How Chapter 11 Works for Business Bankruptcy
Chapter 11 of the United States Bankruptcy Code is available to both businesses and individuals to reorganize their debts. However, it is primarily used by businesses and is available to all types of legal entities from corporations to sole proprietorships.
Businesses or its creditors can file for protection under this section of the code when the business is no longer able to service its debt. The benefit is that the debtor retains control of business operations as a debtor in possession.
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While maintaining most of the features of other bankruptcy chapters, going this route gives the trustee the power to operate the business. Unless disqualified for cause, the debtor ordinarily acts as trustee while overseen by the court.
There are 2 ways these types of proceedings can begin, each of which involves a petition to the court. In voluntary proceedings, the debtor files the petition for protection to the court. But in involuntary proceedings, the creditors file the petition when it meets certain requirements.
Restructure
The debtor can then restructure his business using a variety of mechanisms. The debtor can obtain new financing on better terms than previously. The debtor can also cancel or reject contracts. The debtor also receives an automatic stay from litigation.
In cases where debts exceed the business's assets and restructuring results in the owners being left with no value, the owners' rights and interests are usually ended and the company's creditors assume ownership and control of the company.
While creditors are heard in court, it is the court that makes the final determination of the restricting plans.
Conversion
While Chapter 11 provides an automatic stay of collection efforts, creditors may ask the court to convert the bankruptcy to a 7, which will liquidate the debtor company. If this is in the best interest of the creditors, the court may grant this conversion. Sometimes liquidation can occur under an 11 to provide a greater return on the company's assets.
Contracts
In some cases, when executor contracts are cancelled, the non-debtor contracting party becomes an unsecured creditor in the bankruptcy.
Creditors
Creditors are given the same priority in this as in other chapters. Secured creditors are paid first and unsecured creditors are paid via a specified order. Each level must be paid in full before the next creditor level receives any payment.
Stocks
Chapter 11 will cause a company's stock to be delisted on the exchanges. These stocks may resume trading as over the counter stocks. The eventual result in many cases is making the stocks valueless.
Final thoughts
Sometimes it is in the best interest of the creditors for the company to be in Chapter 11 rather than a different bankruptcy chapter. Its value is greater than if assets were sold off piecemeal. Jobs may also be saved and creditors will benefit.
In the past, many large companies have been forced into this type of bankruptcy reorganization, one of the largest being Lehman Brother Holdings, Inc. in 2008.
How Chapter 11 Works for Business Bankruptcy
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