Chapter 11 Bankruptcy: An Overview (2024)

Running a successful business involves many moving parts, any of which can cause a company to stumble. Difficulties obtaining materials, staffing and management issues, and increased inflationary costs are just a few of the obstacles that can leave a business unable to pay its bills. When a company generates income but can't pay its bills due to a temporary setback, Chapter 11 bankruptcy can reorganize its debts into a manageable payment plan, giving it the breathing room needed to stay in business.

What Is Chapter 11 Bankruptcy?

Chapter 11 is a reorganization bankruptcy that businesses file when financially strapped. For instance, a company struggling to pay vendors, payroll, rent, or taxes would likely close without debt relief. Chapter 11 allows the company to work with creditors to create a payment plan that the company can meet.

From the company's perspective, the goal is to lighten the business's debt burden. Payment changes can include modifying interest, due dates, and other terms. It can even "discharge" or erase debt obligations.

How Does Chapter 11 Work?

The company and creditors negotiate new debt payment terms the business can afford. The plan might also include selling assets or downsizing the debtor's operations to reduce expenses.

Once all required creditors agree to the plan terms, the plan becomes a new contract. In a traditional Chapter 11, if the plan involves debt forgiveness, the company immediately benefits from the debt discharge.

Pros and Cons of Filing for Chapter 11

The primary advantage of Chapter 11 is that it allows the company to stay in business and creditors to get paid. When a company and receptive creditors work collaboratively, all parties benefit.

However, a successful Chapter 11 depends on the ability of all parties to agree on reasonable payment terms, which doesn't always happen. The possibility of a Chapter 11 case turning into a Chapter 7 matter that closes the company is likely the riskiest part of the filing.

Can a Company Survive Chapter 11?

Surviving Chapter 11 is often in the company's and creditors' best interest. Ultimately, whether a company will survive Chapter 11 will depend on creditors' willingness to negotiate new payment terms.

However, finding a middle ground can be difficult when creditors believe they're being asked to capitulate more than is fair or that they'd receive more if the company's assets were sold in Chapter 7. To prevent such problems and ensure success, bankruptcy lawyers often work with creditors before filing a Chapter 11 case.

Who Can File for Chapter 11 Bankruptcy?

Chapter 11 is for ongoing businesses that have the potential to remain open with financial assistance. Individuals whose debts are too high to qualify for Chapter 13 can also file for Chapter 11.

Chapter 11 won't help a business without a steady customer base and can't reopen a closed business. Individuals must also demonstrate that they earn a steady income. Creditors won't agree to a plan unless the bankruptcy filer can generate enough revenue to fund it.

Example. Charlie's Bike Shop has multiple stores in the Washington D.C. area but lost considerable revenue when an unexpected snowstorm prevented tourists from renting bicycles during the annual cherry blossom season. Business picks up during the summer, but the bike shop can't meet its obligations. The company hires a Chapter 11 bankruptcy lawyer who successfully negotiates a plan with creditors and files the Chapter 11 case.

Example. Moira, a famous actress, makes a social media misstep and finds herself the most recent victim of cancel culture. As a result, her studio rescinds a lucrative movie role to distance itself from the bad publicity. Fortunately, Moira's agent finds her work, but it pays much less, and she can't meet her current obligations. She knows she'll lose her mansion in Chapter 7, a liquidation bankruptcy, so she opts for reorganization. Because her debts total over $3,000,000 and exceed the Chapter 13 limits, she must use Chapter 11 to reorganize her debts.

How Does Chapter 7 Differ From Chapter 11?

It will depend on whether an individual or company files or is involved in the bankruptcy case. Here are the basics.

Chapter 7 for Individuals

Chapter 7 works differently for individuals and businesses. Individuals who file for Chapter 7 can keep or "exempt" property needed to maintain a household and employment. All other property is sold for the benefit of creditors. In exchange, the bankruptcy court discharges qualifying debt, such as credit card balances, medical bills, and personal loans.

It's common for business owners to file an individual Chapter 7 case after the company closes and discharge personal debt and business debt, such as obligations arising from a personal guarantee. In both instances, the process usually takes four to six months, and filers don't repay creditors.

Example. Holly's Local Bagels, LLC closed soon after Mega Bagel Corp. moved in down the street. Because Holly personally guaranteed payment of the bagel shop's lease, she met with a lawyer about bankrupting Local Bagels. Holly was surprised to learn she'd remain responsible for the lease even after Local Bagel's bankruptcy. Instead, she followed the lawyer's advice and filed for Chapter 7 herself. In her bankruptcy, Holly discharged the personal guarantee and her personal debts, receiving a fresh financial start.

Chapter 7 for Small Businesses

It's unusual for a small business to file for Chapter 7. Essentially, Chapter 7 closes the business without a debt discharge—businesses aren't entitled to debt relief. All that occurs is the trustee sells the business or the business property, whichever is more valuable. A business also isn't entitled to protect property with bankruptcy exemptions.

An exception exists for sole proprietors because they're treated more like individuals in Chapter 7. Sole proprietors can protect property with bankruptcy exemptions and receive a discharge for qualifying individual and business debt.

