Businesses turn to Chapter 11 of the Bankruptcy Code when they cannot resolve their debt burdens through negotiation or expense reduction but would be capable of operating at a profit if their debt could be managed. Unlike a Chapter 7 liquidation that wipes out debt when a business ends, a Chapter 11 reorganizes business debt.
A Chapter 11 debtor that remains in possession of the business is referred to as “debtor in possession”. The business keeps its assets and continues to operate while implementing strategies to make the business profitable. The business proposes a plan that typically modifies the repayment terms of loans, leases, and contracts with certain classes of creditors. For example, unsecured creditors might receive substantially less than they are owed.
Creditors whose legal obligations are changed by the plan (“impaired creditors”) are allowed to vote in favor of or against its confirmation. Since a majority of at least one class of impaired creditors must usually vote to approve the plan before the Bankruptcy Court will confirm it, businesses typically negotiate terms of the plan with creditors to win their approval.
Chapter 11 Eligibility
Almost any business can file a Chapter 11 petition, including corporations, partnerships, and sole proprietorships. Even individuals who are not in business can file a Chapter 11 bankruptcy, depending on the amount of debt they have. Most individuals, including those who own an unincorporated business, find it easier to use Chapter 13 when their debt is below certain limits. A Chapter 13 is a simpler version of Chapter 11 that is tailored to the needs of individuals with lower debts. Corporations and partnerships are not eligible for Chapter 13 relief.
To be eligible for Chapter 11, a business must have a physical location or own property in the United States. Individuals (as opposed to corporations) must obtain credit counseling before filing and must not have had a prior bankruptcy dismissed under certain conditions within the previous 180 days.
To earn confirmation of a reorganization plan, the business will need to demonstrate to the Bankruptcy Court that the plan is feasible and offers a reasonable probability of success. Most reasonable plans that are proposed in good faith will be confirmed if they have the majority support of at least one class of creditors. If, at some point, the Court concludes that the business will not succeed, it can dismiss the case or convert it to a Chapter 7.
Small Business Eligibility
A Chapter 11 proceeding is more complex and time-consuming, and therefore costlier, than a Chapter 7. For that reason, larger corporations have traditionally relied on Chapter 11 relief. Certain small business debtors, however, are eligible for a simpler and quicker version of Chapter 11 that dispenses with creditor committees in exchange for greater oversight by a bankruptcy trustee.
A small business debtor is defined as a debtor that:
- operates a business (other than the management of its own real estate); and
- owes debts that total less than $2,490,925.
A small business debtor must provide the Bankruptcy Court with its balance sheet, statement of operations, cash-flow statement, and most recent tax return. Businesses that cannot provide those documents must be prepared to explain why they do not exist.
Ask for Advice
A Chapter 11 bankruptcy may remain in effect for many years. Whether it makes sense to commit the business to a Chapter 11, to file under Chapter 7, or to pursue alternatives to bankruptcy is a decision that should only be made in consultation with a team of advisors that includes a business bankruptcy attorney. To determine the best legal strategy for your unique case, please contact Marshall Grant, PLLC at [email protected].
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