Chapter 11 of the United States Bankruptcy Code (
Title 11 of the United States Code
Title 11 of the United States Code, also known as the United States Bankruptcy Code, is the source of bankruptcy law in the United States Code.
Chapters
Title 11 is subdivided into nine chapters. It used to include more chapters, but some of them ...
) permits reorganization under the
bankruptcy laws of the United States. Such reorganization, known as Chapter 11 bankruptcy, is available to every
business, whether organized as a
corporation
A corporation is an organization—usually a group of people or a company—authorized by the state to act as a single entity (a legal entity recognized by private and public law "born out of statute"; a legal person in legal context) and ...
,
partnership
A partnership is an arrangement where parties, known as business partners, agree to cooperate to advance their mutual interests. The partners in a partnership may be individuals, businesses, interest-based organizations, schools, governments ...
or
sole proprietorship
A sole proprietorship, also known as a sole tradership, individual entrepreneurship or proprietorship, is a type of enterprise owned and run by one person and in which there is no legal distinction between the owner and the business entity. A sole ...
, and to individuals, although it is most prominently used by corporate entities. In contrast,
Chapter 7 governs the process of a
liquidation bankruptcy, though liquidation may also occur under Chapter 11; while
Chapter 13
Title 11 of the United States Code sets forth the statutes governing the various types of relief for bankruptcy in the United States. Chapter 13 of the United States Bankruptcy Code provides an individual with the opportunity to propose a plan o ...
provides a reorganization process for the majority of private individuals.
Chapter 11 overview
When a business is unable to service its debt or pay its
creditors
A creditor or lender is a party (e.g., person, organization, company, or government) that has a claim on the services of a second party. It is a person or institution to whom money is owed. The first party, in general, has provided some property ...
, the business or its creditors can file with a
federal bankruptcy court
United States bankruptcy courts are courts created under Article I of the United States Constitution. The current system of bankruptcy courts was created by the United States Congress in 1978, effective April 1, 1984. United States bankruptcy ...
for protection under either Chapter 7 or Chapter 11.
In Chapter 7, the business ceases operations, a trustee sells all of its assets, and then distributes the proceeds to its creditors. Any residual amount is returned to the owners of the company.
In Chapter 11, in most instances the debtor remains in control of its business operations as a
debtor in possession, and is subject to the oversight and jurisdiction of the court.
[Joseph Swanson and Peter Marshall, Houlihan Lokey and Lyndon Norley, Kirkland & Ellis International LLP (2008). A Practitioner's Guide to Corporate Restructuring. City & Financial Publishing, 1st edition .]
A Chapter 11 bankruptcy will result in one of three outcomes for the debtor: reorganization, conversion to Chapter 7 bankruptcy, or dismissal. In order for a Chapter 11 debtor to reorganize, the debtor must file (and the court must confirm) a plan of reorganization. In effect, the plan is a compromise between the major stakeholders in the case, including the debtor and its creditors.
Most Chapter 11 cases aim to confirm a plan, but that may not always be possible.
If the judge approves the reorganization plan and the creditors all agree, then the plan can be confirmed. Section 1129 of the Bankruptcy Code requires the bankruptcy court reach certain conclusions prior to confirming or approving the plan and making it binding on all parties in the case, most notably that the plan complies with applicable law and was proposed in good faith.
The court must also find that the reorganization plan is feasible in that, unless the plan provides otherwise, the plan is not likely to be followed by further reorganization or liquidation.
In a Chapter 11 bankruptcy, the debtor corporation is typically recapitalized so that it emerges from bankruptcy with more equity and less debt, a process through which some of the debtor corporation's debts may be discharged. Determinations as to which debts are discharged, and how equity and other entitlements are distributed to various groups of investors, are often based on a
valuation of the reorganized business. Bankruptcy valuation is often highly contentious because it is both subjective and important to case outcomes. The methods of valuation used in bankruptcy have changed over time, generally tracking methods used in investment banking, Delaware corporate law, and corporate and academic finance, but with a significant time lag.
