Petition for Chapter 11 Bankruptcy paperworkBusiness sections regularly report on big corporations that have hit on hard times filing for what’s called Chapter 11 bankruptcy. It’s difficult to name an airline that hasn’t gone through it in the past dozen years. Two of Detroit’s Big Three automakers — General Motors and Chrysler — filed in 2009. Casinos do it. Drug companies do it. And after years of resisting despite a tsunami of red ink washing away assets and swamping stores, even venerable Sears sought relief through Chapter 11 in October 2018.

It’s not just big corporations. Smaller, regional businesses, such as Irving, Texas-based Taco Bueno and University Physician Group in Detroit, filed for Chapter 11 protection in November 2018.

During the peak of the Great Recession and the early years of the recovery (2008-2012), nearly 250,000 businesses filed for bankruptcy (not all of them Chapter 11). Since then, business bankruptcies have dipped dramatically (as have all forms of bankruptcy), averaging a bit less than 24,000 annually, although analysts have noted, with worry, about the uptick in Chapter 11 filings that began in December 2017.

It’s a virtual guarantee we’ve all heard of Chapter 11 bankruptcy, then. But what is it? How does it work? Who can qualify? What are its advantages?

Let’s check it out.

What is Chapter 11 bankruptcy?

Named for the U.S. bankruptcy code 11, Chapter 11 customarily is sought by corporations seeking time and opportunity to restructure their debts, renewing the debtor’s chances of making a go of its business (as Delta, United, Macy’s, and GM— to name four — have done), so long as the debtor fulfills its obligations under its reorganization plan.

Chapter 11 allows a troubled business — any sort of business, including big corporations but also partnerships, LLCs, and sole proprietorships — to restructure its debts and other obligations.

“Chapter 11s,” says bankruptcy attorney James G. Aaron, chairman of New Jersey-New York-based Ansell Grimm & Aaron, “look to reorganize past-due debt, stop the payment of the past-due debt, and say to a court that you can reorganize by paying your creditors more than they would receive in a Chapter 7 liquidation of the assets.”

To build confidence among creditors, under Chapter 11 the debtor corporation submits a reorganization plan that includes a disclosure statement to creditors, a key phase in the process.

A Chapter 11 corporation will attempt to regain profitability through the application of assorted tools, including a total discharge of some debt, repayment of others, liquidation of certain assets, downsizing its workforce, and termination of leases and long-term contracts.

The disclosure phase is phase is key, says Boston-based bankruptcy attorney Matthew J. Kidd. Creditors “will evaluate [the plan’s] feasibility, and the probability of recoupment from operational income and other sources.”

To reiterate, the debtor company (or, in rare cases, individual with an enormous amount of debt) filing Chapter 11 has first shot at

proposing a reorganization plan. If the debtor does not lay out a plan, creditors may propose one instead.

Who Can File Chapter 11 Bankruptcy?

Chapter 11 is considered a business, or commercial, bankruptcy for a reason: It tends to be more flexible, and therefore more complicated and expensive to execute, than Chapters 7 and 13 bankruptcies, which favor individual (or spouse-and-spouse) filers. It also has no limitations on the amount of debt to be addressed; for this reason alone, Chapter 11 is the typical choice for large businesses seeking to restructure their debt in hopes of survival.

Among the complications: A creditors committee usually is appointed by the U.S. Trustee from among the 20 creditors with the largest unsecured stakes (excluding insiders). The committee, representing all the creditors, provides oversight for the debtor’s ongoing operations; the debtor, while maintaining possession of its assets — becoming, officially, a debtor in possession — can negotiate a plan of reorganization with the committee.

If approved, the debtor organization gets on with its plan. In cases of suspected fraud or gross mismanagement, however, the court may appoint a trustee, who will oversee operations of the debtor throughout the process. The business operates as planned, but the original owner is no longer in control.

None of this means individuals or small businesses can’t, or shouldn’t, file under Chapter 11. But when it comes to reorganizing under the protection of bankruptcy, Chapter 13 is usually a better bet, offering a streamlined process at a discounted price while allowing the debtor to maintain possession of his assets, get square on secured debt, and, at the end of the plan, discharge unsecured debt.

What’s the process?

  • Begin with the disclosure statement, describing the debtor’s structure and how it conducts its business. It’s here the business seeking relief attempts to convince the court reorganization will help it survive and recover to the point of profitability.
  • Confirmation follows, in which creditors vote on the reorganization plan. Creditors are parceled into classes, and their votes weighed, based on the type and amount of debt they hold. Generally, the judge and creditors must approve the plan, although there is an exception in which the debtor company gets its way through what’s known as “cram down.”
  • Next comes the post-confirmation period, in which the company attempts to make good on its restructuring, making promised payments, through a third party, to creditors.
  • If successful, the final phase arrives: The company’s restructuring has prevailed, the creditors are substantially repaid, and the bankruptcy is discharged.

