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Chapter 11 refers to the provisions in the Federal Bankruptcy Code for court-supervised reorganization of debtor companies. A company files for Chapter 11 protection when it can no longer pay its creditors or when it expects future liabilities it cannot hope to pay, such as product liability damage awards. In 1991, the U.S. Supreme Court ruled that the provision of federal bankruptcy law that permits corporations to reorganize while continuing to operate was also available for use by individuals. The Bankruptcy Reform Act of 1994 further amended Chapter 11.
1. Bankruptcy filing imposes an automatic stay.
- Creditors generally cannot file or continue suits for repayment.
- Debts are frozen and creditors generally must stop collection actions. This is called the "automatic stay."
- Debtor's day-to-day operations continue.
- Spending, borrowing, and asset sales outside of the debtor's normal course of business must be approved by the court.
- Secured creditors can ask the court for exemption from the automatic stay to undertake or continue to recover the collateral that secures their claim.
2. Unsecured creditors form a committee.
- The U.S. trustee appoints the committee, which ordinarily consists of the 7 largest unsecured creditors who are willing to serve on the panel.
- The U.S. trustee can appoint additional committees to represent other creditors and shareholders.
- The committee chooses representatives to deal with the debtor company.
- The committee and U.S. trustee oversee the debtor's business operations.
- Creditors and the U.S. trustee can ask the court to appoint an examiner to investigate possible fraud or mismanagement.
- Creditors and the U.S. trustee can ask the court to order the appointment of a case trustee to run the debtor company.
- If the court orders the appointment, the U.S. trustee selects the case trustee unless a party asks that creditors be allowed to elect the case trustee.
3. The committee, other creditors, and the debtor company negotiate a reorganization plan.
- Parties negotiate a plan for the reorganization of the debtor's business and repayment of frozen debts. This step can take months or years.
- Only the debtor can file a reorganization plan with the court for the first 120 days of the bankruptcy case. The court can extend the duration of the so-called "exclusivity" period and often does so.
- If the debtor does not file a plan during the exclusivity period, if the debtor's plan is not approved by the court, or if a trustee is appointed, any party can file a plan.
- The proponent of the plan prepares a disclosure statement, which must be approved by the court at a separate hearing.
4. Creditors and shareholders vote on the plan.
- Only creditors and shareholders whose claims and interests are impaired or affected by the plan vote on it.
- A class of creditors accepts the plan if the plan is approved by creditors who hold more than half of the claims in the class by number and at least two-thirds of the claims by amount.
- A class of shareholders accepts the plan if the plan is approved by shareholders who hold at least two-thirds of the equity interest in the class by amount.
5. Judge considers the plan.
- The bankruptcy judge approves the plan if it complies with the Bankruptcy Code and all impaired classes approve.
- If at least one of the impaired classes approves the plan and it meets certain statutory tests, the judge can confirm the plan in a "cramdown," even if not all impaired classes approve.
6. Reorganized company emerges.
- Generally, the debtor's debts are discharged.
- The debtor and creditors must comply with the confirmed plan.
- The automatic stay ends and a permanent injunction goes into effect against any effort to collect prepetition debts other than as provided in the plan.
- The reorganized debtor operates like a normal company.
- Only about 17% of the debtors who file Chapter 11 cases get their plans confirmed.
Expedited Procedure for Small Businesses
The Bankruptcy Reform Act of 1994 included an expedited confirmation process to be used in Chapter 11 cases filed by small businesses.
The debtor can elect to use the new process if it has less than $2 million in debts and its primary business is not owning or operating real estate.
The court can order that a creditors' committee not be appointed.
Unless the court orders otherwise, the debtor's exclusivity period for filing a plan is shortened to 100 days and all plans must be filed within 160 days.
The court may conditionally approve the disclosure statement. This saves time by combining the court hearing on the disclosure statement with the hearing on confirmation of the plan.
Citation: "Economics: Chapter 11 Bankruptcy." The World Almanac and Book of Facts. 2006. Issues & Controversies. Facts On File News Services. 23 Dec. 2008.