What Is Chapter 11 Bankruptcy?

Chapter 11 of the 1978 Bankruptcy Act provides for reorganization under the bankruptcy laws of the United States, allowing businesses to restructure their debts while continuing operations.

Chapter 11 of the 1978 Bankruptcy Act, commonly referred to as “Chapter 11 Bankruptcy” or “Reorganization Bankruptcy,” allows businesses, and in some cases, individuals engaged in business affairs, the flexibility to restructure their debts while maintaining operational control. This form of bankruptcy is designed to facilitate the rehabilitation of financially distressed businesses through a reorganization plan that repays creditors over time, often while continuing daily operations.

Legal Framework and Provisions

The 1978 Bankruptcy Act

Enacted to modernize the U.S. bankruptcy system, the 1978 Bankruptcy Act introduced Chapter 11 as a means for businesses to reorganize their operations and manage debts under the court’s protective oversight, substituting older procedures with more formal and structured guidelines.

Key Components of Chapter 11

• Debtor in Possession (DIP): Unless the court orders otherwise, the debtor usually remains in possession of the business (DIP) and continues to control its operations. This allows the management to run day-to-day activities, albeit with court and creditor oversight.
• Automatic Stay: An automatic stay function prevents creditors from initiating or continuing lawsuits, foreclosures, or collection activities against the debtor, providing a breathing spell to restructure operations.
• Reorganization Plan: The debtor proposes a reorganization plan outlining how it intends to repay its debts over a specified period. This plan must be confirmed by the bankruptcy court and accepted by the creditors.
• Creditors’ Committee: Often, a creditors’ committee is formed to represent the interests of unsecured creditors and to negotiate the terms of the reorganization plan.

Types of Entities That Can File

While Chapter 11 is typically used by corporations and partnerships, individual business owners can also file if their business-related debts meet certain criteria specified in the Bankruptcy Code.

Special Considerations in Chapter 11

Advantages

• Operational Continuity: Businesses can continue operations, providing an opportunity to stabilize cash flow.
• Debt Restructuring: Debtors can restructure secured and unsecured debts and reject burdensome contracts and leases.

Disadvantages

• Costly Process: Chapter 11 can be expensive due to legal fees and the need for ongoing court involvement.
• Complex Approval: Gaining creditor and court approval for the reorganization plan can be challenging and time-consuming.

Historical Context

Chapter 11 reorganizations have a significant success rate in the right conditions, with notable historic examples including the restructurings of major corporations like General Motors and United Airlines. These cases demonstrate the efficacy of Chapter 11 in salvaging productive entities of fundamental economic importance.

Comparisons and Related Terms

• Chapter 7 Bankruptcy: This contrasts with Chapter 11 by providing for liquidation rather than reorganization. Under Chapter 7, a business ceases operations, and its assets are sold to pay off creditors.
• Chapter 13 Bankruptcy: Mainly available to individuals with regular income, Chapter 13 offers a simplified reorganization over a three to five-year period.
• Pre-packaged Bankruptcy: A variant where the reorganization plan is negotiated and agreed upon by creditors before the company files for Chapter 11.

FAQs

What happens to shareholders in a Chapter 11 bankruptcy?

Shareholders’ rights typically become subordinated to those of the creditors. If the company successfully reorganizes, shareholders might retain some equity; however, in unsuccessful cases, they often lose their stakes.

How long does a Chapter 11 bankruptcy typically take?

The duration varies greatly but generally ranges from a few months to several years, depending on the complexities involved and the court’s calendar.

Can a Chapter 11 plan be modified once approved?

Yes, modifications can be made if new circumstances arise, but they must be approved by the bankruptcy court.

References

• United States Courts: Chapter 11 - Bankruptcy Basics
• Cornell Law School: Legal Information Institute - Chapter 11
• Historical Case Studies: General Motors and United Airlines Chapter 11 Reorganizations

Summary

Chapter 11 bankruptcy represents a crucial mechanism within U.S. bankruptcy law enabling businesses, and in certain conditions, individual business owners, to structure a plan to repay debts while continuing to operate. While complex and often expensive, its successful application can lead to the rejuvenation of financially distressed enterprises, hence preserving jobs and economic value.