Chapter 11 Bankruptcy Explained
Chapter 11 Bankruptcy provides an opportunity to reorganize debts and for a business with severe financial problems to stay in business.
There are three different types of Chapter 11 Bankruptcy. The first and most well-known type is Chapter 11 for large corporations. The second and most common type is for small businesses. A small business is defined as one with fewer than 500 employees and less than 2.19 million dollars in debt. The third and by far the most unusual type of Chapter 11 is for individuals who do not qualify for Chapter 7 or Chapter 13 Bankruptcy.
An individual filing Chapter 11 is given 5 years to repay all or, depending upon the circumstances, part of the debt owed. A business may be given more than 5 years to repay its debts.
There are many benefits to a Chapter 11 Bankruptcy. The court may reduce the amount owed on secured property if the amount owed exceeds the property’s fair market value. For example, if you own a building that has a mortgage of 5 million dollars and the fair market value of the building is only 3 million dollars, the court may reduce the mortgage to 3 million dollars. The 2 million dollars that was removed from the mortgage becomes an unsecured debt to be paid along with other unsecured debt over the life of the plan.
Depending upon the facts of the case, unsecured debts may also be reduced, sometimes significantly. If the Chapter 11 payment plan states that the unsecured creditors are to be paid 10% over 5 years, then the 2 million dollars that came off of the mortgage in our example will be reduced to $200,000. The $200,000 will be paid, along with other unsecured debts, over the repayment period, which is often 5 years.
As in other types of bankruptcies, an automatic stay goes into effect when the Chapter 11 is filed with the bankruptcy court. This prevents creditors from taking collection or legal actions against the debtor while the bankruptcy is pending. The court may also allow a debtor to obtain new financing under better terms by allowing a new creditor priority over prior creditors to the business’ earnings. The court may allow the debtor to reject and cancel contracts.
Although a Chapter 11 Bankruptcy may provide much relief and even allow a failing business to continue, it takes much effort, and it is costly. Extensive paperwork is needed to gain approval of a Chapter 11 Bankruptcy. Complete bank records for the previous several years are required, as are financial statements and profit and loss statements. While the plan is in effect, financial reports must be filed every month. There will be oversight by the court while the Chapter 11 is in effect. Even the most basic Chapter 11 may cost $30,000 to $50,000 in legal and accounting expenses.