Features of Chapter 11 reorganization
Chapter 11 retains many of the features present in all, or most, bankruptcy proceedings in the United States. It provides additional tools for debtors as well. Most importantly, empowers the trustee to operate the debtor's business. In Chapter 11, unless a separate trustee is appointed for cause, the debtor, as debtor in possession, acts as trustee of the business.
Chapter 11 affords the debtor in possession a number of mechanisms to restructure its business. A debtor in possession can acquire financing and loans on favorable terms by giving new lenders first priority on the business's earnings. The court may also permit the debtor in possession to reject and cancel contracts. Debtors are also protected from other litigation against the business through the imposition of an
automatic stay
In United States bankruptcy law, an automatic stay is an automatic injunction that halts actions by creditors, with certain exceptions, to collect debts from a debtor who has declared bankruptcy. Under section 362 of the United States Bankruptcy ...
. While the automatic stay is in place, creditors are stayed from any collection attempts or activities against the debtor in possession, and most litigation against the debtor is stayed,
or put on hold, until it can be resolved in bankruptcy court, or resumed in its original venue. An example of proceedings that are not necessarily stayed automatically are family law proceedings against a spouse or parent. Further, creditors may file with the court seeking relief from the automatic stay.
If the business is
insolvent
In accounting, insolvency is the state of being unable to pay the debts, by a person or company ( debtor), at maturity; those in a state of insolvency are said to be ''insolvent''. There are two forms: cash-flow insolvency and balance-sheet i ...
, its debts exceed its assets and the business is unable to pay debts as they come due, the bankruptcy restructuring may result in the company's owners being left with nothing; instead, the owners' rights and interests are ended and the company's creditors are left with ownership of the newly reorganized company.
All creditors are entitled to be heard by the court. The court is ultimately responsible for determining whether the proposed plan of reorganization complies with bankruptcy laws.
One controversy that has broken out in bankruptcy courts concerns the proper amount of disclosure that the court and other parties are entitled to receive from the members of the creditor's committees that play a large role in many proceedings.
Chapter 11 plan
Chapter 11 usually results in reorganization of the debtor's business or personal assets and debts, but can also be used as a mechanism for liquidation. Debtors may "emerge" from a chapter 11 bankruptcy within a few months or within several years, depending on the size and complexity of the bankruptcy. The Bankruptcy Code accomplishes this objective through the use of a bankruptcy plan. The debtor in possession typically has the first opportunity to propose a plan during the period of exclusivity. This period allows the debtor 120 days from the date of filing for chapter 11 to propose a plan of reorganization before any other party in interest may propose a plan. If the debtor proposes a plan within the 120-day exclusivity period, a 180-day exclusivity period from the date of filing for chapter 11 is granted in order to allow the debtor to gain confirmation of the proposed plan.
With some exceptions, the plan may be proposed by any party in interest. Interested creditors then vote for a plan.
Confirmation
If the judge approves the reorganization plan and the creditors all agree, then the plan can be confirmed. If at least one class of creditors objects and votes against the plan, it may nonetheless be confirmed if the requirements of
cramdown
A cram down or cramdown is the involuntary imposition by a court of a reorganization plan over the objection of some classes of creditors.
Home mortgage loans
While typically used in a corporate context, the phrase has gained popularity in the co ...
are met. In order to be confirmed over the creditors' objection, the plan must not discriminate against that class of creditors, and the plan must be found fair and equitable to that class. Upon confirmation, the plan becomes binding and identifies the treatment of debts and operations of the business for the duration of the plan. If a plan cannot be confirmed, the court may either convert the case to a liquidation under chapter 7, or, if in the best interests of the creditors and the estate, the case may be dismissed resulting in a return to the status quo before bankruptcy. If the case is dismissed, creditors will look to non-bankruptcy law in order to satisfy their claims.
