What Is Chapter 11 Bankruptcy? Chapter 11 can breathe new life into business owners and individuals who are struggling with debt. Also known as reorganization, Chapter 11 bankruptcy enables businesses to continue operating while creditors and the owner work together to reorganize debts.
However, bankruptcy isn’t solely about keeping your business afloat. This guide will explain how Chapter 11 works and why business owners or individuals might consider filing for it.
What Is Chapter 11 Bankruptcy?
Chapter 11 bankruptcy, also known as reorganization or business bankruptcy, provides a lifeline for struggling businesses and individuals burdened by debt. This type of bankruptcy allows businesses to continue operating while they formulate a plan to repay or discharge their debts. The main objective is to keep the business running during and after the bankruptcy process.
Many people mistakenly believe that Chapter 11 bankruptcy is exclusively designed for large corporations. While it is true that numerous prominent companies like Toys ‘R’ Us and Kmart have filed for Chapter 11 bankruptcy, small business owners seeking debt relief while maintaining business operations can also benefit from it. In the case of small businesses, the owner typically retains ownership throughout the bankruptcy process.
Throughout the bankruptcy proceedings, the business can continue its day-to-day operations, and the owner retains decision-making authority regarding strategies to boost sales and profitability. The business remains free to sell its inventory and purchase necessary materials for fulfilling new contracts.
However, small business owners are subject to certain restrictions. They must seek permission before selling any assets (excluding inventories) or initiating/terminating rental contracts. Additionally, the court’s approval is required for hiring lawyers or other service providers to assist with the bankruptcy process.
Regular monthly reports are mandatory for business owners to keep the court informed about their company’s financial status. These reports typically include a business income statement and an expense statement.
What Happens to Assets and Debts in Chapter 11 Bankruptcy?
Chapter 11 bankruptcy stands apart from other consumer bankruptcy types because it does not prescribe a specific outcome for debts. Certain debts, such as student loans and unpaid child maintenance, are not eligible for discharge. If these types of debts are included in the bankruptcy plan, the plan must outline a method to repay them. In the case of back taxes owed by a business, they must be repaid within a five-year timeframe.
The responsibility for devising a repayment plan for some or all of the debts lies with the individual or entity declaring bankruptcy. These debts can be repaid partially or in full over a designated period, while others may be entirely discharged. Typically, repayment plans last for a period of five years. However, in rare cases, Chapter 11 bankruptcy may extend up to 10 years to complete the process.
In Chapter 11 bankruptcy, both individuals and businesses have the opportunity to retain the majority of their assets. However, as part of the reorganization plan, the debtor may propose selling certain assets. For instance, a business owner might choose to sell the entire business during the Chapter 11 bankruptcy process.
It’s important to understand that in a Chapter 11 bankruptcy, an individual can utilize their personal assets to repay creditors. The bankruptcy case does not generally encompass the assets of corporate owners, but assets belonging to sole proprietors and partners in partnerships may be subject to inclusion. However, this doesn’t necessarily mean that they will lose all their assets. Some of their assets may not receive full protection under the bankruptcy process.
When Is It a Good Idea to File for Chapter 11 Bankruptcy?
Chapter 11 bankruptcy can be a valuable but costly tool. In the following cases, it may be a good idea:
Chapter 11 bankruptcy may be a good option for small business owners that want to continue their business. Bankruptcy can help you with your debts but not your income. Chapter 11 will not help a small company that is having trouble generating revenue.
Reorganizing and shedding enough debt may allow large businesses to avoid selling or liquidation.
A creditor can force a debtor into Chapter 11 bankruptcy if they owe a large amount of money and are not paying their obligations.
Chapter 11 is an option for individuals with debts exceeding the Chapter 13 bankruptcy limit ($465,275 unsecured debts, and $1,395,875 secured debts). If the filing fees are lower than expected commissions in Chapter 13 bankruptcy, people with smaller debts can choose Chapter 11.