Going through Chapter 11 isn’t cheap. There’s a $1,167 filing fee, administrative costs for the U.S. Trustee, and, most likely, an experienced bankruptcy attorney banking endless billable hours.

What Debts Can Be Included in Chapter 11?

Most debts incurred prior to declaring bankruptcy can be discharged. These include, but are not limited to, business debts, back rent, and credit card bills.

It’s easier to note what can’t be done away with in Chapter 11 filings, beginning with this: A debtor who commits misconduct

during the course of a bankruptcy proceeding will be denied discharge.

Otherwise, debts that cannot be discharged include certain tax claims (income, property, payroll, sales) and mortgages. These can be restructured, however, as part of a realistic repayment scheme that allows the business to endure.

Restructuring plans must survive a “fair and equitable” test, a key consideration of which is whether secured creditors will receive at least the value of their collateral.

Can Chapter 11 Save My Small Business?

The shortest possible answer is this: Yes. In some cases. But don’t get your hopes up.

Only about 10% of Chapter 11 filings result in success; far more often, they end up in Chapter 7 straight bankruptcy, in which the company closes and its assets are sold to pay back secured creditors.

“Any business entity of any form is eligible for a Chapter 11,” says attorney Aaron. “The philosophy is the same.” Indeed, under the right circumstances, Chapter 11 could help a small business survive.

Take a start-up company that has taken on substantial debt in development costs. Just as the business finally begins to generate significant income, the bills come due, there’s not sufficient cash to meet them, and there’s no place to raise needed capital.

“Chapter 11 would make sense,” Aaron says, “because the Chapter 11 stops the creditors from seeking payment [and] gives the debtor 120 days from the date of filing to file a plan of reorganization.”

In some cases, Aaron says, courts weigh what creditors might recover from a straight liquidation vs. what they could reasonably expect over a period of time and extend the duration allowed for the company to pay its debts — up to five years.

If the court is convinced, this Chapter 11 grace period allows the business to get on its feet, when otherwise, Aaron notes, creditors would shut down the company “without allowing [it] the opportunity to capitalize on all the hard work it has put in up to the date of filing.”

Moreover, sole proprietors or general partners of a small business are personally liable for the business’ debts. Your personal assets are your business’ assets, which means business creditors can seize your stuff to settle your debt.

A Chapter 11 filing could protect your business and personal assets.

You may qualify if you’re pursuing commercial or business activities that in sum do not exceed $2 million. Qualifying small business debtors go on a “fast track,” getting different treatment from a customary Chapter 11 case. A creditors committee may not be appointed, and the court may decide a separate hearing to approve a disclosure statement is not necessary.

Small business cases move faster because the stakes and number of creditors tend to be smaller/fewer. The court may approve a disclosure statement conditionally, awaiting final approval after notice and a hearing, and a creditors’ vote to accept or reject the reorganization plan.

But, again, the odds are stacked against surviving Chapter 11. Target has, but for every Target, there are nine Toys “R” Usses that didn’t.

How Long Does Chapter 11 Take?

Because it is complicated, what with disclosures and committees and hearings and special accounts and audits and votes and, sometimes, refinancing and oversight by the U.S. Trustee’s Office, Chapter 11 is not only labor-intensive, it can be extremely time consuming.

“In theory,” Aaron says, “a company could be in and out of bankruptcy in 30-45 days.” Others, he says, “drag on for years,” weighed down by pre-existing litigation and other potential complications, such as whether the company is a single-asset entity — say a real estate partnership with a lone shopping center that’s hit a tough patch.

The bottom line on how long Chapter 11 can take is, it depends.

Communicate optimism

Ideally, the business navigating Chapter 11 continues to operate through the reorganization until it emerges ready for success on a freshly poured foundation.

This continued functioning is a key ingredient of Chapter 11 proceedings, but, because customers, clients, vendors, partners, and even employees tend to hear “bankruptcy” — and translate it into “going out of business” — much louder and more readily than “reorganization for success,” these stakeholders must be reassured about the path ahead.

“People are frightened by the unknown and misunderstood,” says Eden Gillott, president of her eponymous New York-based communications firm. “You need to reassure each audience by not only communicating with them, but also listening to their concerns. What do they need to hear? The answer to the question, ‘So how does this affect me?’ ”

Keep it upbeat, Gillott says. A sunny outlook might be just the thing to help a business survive the Chapter 11 storm ahead.