In order to proceed to the confirmation hearing, a disclosure statement must be approved by the bankruptcy court. Once the disclosure statement is approved, the plan proponent will solicit votes from the classes of creditors. Solicitation is the process by which creditors vote on the proposed confirmation plan. This process can be complicated if creditors fail or refuse to vote. In which case, the plan proponent might tailor his or her efforts in obtaining votes, or the plan itself. The plan may be modified before confirmation, so long as the modified plan meets all the requirements of Chapter 11.
A chapter 11 case typically results in one of three outcomes: a reorganization; a conversion into chapter 7 liquidation, or it is dismissed.
In order for a chapter 11 debtor to reorganize, they must file (and the court must confirm) a plan of reorganization. Simply put, the plan is a compromise between the major stakeholders in the case, including, but not limited to the debtor and its creditors. Most chapter 11 cases aim to confirm a plan, but that may not always be possible. Section 1121(b) of the Bankruptcy Code provides for an exclusivity period in which only the debtor may file a plan of reorganization. This period lasts 120 days after the date of the order for relief, and if the debtor does file a plan within the first 120 days, the exclusivity period is extended to 180 days after the order for relief for the debtor to seek acceptance of the plan by holders of claims and interests.
If the judge approves the reorganization plan and the creditors all “agree,” then the plan can be confirmed. §1129 of the Bankruptcy Code requires the bankruptcy court reach certain conclusions prior to “confirming” or “approving” the plan and making it binding on all parties in the case. Most importantly, the bankruptcy court must find the plan (a) complies with applicable law, and (b) has been proposed in good faith. Furthermore, the court must determine whether the plan is “feasible,” in other words, the court must safeguard that confirming the plan won’t yield to liquidation down the road.
The plan must ensure that the debtor will be able to pay most administrative and priority claims (priority claims over unsecured claims) on the effective date.
Automatic stay
Like other forms of bankruptcy, petitions filed under chapter 11 invoke the
automatic stay
In United States bankruptcy law, an automatic stay is an automatic injunction that halts actions by creditors, with certain exceptions, to collect debts from a debtor who has declared bankruptcy. Under section 362 of the United States Bankruptcy ...
of § 362. The automatic stay requires all creditors to cease collection attempts, and makes many post-petition debt collection efforts void or voidable. Under some circumstances, some creditors, or the
United States Trustee
The United States Trustee Program is a component of the United States Department of Justice that is responsible for overseeing the administration of bankruptcy cases and private trustees. The applicable federal law is found at and , et seq.
In ...
, can request the court convert the case into a liquidation under chapter 7, or appoint a trustee to manage the debtor's business. The court will grant a motion to convert to chapter 7 or appoint a trustee if either of these actions is in the best interest of all creditors. Sometimes a company will liquidate under chapter 11 (perhaps in a 363 sale), in which the pre-existing management may be able to help get a higher price for divisions or other assets than a chapter 7 liquidation would be likely to achieve. Section 362(d) of the Bankruptcy Code allows the court to terminate, annul, or modify the continuation of the automatic stay as may be necessary or appropriate to balance the competing interests of the debtor, its estate, creditors, and other parties in interest and grants the bankruptcy court considerable flexibility to tailor relief to the exigencies of the circumstances. Relief from the automatic stay is generally sought by motion and, if opposed, is treated as a contested matter under Bankruptcy Rule 9014. A party seeking relief from the automatic stay must also pay the filing fee required by 28 U.S.C.A. § 1930(b).
Executory contracts
In the new millennium, airlines have fallen under intense scrutiny for what many see as abusing Chapter 11 bankruptcy as a tool for escaping labor contracts, usually 30–35% of an airline's operating cost. Every major US airline has filed for Chapter 11 since 2002. In the space of 2 years (2002–2004) US Airways filed for bankruptcy twice leaving the
AFL–CIO
The American Federation of Labor and Congress of Industrial Organizations (AFL–CIO) is the largest federation of unions in the United States. It is made up of 56 national and international unions, together representing more than 12 million ac ...
, pilot unions and other airline employees claiming the rules of Chapter 11 have helped turn the United States into a
corporatocracy
Corporatocracy (, from corporate and el, -κρατία, translit=-kratía, lit=domination by; short form corpocracy) is an economic, political and judicial system controlled by corporations or corporate interests.
