely exempt from the bankruptcy process. This means that someone filing for Chapter 7 must continue to make payments on his mortgage. If he cannot make these payments, he may also eventually end up going through a judicial or non-judicial foreclosure process on top of his bankruptcy.
Similarly, the bankruptcy process does not allow an individual to stop making alimony or child support payments or to stop paying taxes.
Liquidation vs. Debt Repayment
A trustee takes over a debtor's assets in a Chapter 7 filing. These assets are liquidated — sold by the trustee in exchange for cash — which is then distributed among creditors.
Restructured debt, as found in Chapter 11 bankruptcy, must be repaid according to the new terms agreed upon during the filing process — usually over a period of three to five years.
Chapter 11 bankruptcies are often very expensive because they involve businesses, which complicate matters. Filing for Chapter 11 alone often costs over $1,000.
Attorneys' fees are especially expensive as the Chapter 11 process requires more legal input and takes much longer — often up to a year or longer.
Moreover, Chapter 11 attorneys are less common than other bankruptcy attorneys, meaning those who take on Chapter 11 filings often charge more by the hour than would attorneys who handle Chapter 7 or Chapter 13 filings.Comparatively, Chapter 7 bankruptcy is very affordable and some fees, such as the cost to attend credit counseling, may be waived sometimes for those who have no cash to spare. Filing is relatively cheap and tends to stay under $500, though there are additional attorneys' fees.
In most cases, a Chapter 11 bankruptcy will cost many thousands of dollars (often in relation to business size), while a Chapter 7 bankruptcy will cost somewhere between $1,000 and $2,000.
Chapter 11 vs. Chapter 7 Effects on Credit
Both Chapter 11 and Chapter 7 bankruptcies remain on credit reports for 10 years after the filing date. In contrast, Chapter 13 bankruptcy lasts on a credit report for only seven years.
The effect of having a bankruptcy on a credit report can be very negative. It usually prevents individuals from taking out new loans or getting approved for credit cards. It also makes buying a car or home almost impossible. While this can make sense early on in a bankruptcy, many years down the road, long after debts have been forgiven or repaid, it can continue to haunt the filer.
Business Use of Chapter 11 and Chapter 7
Businesses frequently use both types of these bankruptcies. Choosing between these two chapters comes down to what business owners hope to achieve with their business in the long run.
If the business is not profitable or worth keeping, Chapter 7 bankruptcy is a reasonable choice. If the business is profitable, Chapter 11 may be a good option.
It is worth noting, however, that few small businesses survive the costs of Chapter 11 bankruptcy.
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“Chapter 11 vs Chapter 7 Bankruptcy.” Diffen.com. Diffen LLC, n.d. Web. 15 Jan 2019. < >