However, while many sole proprietors lose their business in Chapter 7, sole proprietors with service-only companies often fare better. Why? Because the Chapter 7 trustee can't sell the sole proprietor's ability to provide a service. These sole proprietors can usually discharge personal and business debt without jeopardizing the service-focused business.

Example. Joseph, a motivational speaker, invested in himself early in his career. Assuming all his business needed was exposure to thrive, he accepted a nominal fee for speaking engagements nationwide. Joseph also paid his travel and hotel expenses with his credit card. However, he couldn't demand higher speaking fees and eventually maxed out his credit card. Joseph filed for Chapter 7 bankruptcy. As a sole proprietor, he could discharge the business credit card debt and his personal debt. Also, because his business involved a personal service the trustee could not sell, Joseph retained his company as a motivational speaker.

Explore the differences between Chapter 7 and 11 bankruptcy.

How Does Chapter 13 Differ From Chapter 11?

It will depend on whether an individual or company files or is involved in the bankruptcy case. Here are the basics.

Chapter 13 is a reorganization bankruptcy that allows paying creditors what the filer can afford for three to five years. The benefits of Chapter 13 include keeping all property, catching up on mortgage, car, and other secured payments, and keeping the collateralized property.

Companies can't file for Chapter 13 bankruptcy. However, business owners sometimes file Chapter 13 individually. This strategy is helpful when reorganizing personal finances through a Chapter 13 plan is enough to keep the company afloat.

For instance, paying a reduced amount toward personal credit cards and other debt will often allow the owner to draw less from the business. Learn more about Chapter 13 vs. Chapter 11 bankruptcy.

Chapter 11 for Individuals and Business Owners

Chapter 11 is a reorganization bankruptcy similar to Chapter 13. However, unlike Chapter 13, creditors participate in plan creation in traditional Chapter 11 cases, making it a longer, more complicated process. Chapter 11, Subchapter V resembles Chapter 13 more closely and has streamlined provisions to expedite bankruptcy for small business owners.

Should You or Your Business File for Chapter 11?

Most people choose Chapter 11 when other options don't exist. When possible, most debtors elect to file for bankruptcy under Chapter 7 or 13 to avoid the time, cost, and risk involved in Chapter 11 proceedings.

A business won't file for Chapter 7 unless the company is closing—and usually not even then because the benefits don't outweigh the potential to open the door for creditor litigation. Also, when a business needs help staying in business, the company's only option is to reorganize under Chapter 11. Chapter 13 isn't available to companies.

Similarly, individuals who want to negotiate reduced payment terms with creditors don't file for Chapter 11 unless they must because their debts exceed Chapter 13 limits. Individuals choose cheaper, less complicated Chapter 13 when possible.

The simplest way to determine which chapter is best for you is by meeting with a knowledgeable bankruptcy lawyer.

How Much Does Chapter 11 Bankruptcy Cost?

Filing for Chapter 11 isn't cheap; traditionally, only large corporations could afford the costs. Fortunately, Chapter 11 has evolved, and most businesses can use it to stay open.

Most small businesses still find traditional Chapter 11 filings cost-prohibitive. Small businesses file the more affordable Chapter 11, Subchapter V option. It's cheaper because its streamlined procedures are structured more like Chapter 13.

Filing for Chapter 11 Bankruptcy

Below is a simplified explanation of the traditional Chapter 11 process, followed by a brief description of the more straightforward Subchapter V procedures.

Bankruptcy Petition

Generally, Chapter 11 cases are voluntary and begin when the company files a bankruptcy petition seeking relief. However, sometimes creditors file an involuntary bankruptcy petition against the business.

Collection Actions

All bankruptcy chapters work by stopping the collection process. Once filed, the "automatic stay" prohibits most creditors from pursuing the individual or business filer, giving the filer, creditors, and the court breathing room to address finances in an organized fashion.

For instance, the stay will temporarily stop:

• payment requests
• an eviction or foreclosure
• a collections trial
• bank levies, till taps, property seizure, and
• other collection processes.

The automatic stay lifts once the bankruptcy court approves a plan that acts as a new contract between the company and creditors.

Company Control

Unlike other bankruptcy chapters, a bankruptcy trustee isn't responsible for the business and bankruptcy property. The filer continues to run the everyday functions as a "debtor in possession" during the Chapter 11 bankruptcy. However, small business bankruptcies filed under Chapter 11, Subchapter V are subjected to more oversight.

Chapter 11 Reorganization Plan

The company and creditors work toward negotiating a reorganization plan. When possible, the company's bankruptcy attorney will start negotiations before filing the case. If you're wondering why Chapter 11 cases are complicated and lengthy, here's why.

The debtor has the exclusive right to propose a reorganization plan for the first four months, but the court can extend it to 18 months. Once the exclusivity period expires, the creditors' committee or other parties can propose alternate reorganization plans.