The concept has been used ...
. The trustee or debtor-in-possession is given the right, under § 365 of the Bankruptcy Code, subject to court approval, to assume or reject executory contracts and unexpired leases. The trustee or debtor-in-possession must assume or reject an executory contract in its entirety, unless some portion of it is severable. The trustee or debtor-in-possession normally assumes a contract or lease if it is needed to operate the reorganized business or if it can be assigned or sold at a profit. The trustee or debtor-in-possession normally rejects a contract or lease to transform damage claims arising from the nonperformance of those obligations into a prepetition claim. In some situations, rejection can also limit the damages that a contract counterparty can claim against the debtor.
Priority
Chapter 11 follows the same priority scheme as other bankruptcy chapters. The priority structure is defined primarily by § 507 of the Bankruptcy Code ().
As a general rule, administrative expenses (the actual, necessary expenses of preserving the bankruptcy estate, including expenses such as employee wages, and the cost of litigating the chapter 11 case) are paid first.
Secured creditor
A secured creditor is a creditor with the benefit of a security interest over some or all of the assets of the debtor.
In the event of the bankruptcy of the debtor, the secured creditor can enforce security against the assets of the debtor and av ...
s—creditors who have a
security interest
In finance, a security interest is a legal right granted by a debtor to a creditor over the debtor's property (usually referred to as the ''collateral'') which enables the creditor to have recourse to the property if the debtor defaults in makin ...
, or
collateral
Collateral may refer to:
Business and finance
* Collateral (finance), a borrower's pledge of specific property to a lender, to secure repayment of a loan
* Marketing collateral, in marketing and sales
Arts, entertainment, and media
* ''Collate ...
, in the debtor's property—will be paid before unsecured creditors. Unsecured creditors' claims are prioritized by § 507. For instance the claims of suppliers of products or employees of a company may be paid before other unsecured creditors are paid. Each priority level must be paid in full before the next lower priority level may receive payment.
Section 1110
Section 1110 () generally provides a secured party with an interest in an aircraft the ability to take possession of the equipment within 60 days after a bankruptcy filing unless the airline cures all defaults. More specifically, the right of the lender to take possession of the secured equipment is not hampered by the automatic stay provisions of the Bankruptcy Code.
Subchapter V
In August 2019, the Small Business Reorganization Act of 2019 ("SBRA") added
Subchapter V
Chapter or Chapters may refer to:
Books
* Chapter (books), a main division of a piece of writing or document
* Chapter book, a story book intended for intermediate readers, generally age 7–10
* Chapters (bookstore), Canadian big box bookstore ...
to Chapter 11 of the Bankruptcy Code. Subchapter V, which took effect in February 2020, is reserved exclusively for the small business debtor with the purpose of expediting bankruptcy procedure and economically resolving small business bankruptcy cases.
Subchapter V retains many of the advantages of a traditional Chapter 11 case without the unnecessary procedural burdens and costs. It seeks to increase the
debtor's ability to negotiate a successful reorganization and retain control of the business and increase oversight and ensure a quick reorganization.
A Subchapter V case contrasts from a traditional Chapter 11 in several key aspects: It's earmarked only for the "small business debtor" (as defined by the Bankruptcy Code), so, only a debtor can file a plan of
reorganization
A corporate action is an event initiated by a public company that brings or could bring an actual change to the securities—equity or debt—issued by the company. Corporate actions are typically agreed upon by a company's board of directors ...
. The SBRA requires the U.S. Trustee appoint a "subchapter V trustee" to every Subchapter V case to supervise and control estate funds, and facilitate the development of a consensual plan. It also eliminates automatic appointment of an official committee of unsecured creditors and abolishes quarterly fees usually paid to the U.S. Trustee throughout the case. Most notably, Subchapter V allows the small business owner to retain their equity in the business so long as the reorganization plan does not discriminate unfairly and is fair and equitable with respect to each class of claims or interests.
