Chapter 11 Bankruptcy: An Overview

Both individuals and businesses can file for Chapter 11 bankruptcy. Learn more.

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Chapter 11 is a section of the bankruptcy code that permits individuals and businesses to either liquidate or reorganize debt. Distinct from Chapter 7 and Chapter 13 bankruptcy cases, Chapter 11 typically involves greater sums of money regarding the assets and debts of the individual or business.

Who Can File for Chapter 11 Bankruptcy?

Chapter 11 is available for both individuals and businesses. As an individual debtor, you can reorganize the debts that are in your name in an effort to restructure your finances and protect your assets. If you file as a business, you can still reorganize the debt but you are limited to debts of the business.

Typical Chapter 11 Cases Filed by Individuals

Chapter 11 cases are seldom filed by individuals. However, when individuals do file for Chapter 11, it's usually for one of two reasons: real estate investment reorganization or reorganizing unsecured debts that are too high to qualify for Chapter 13 relief.

Real Estate Investors May Use Chapter 11 to Rewrite Mortgages

Chapter 11 is a powerful tool that allows real estate investors to rewrite mortgages. For example, if you own a property worth $50,000 but you owe $100,000 on the loan, Chapter 11 will allow you to reduce the principle balance of the mortgage to the value of the property. This would reduce the mortgage from $100,000 to $50,000.

Not only that, but Chapter 11 will also allow you to reduce the interest rate and extend the term of repayment, often times to another 360 months (30 years). This results in a lower monthly mortgage payment and allows the property to become profitable again.

Using Chapter 11 to Reorganize Large Amounts of Unsecured Debt

Most individuals use Chapter 13 bankruptcy to reorganize and pay back debt under a repayment plan. However, Congress has limited the amount of debt you may have to qualify for Chapter 13. The current debt limit for a Chapter 13 debtor is $360,475 for unsecured debts. If your total unsecured debt is more than this, you could file for Chapter 11 bankruptcy instead.

A Chapter 11 allows you to restructure and pay back your unsecured debt in a manner similar to Chapter 13. You will have a regular monthly payment to each of your creditors and once you have completed repayment according to your court-approved plan, the judge will give you a discharge absolving you of any future liability on most debts.

Typical Chapter 11 Business Cases

Most chapter 11 business cases deal with the restructuring of multiple types of debt including: priority tax debt, secured debt, unsecured debt, and leases, while also seeking to protect the business assets.

Priority Tax Debt

Chaper 11 can be a useful tool to reorganize past due taxes that your company has incurred. Debts such as property taxes, income taxes, and payroll taxes can be restructured to allow you to continue to operate the business but also meet your tax obligations at the same time. While most tax obligations usually get paid off during a five-year period, Chapter 11 allows you to renegotiate repayment terms between your business and the taxing authority on grounds mutually acceptable to both parties.

Secured Debt

Chapter 11 permits a business debtor to reorganize secured debts in a similar manner to individual cases. You identify which secured debts and corresponding collateral will contribute to the profitability of the business. Then, just like in the individual Chapter 11, you may seek to pay the current value of the property as opposed to what you actually owe on it. Examples of collateral include real estate, business equipment, and vehicles.

For example, if you have a fleet of 20 work trucks that are worth approximately $200,000 but you owe $500,000 on them, you can ask the court to allow you to pay only what the collateral is worth as opposed to what is owed. This allows your business to reduce its monthly operating expenses in order to become more profitable.

Unsecured Debt

Debts such as company credit cards, signature loans, or other general unsecured loans can help with upstart and ongoing operating costs, but frequently act as a major burden on future profit margins. Chapter 11 allows you to restructure your unsecured debt and pay towards it with the company’s profit either in a lump sum at the conclusion of your case or in periodic payments over a term of years. Ideally, you and your class of unsecured creditors will agree upon how much and when you pay. If an amicable agreement cannot be reached among the parties, then the judge will decide what is fair and you will be bound by his or her decision.

Lease or Executive Contract Debt

Chapter 11 permits you to accept or reject your leases and executive contracts. For example, imagine you are a hotel owner and previously contracted with a cleaning service for the next five years. You find you can now obtain similar services for half the price, thus increasing the profitability of the business. Chapter 11 will allow you to sever the contract with the current cleaning service. You may then ask the court to allow you to seek a new, more affordable service. As long as you can show that the new contract and corresponding service will contribute to the profitability of the business, the judge will authorize the new contract.

Another example would be if your company leased office space. That same office space may be leasing for twice as much since you originally signed the lease. The bankruptcy code requires you to affirm your intent to retain that lease within a certain number of days after filing or you are automatically deemed to have rejected it. Failure to act may cause you a great deal of time and money and the bankruptcy judge will be powerless to help you correct your mistake.

How to Succeed in Chapter 11 Bankruptcy

A Chapter 11 bankruptcy can be likened to a very contentious election. Each class of creditors (priority, secured, and unsecured) are entitled to vote to accept or reject your proposed treatment of them in your bankruptcy plan. After the initial hearings, the court will authorize you to start soliciting votes. Ideally, you get a vote of acceptance from every creditor and the judge approves the plan on this basis. You will likely have to negotiate various terms of treatment with the individual creditor to obtain acceptance so be prepared to compromise.

In the event you have a creditor who rejects the plan, the creditor’s non-acceptance may be a major impediment to court approval of your plan. If all negotiations fail, you will have to ask the judge to approve your case over the objection of the non-accepting creditor. This request is referred to as “cram down” because you are asking the judge to cram the terms of the plan down the non-accepting creditor’s throat.

As long as you successfully negotiate the treatment of each participating creditor in your bankruptcy, you should be able to restructure your individual or business debt in a way that allows you to emerge from bankruptcy lean and profitable.

To learn about typical procedures in a Chapter 11 case, see Chapter 11 Bankruptcy: Timeline and Process.

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