Cost of Chapter 11 Bankruptcy
Attorney’s fees are the most significant cost in a Chapter 11 bankruptcy. The basic filing cost for Chapter 11 bankruptcy is $1,738. However, for individuals seeking Chapter 11 bankruptcy, attorney’s fees can go up to $10,000. Meanwhile, small businesses filing for Chapter 11 bankruptcy might face attorney’s fees ranging from $15,000 to $30,000. In complex cases, these fees could even reach up to $100,000.
Due to the high attorney fees, Chapter 11 bankruptcy may not be appealing for most individuals or small businesses, unless they have substantial amounts of debt to restructure. If you are considering Chapter 11 bankruptcy, it is advisable to compare the fees of multiple lawyers to determine the best option for your situation. You may be able to find a bankruptcy lawyer who is equally qualified but less expensive, helping you manage the overall costs of the bankruptcy process.
How Long Will It Take to Complete the Process?
Before creditors can propose a plan, individuals or companies filing for bankruptcy under Chapter 11 have a maximum of 18 months to come up with a reorganization plan. It is essential for small business owners and individuals to work towards creating an approved plan within this 18-month period.
The repayment process in Chapter 11 bankruptcy can vary in duration. It can be relatively quick, such as through the sale of a business enterprise, or it may extend over several years. There is no strict time limit for the payoff period, but typically, it spans around five years.
Chapter 11 Bankruptcy: Pros and Cons
Chapter 11 bankruptcy allows business owners to retain their ownership. This is a significant advantage over Chapter 7 bankruptcy, which requires the business owner to sell the company to repay debts. It is essential, however, to carefully consider the advantages and disadvantages of bankruptcy.
|No debt limits||Long timeline (usually 5 years)|
|Assets are typically kept||The protection of your personal assets is not perfect|
|Cheaper than Chapter 13||It could end up costing much more (possibly up to $100,000 or more)|
|Cost and timeline are unpredictable, as well as the outcome|
Chapter 11 bankruptcy is unpredictable, unlike Chapter 7 and Chapter 13. In some cases filing Chapter 11 can be less expensive than other chapters. Lawyer’s fees are usually much higher for Chapter 11 and can reach up to $100,000. It is less predictable how the outcome will turn out. Some debtors may be left paying debts for a decade or more, while in rare cases business owners might have to liquidate their companies.
The Chapter 11 Bankruptcy Process
Each Chapter 11 case begins with the filing of a bankruptcy petition. In most cases, it is the debtor or the business that files the petition. To file a Chapter 11 bankruptcy petition, you must pay $1738. A creditor can file an involuntary Chapter 11 against you if you do not pay your debts.
You are entitled to an automatic stay on all creditor actions as soon as you file a bankruptcy petition. This means your creditors are unable to enforce or collect existing liens.
A Chapter 11 filing gets some breathing space while it works out a repayment plan for its creditors.
Debtor in Possession
The person or entity who files for bankruptcy is called the debtor in possession. In Chapter 11 bankruptcy the debtor-in-possession plays a major role in the bankruptcy proceedings. In most cases, the debtor-in-possession will be the bankruptcy trustee.
The debtor-in-possession is then responsible for reporting and proposing a repayment and reorganization plan that complies with the law. The debtor in possess retains their right to run their business without any oversight from the courts.
Meeting With Creditors
The U.S. trustee will appoint a committee of creditors shortly after the bankruptcy filing. The committee is usually made up of unsecured creditors with the largest seven claims against the debtor. The committee will be smaller if your business or you have fewer than seven outstanding debts.
In a meeting called a 341 Meeting, the debtor-in-possession and the committee will negotiate a plan of reorganization. The reorganization will include a strategy for maintaining the business while paying creditors.
Chapter 11 bankruptcy is founded upon a plan of reorganization, which allows a company or individual to retain their assets and repay some of their debts in the future. In the process, businesses may opt to sell either all or a portion of their assets to settle their debts.
The debtor, who possesses the property, is given a 120-day timeframe to submit a reorganization plan. The court has the authority to extend this period for up to 18 months if necessary. Afterward, creditors are at liberty to propose their own plans. However, for a plan to be accepted, a majority of creditors must approve it, and it must cover at least two-thirds of all debts.