Considerations
The reorganization and court process may take an inordinate amount of time, limiting the chances of a successful outcome and sufficient
debtor-in-possession financing Debtor-in-possession financing or DIP financing is a special form of financing provided for companies in financial distress, typically during restructuring under corporate bankruptcy law (such as Chapter 11 bankruptcy in the US or CCAA in Canada). ...
may be unavailable during an economic recession. A preplanned, pre-agreed approach between the debtor and its creditors (sometimes called a
pre-packaged bankruptcy) may facilitate the desired result. A company undergoing Chapter 11 reorganization is effectively operating under the "protection" of the court until it emerges. An example is the
airline industry
An airline is a company that provides air transport services for traveling passengers and freight. Airlines use aircraft to supply these services and may form partnerships or alliances with other airlines for codeshare agreements, in whic ...
in the United States; in 2006 over half the industry's
seating capacity
Seating capacity is the number of people who can be seated in a specific space, in terms of both the physical space available, and limitations set by law. Seating capacity can be used in the description of anything ranging from an automobile that ...
was on airlines that were in Chapter 11. These airlines were able to stop making debt payments, break their previously agreed upon labor union contracts, freeing up cash to expand routes or weather a price war against competitors — all with the bankruptcy court's approval.
Studies on the impact of forestalling the creditors' rights to enforce their security reach different conclusions.
Statistics
Frequency
Chapter 11 cases dropped by 60% from 1991 to 2003. One 2007 study
[(January 24, 2007), "Small Firms Spurn Chapter 11", ''Wall Street Journal'', p. B6B.] found this was because businesses were turning to bankruptcy-like proceedings under state law, rather than the federal bankruptcy proceedings, including those under chapter 11. Insolvency proceedings under state law, the study stated, are currently faster, less expensive, and more private, with some states not even requiring court filings. However, a 2005 study
claimed the drop may have been due to an increase in the incorrect classification of many bankruptcies as "consumer cases" rather than "business cases".
Cases involving more than US$50 million in assets are almost always handled in federal bankruptcy court, and not in bankruptcy-like state proceeding.
Largest cases
The
largest bankruptcy in history was of the US investment bank
Lehman Brothers
Lehman Brothers Holdings Inc. ( ) was an American global financial services firm founded in 1847. Before filing for bankruptcy in 2008, Lehman was the fourth-largest investment bank in the United States (behind Goldman Sachs, Morgan Stanley, a ...
Holdings Inc., which listed $639 billion in assets as of its Chapter 11 filing in 2008. The 16 largest corporate bankruptcies as of 13 December 2011
Enron, Lehman Brothers, MF Global and Refco have all ceased operations while others were acquired by other buyers or emerged as a new company with a similar name.
‡ The Enron assets were taken from the 10-Q filed on November 11, 2001. The company announced that the annual financials were under review at the time of filing for Chapter 11.
See also
*
722 redemption
722 Redemption is a process within the Bankruptcy in the United States, U.S. bankruptcy code under Chapter 11, Title 11, United States Code, section 11 U.S.C. 722 that allows a debtor to redeem collateral based on the market value of the collater ...
*
Administration (law) in the United Kingdom, Australia, and New Zealand
*
Examinership
Examinership is a process in Irish law whereby the protection of the Court is obtained to assist the survival of a company. It allows a company to restructure with the approval of the High Court.
To obtain the appointment of an examiner it ...
in Ireland
*
Insolvency law of Canada
The Parliament of Canada has exclusive jurisdiction to regulate matters relating to bankruptcy and insolvency, by virtue of Section 91(2) of the Constitution Act, 1867. It has passed the following statutes as a result:
:* The ''Bankruptcy and Ins ...
References
External links
US changes bankruptcy protection laws via
BBC News
BBC News is an operational business division of the British Broadcasting Corporation (BBC) responsible for the gathering and broadcasting of news and current affairs in the UK and around the world. The department is the world's largest broad ...
.
Complete Title 11 (ZIP file) via www.house.gov
{{Title 11 of the United States Code
United States bankruptcy legislation
Title 11 of the United States Code