Chapter 11 Plan Confirmation

Creditors vote on whether they accept a proposed Chapter 11 plan. In reality, the debtor and creditors can agree to any plan they negotiate, which is why many Chapter 11 attorneys negotiate deals before filing the case.

If the required creditors agree to a plan, the court will approve or "confirm" it. But more often, creditors or other parties dissatisfied with the debtor's progress will move to dismiss or convert the case to Chapter 7.

Plan Requirements

When reviewing a plan, the bankruptcy court considers the following factors:

• Feasible. The bankruptcy court must find that the proposed plan is likely to succeed. The debtor must prove the ability to raise sufficient revenues to cover expenses and creditor payments.
• Good Faith. The company must propose the plan in good faith and not seek to further an agenda forbidden under the law.
• Best Interests of Creditors. The "best interests" test ensures the proposed plan pays the creditor at least as much as the creditor would have received if the debtor had filed a Chapter 7 liquidation and the Chapter 7 trustee sold the debtor's property and distributed the proceeds. If the debtor has a lot of assets, the "best interests" test could require the debtor to pay creditors in full. However, most Chapter 11 debtors are financially underwater and meet the "best interests" test by paying creditors only a fraction of what they owe.
• Fair and Equitable. The plan also must be "fair and equitable." Secured creditors must receive at least the value of their collateral, paid over time. The debtor's owners can't retain ownership based on equity interests without paying certain minimum amounts to creditors.

In Chapter 11, Subchapter V cases, the bankruptcy court uses the same criteria when assessing the confirmability of the plan.

Chapter 11 Case Length

There is no absolute limit on the duration of a Chapter 11 case. Some Chapter 11 cases wrap up within a few months, but it's more usual for it to take six months to two years for a Chapter 11 case to come to a close.

Small Business Debtors in Chapter 11, Subchapter V Cases

Small businesses and major corporations follow the same rules and requirements when reorganizing under Chapter 11. However, special provisions help small business debtors move through the Chapter 11 process more quickly while reducing legal fees and other restructuring expenses.

A company qualifies as a "small business debtor" by meeting the small business case requirements under Chapter 11, Subchapter V:

• is engaged in business or other commercial activities, and
• owes no more than the current limit in total claims, excluding obligations owed to insiders such as family members of the business owners (current limits are on the U.S. Courts Chapter 11 bankruptcy page).

Benefits and special procedures applying to small business Chapter 11 matters include:

No Creditors' Committee. Ordinarily, in Chapter 11 cases, a committee is appointed to represent the interests of unsecured creditors. A creditors' committee can retain attorneys and other professionals at the debtor's expense, significantly increasing the cost of Chapter 11 reorganization. Small business cases don't involve creditors' committees.

Additional Filing and Reporting Duties. Small businesses are subject to some reporting and filing requirements not imposed on other Chapter 11 debtors. A small business debtor, for example, must attach its most recently prepared balance sheet, statement of operations, cash flow statement, and federal tax return to its bankruptcy petition when it files for Chapter 11 relief.

Additional U.S. Trustee Oversight. The United States Trustee's Office is the agency that oversees bankruptcy cases on behalf of the Department of Justice. Under bankruptcy laws, small business cases are subject to more oversight by the U.S. Trustee's office than other Chapter 11 proceedings.

Plan Deadline. Generally, there is no deadline for filing a Chapter 11 plan unless set by the bankruptcy court. However, the debtor has only 300 days to propose a Chapter 11 plan in small business cases. The court can extend the 300-day deadline, but only if the debtor proves that it can obtain approval of a plan within a reasonable period.

Longer Exclusive Period to Propose Plan. In some cases, creditors file competing Chapter 11 plans. Chapter 11 plans filed by creditors typically provide for liquidating or taking over the debtor's assets and business. The debtor usually has the exclusive right to propose a Chapter 11 plan for 120 days. In small business cases, the exclusivity period is 180 days. The extended exclusivity period reduces the debtor's risk of the business closing while litigating competing plans.

No Disclosure Statement. Ordinarily, in Chapter 11, the debtor must prepare a disclosure statement, submit it to the bankruptcy court for approval, and circulate copies to creditors and other parties in interest. Disclosure statements in Chapter 11 cases are similar to prospectuses for stock offerings. They must provide extensive information about the debtor and proposed plan and are often expensive to prepare. The bankruptcy court can waive the disclosure statement in small business cases to expedite reorganization and reduce legal and other costs significantly.

When to Consult a Business Bankruptcy Attorney

Counsel must represent all businesses that file for Chapter 11. A bankruptcy attorney will be in the best position to explain your options and the specific procedures you can expect in your case.

Need More Bankruptcy Help?

Did you know Nolo has made the law accessible for over fifty years? It's true—and we wholeheartedly encourage research and learning. You'll find many more helpful bankruptcy articles on Nolo's bankruptcy homepage, and information needed to complete the official downloadable bankruptcy forms is located on the Department of Justice U.S. Trustee Program.

However, online articles and resources can't address all bankruptcy issues and aren't written with the facts of your particular case in mind. The best way to protect assets in bankruptcy is by hiring a local bankruptcy lawyer.