How Does Chapter 11 Bankruptcy Work?
Many people are puzzled over Chapter 11 bankruptcy. The word bankruptcy, when applied to corporations or businesses, often is equated to the death of a company. In fact, many companies do file for bankruptcy, and never return again to do business. But others file bankruptcy—sometimes multiple times—and continue operations seemingly as if nothing happened. How is that possible?
What is Chapter 11 Bankruptcy?
Chapter 11 bankruptcy is a very different animal than Chapter 7 or 13 bankruptcies. In Chapter 11, the company can often continue to run its operations while the bankruptcy is going on. The company is sometimes referred to as a “debtor in possession.” Sometimes, if there is fraud, a trustee will be appointed to run the business, but this is not common. A trustee can also be appointed when small businesses file for Chapter 11, regardless of whether there is fraud or not.
However, even if no trustee is appointed, and the company still runs and operates, the company loses the ability to make day-to-day decisions for itself. The bankruptcy court will approve of almost every aspect of the company’s operations—including making decisions that are made to lower the expenses of the business—and allow it to pay creditors. This can include decisions to break leases or contracts, decisions to sell company property, or decisions related to laying off employees.
While the company is operating, it is also formulating a plan to continue operations, called a reorganization plan. This plan is like a proposed contract between the company and its creditors, where the company is proposing how it will cut costs or downsize or reorganize, and how doing so will allow it to pay off creditors to some extent.
Of course, the company can also propose a plan where it completely shuts down operations. Either way, creditors and the court must approve of the debtor’s reorganization plan.
Because creditors have to approve the plan, creditors generally have to be treated equally, although in some cases, certain creditors will get special treatment if the creditor is vital to keeping the company viable, or if paying the creditor is vital to employees or a significant number of workers. Creditors also are motivated to be cooperative because if they cannot agree on a reorganization plan for the debtor, the debtor may end up liquidating completely in a Chapter 7 bankruptcy, where creditors would get much less than they would in the Chapter 11.
Court Findings Before Approval
Before the court approves a reorganization plan, the court must find that the plan is actually feasible—that is, that it is a doable plan and that if completed, it will pay off creditors, at least in part. The court must also find that the creditors are being paid enough—that the plan is fair and equitable to all creditors. If the plan does not meet these requirements, the court can convert the case to a Chapter 7 bankruptcy.