A chapter of the US Bankruptcy Code, Chapter 11 permits reorganisation of a company under the bankruptcy laws of the US. If a company is unable to pay its creditors or service its debts it may file for Chapter 11 protection with a federal bankruptcy court. Chapter 11 allows the debtor to remain in control of business operations while working with its creditors to reorganise the company, under the supervision of the court. Lehman Brothers was the largest organisation ever to file for Chapter 11 bankruptcy, listing over $639 billion in assets.
How Chapter 11 works
A Chapter 11 case begins with the filing of a petition with the local bankruptcy court. This petition may be either voluntary (filed by the debtor) or involuntary (filed by the company’s creditors). The debtor must also produce information and schedules for the court outlining the company’s:
Assets and liabilities.
Current income and expenditures.
Contracts and unexpired leases.
Statement of financial affairs.
After filing for Chapter 11 the debtor becomes the ‘debtor in possession’. This allows the debtor to maintain control of its assets while the company undergoes reorganisation. The debtor has 120 days to file a written disclosure statement and plan of reorganisation with the court. This plan must specify how each claim on the company will be dealt with. Creditors whose claims will not be met in full then vote on the plan.
After the disclosure has been approved by the court and the results of the ballot of creditors reviewed, the court will conduct a hearing to decide whether or not to endorse the reorganisation plan. The approved plan will usually allow the debtor to manage its debts by repaying part of some obligations and dismissing others. It also permits the debtor to terminate any contracts or leases that are unmanageable, recover its assets and reorganise its operations in order to return to profitability.
As soon as the bankruptcy petition is filed, a period of time, known as an automatic stay, comes into effect. An automatic stay invokes the suspension of all judgements, payment collections and repossessions, allowing the debtor time to conduct negotiations to try to resolve the company’s financial situation.
Debtor in possession
When a corporate files for Chapter 11, its shareholders’ personal assets are not put at risk beyond the value of their investment in the company’s stock. The debtor in possession must take responsibility for various duties, such as accounting for property, examining claims, filing reports as required by the bankruptcy administrator and employing attorneys and other professionals to assist in the bankruptcy case. In a small number of cases, usually involving fraud, dishonesty, incompetence or gross mismanagement, the court may appoint a trustee to assume control of the business. Alternatively, any interested party may request the appointment of a trustee.
Once court fees have been paid – there is a $1,000 case filing fee and a $39 dollar administrative fee, both of which may be paid in instalments, but must be paid in full within 120 days of filing the petition – the order in which the company’s creditors must be paid is as follows: secured creditors, unsecured priority creditors, general unsecured creditors and equity security holders.
If a company is prevented from restructuring because of the extent of its debt or other problems, it may file for Chapter 7 bankruptcy. In this event it ceases all operations and goes into liquidation. A trustee is appointed to sell the company’s assets and pay off its debts. Chapter 11 is considered a more favourable option then Chapter 7, since it gives the company a chance to reorganise its operations and attempt to return to profitability. It usually results in the company’s creditors getting more money than they would in the event of a Chapter 7 liquidation. Some Chapter 11 cases do, however, end in liquidation.