For the court to accept the plan, the debtor must be capable of making reasonable monthly payments. The plan should be in the best interests of the creditors and offer them more money compared to what they would receive under Chapter 7 bankruptcy. Furthermore, the plan must be fair, equitable, and made in good faith.
The actual reorganization will be tailored to meet the specific needs of both the debtor and creditors. It requires taxes to be paid within five years and must adhere to the above-mentioned requirements. The courts hold wide discretion in determining how to implement the plan.
Confirmation of Plan
The bankruptcy trustee will convene a confirmation hearing once a sufficient number of creditors have agreed to the plan. A plan that is accepted by creditors and meets the statutory requirements will likely be approved by courts.
The repayment period starts once the plan has been approved.
The debtor will implement the plan once it is approved. This usually means that the debtor makes monthly payments until all plan obligations have been met. In some cases, the plan will require the debtor to sell certain assets before distributing the money to creditors. The repayment phase of the plan may last for several years.
Debts Are Discharged
The remaining debts will be discharged once the debtor fulfills the obligations of the plan. The debtor is no longer responsible for the debt and creditors are unable to attempt to collect it. The debtor is now able to regain their financial and credit status.
Comparing the Different Types of Bankruptcy
Bankruptcy is a complex process. It is important to consult a bankruptcy lawyer to help you navigate the process.
Chapter 11 vs. Chapter 7
Chapter 7 or Chapter 11 bankruptcy is a choice for small business owners. Chapter 11 bankruptcy enables owners to keep their businesses running while reducing their debts. The owner can choose to sell assets, but it’s not always necessary.
On the other hand, Chapter 7 bankruptcy requires the business to liquidate non-exempt assets to pay creditors. There is a filing charge (and an attorney’s fee if you choose to hire one), but the costs associated with Chapter 7 bankruptcy tend to be lower.
Chapter 11 vs. Chapter 13
Some individuals with complex finances or large amounts of debt might find Chapter 11 bankruptcy to be cheaper than Chapter 13 bankruptcy. Chapter 11 is the bankruptcy option most high-income people choose. The fees for lawyers in Chapter 11 bankruptcy can be more than $10,000, compared to $1,800 for Chapter 13 bankruptcy. However, in cases of high debt, bankruptcy commissions can make Chapter 13 bankruptcy more expensive than Chapter 11 bankruptcy (at least $10,000 versus $1,800).
In Chapter 13 bankruptcy, the debtor must pay a commission (up to 5 percent of the total payment) to a trustee. In contrast, Chapter 11 bankruptcy allows debtors to administer their own bankruptcy payments.
Alternatives to Bankruptcy
You may not have to declare bankruptcy if your business is in financial difficulty. Here are some of the ways businesses and individuals can get out of debt without declaring bankruptcy.
Negotiating Outside the Court
You may be able to negotiate a debt repayment plan or debt reduction outside bankruptcy court if your business is struggling to pay off a single large debt. This is a quicker and cheaper option than a costly Chapter 11 bankruptcy. A business with multiple debts might find that declaring bankruptcy allows it to negotiate with creditors all at once.
Sell Your Business
You may be able to sell your business to pay off existing debts if it is viable. You may want to speak with a bankruptcy lawyer if you are considering selling a financially distressed business. Under Chapter 11 bankruptcy laws, a business can clear its debts by selling it as a going concern.
Close the Business
It may be unnecessary for a business with few assets to declare bankruptcy. The business may default on its debts by closing down, but creditors might not pursue the difference. Consult a bankruptcy lawyer and a credit counselor before deciding on this option, as it may have negative consequences. You could still be liable for certain debts (such as taxes or those that require a personal guarantee).
Lawyers offer free consultations in many areas of the country to business owners or individuals who are contemplating bankruptcy. The consultations are also a good way to compare prices between lawyers and to find out if there is a solution to avoid bankruptcy.
Considering Chapter 11 Bankruptcy?
Set up a meeting with Bruner Wright’s experienced Florida bankruptcy attorneys today. Whether it’s Chapter 7, Chapter 11, or Chapter 13 bankruptcy, our team is here to guide you through the process and offer expert recommendations tailored to your situation. While bankruptcy might not be suitable for everyone, it could provide the debt relief you need.
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