Chapter 11 of the United States Bankruptcy Code deals with the reorganization of an existing business. Chapter 11, therefore, is often called a reorganization bankruptcy. Corporations file for this type of bankruptcy when they want to restructure their debts and financial obligations while remaining in control of their business. Companies that have pursued Chapter 11 reorganization include General Motors, K-Mart, and United Airlines.
A Chapter 11 proceeding begins when a corporation or limited liability company files a Chapter 11 petition in the bankruptcy court. In the petition, the company identifies itself (name, location, and tax details), requests relief under Chapter 11, and shows intent to file a reorganization plan. This petition usually must be accompanied by certain forms, including lists of assets and liabilities, incomes and expenditures, and executor contracts and ongoing leases.
Once a debtor files this petition, an automatic stay takes effect that prevents creditors from taking action. Further, the debtor can continue running the company as the bankruptcy process continues. However, the debtor serves as a fiduciary in the same capacity as the US bankruptcy trustee. The debtor must submit periodic reports to the court, including tax reports and accounting statements. Without the authority of the court, the company cannot undertake certain actions, such as selling assets aside from inventory, starting a rental agreement, or expanding or stopping business operations.
In cases involving fraud, incompetence, dishonesty, or gross mismanagement, a creditor or a US Trustee can petition the court to order the appointment of a trustee, for the best interests of creditors and equity security holders. The court then conducts a hearing, and if there are grounds to believe that the company’s management acted dishonestly or fraudulently, the court orders the appointment of a trustee.
In some instances, a company’s creditors can file a Chapter 11 petition against the company. This is known as an involuntary petition. The court makes an order of relief against the debtor, upon which the debtor assumes the role of a debtor in possession. A debtor in possession has 120 days to submit a reorganization plan. This period may, however, be extended to 18 months by the court.
The plan identifies the different classes of creditors (secured, unsecured, priority unsecured, and general unsecured) and then states how they will be treated. The plan should include reorganization proposals, such as renegotiating debts, downsizing the company to minimize expenses, and selling assets to pay debts.
After a debtor submits a plan, impaired creditors (those who will receive less than they are owed) vote on the plan. Those who will receive their full dues are presumed to vote yes. Ideally, at least one group of impaired creditors must agree with the plan for the court to confirm it.
The court confirms a plan if it is fair, equitable, and does not discriminate against any creditors. The plan also must be feasible, in the best interests of the creditors, and presented in good faith by the debtor. Once a court approves the plan, the reorganization begins.
After the 120-day or 18-month period, if the debtor does not submit a plan, a creditor or US Trustee may do so. This plan will be put to a vote by the creditors, and if they agree with it, the plan will move to the court for confirmation.
