Chapter 11 Bankruptcy

Bankruptcy – Chapter 11

Chapter 11 is also known as reorganization bankruptcy as it involves a significant and disruptive overhaul of a debtor’s business affairs, assets, and debts. Most importantly, wherever the debtor/owner requires restructuring the debts with continuity of the business operations, such cases are filed under Chapter 11. Entities generally refer to Chapter 11 if they need a restructuring of their debts. It gives them a new kick start, provided the terms are not detrimental to the conditions laid under the revival plan, such as the debtor’s fulfillment of its obligations.

A corporation taking the route of Chapter 11 for filing bankruptcy has to first understand well about the complexities and the costs involved in the process. Generally, it will be pricey to file proceedings under Chapter 11, knowing that the success rates are significantly less and the process is not a speedy one. However, it does provide an opportunity for the company to reshape itself while continuing to operate, suspend or configure debts and get back on track.

Also, careful consideration of other alternatives needs to be evaluated before starting the filing process along with the post-bankruptcy financial, going concern value, creditworthiness, and economic repercussions that decide what action is right for the company.

Bankruptcy Proceedings

Under this Chapter, the first opportunity is to propose a planned rest with the individual/company filing the Bankruptcy proceedings. Although, the Court may accept the plan if it involves reducing the expenses, renegotiating the debts, and downsizing the business operations. Some plans also include liquidating the business assets to repay the creditors.

During the action, the Bankruptcy Courts help the business recast its obligations and reshape its Balance Sheet. Most firms and companies continue to operate during this process once they file the application. However, they need to seek explicit approvals from the Court for the below decisions:

  • Sale of Assets such as PPE (Property Plant or Equipment) – Except for items such as Inventory in the ordinary course of business.
  • Signing fresh Lease of Property for business or personal use or breaking any existing lease.
  • Signing any Financing arrangements or creating a mortgage to raise funds, etc.
  • Any business expansion or closure.
  • Negotiating or altering existing terms with vendors, unions, contracts, agreements, and so on.
  • To make payment of fees or expenses to Attorneys, Lawyers & other professionals.

Confirmation of Chapter 11 Plan

The Bankruptcy Court will consider inputs from stakeholders such as Creditors (Secured and Unsecured), Equity holders, and outside parties involved in connection with the proposed Chapter 11 plan. The ultimate confirmation of the plan lies with the Court. The latter must delve into the below variables in deciding upon the plan. Few of such variables rarely get applicable if the proposed plan is not agreeable to the creditors.

Likely to Succeed

The plan must be one that is practical and is likely to meet its objectives and purpose.

Must be Bonafide

The plan must not be forbidden under the law and must establish a preparation with good faith.

Best Interest of Creditors

The said plan must pass the test of “best interest” that may require the debtor to pay off the creditors in full in some cases. Chapter 11 debtors are mostly financially unsound and can suggest payment of only a fraction of the amounts due to the creditors.

Fair & Equitable

The plan should be such that all the secured creditors’ payment comes up first and are at least equal to the value of their collateral. Next comes the unsecured creditors. The stockholders will be the last, and they mostly lose all their rights on confirmation of the plan. However, the Court may allow the equity holders to retain the rights of ownership in debtors to pay for the organization’s expenses.

Even between the stockholders, the preferred stockholders will have the first right of distribution if a surplus is available.

Success Rate of Chapter 11

The history and records of success of Chapter 11 Bankruptcy filing are abysmally low, maybe around 10% or so.  And it is so because of various factors like the high cost of filling and related expenses, complicated procedures, restrictive timelines, and so on. Other cases are either dismissed or converted into Chapter 7 liquidations under the approval of the Court. Sometimes, even the Court dismisses or converts the chapter 11 filing to a case for cause. And this can happen when the Court doubts the capability of the debtor for the successful reorganization of the business.

Emerging from Chapter 11

Most companies that come out from Chapter 11 do face some challenges in the form of starting afresh, setting realistic expectations, and recreating their brand image. It is a critical requirement in the post-financial crisis for sustaining the operations in short to medium term, as well as for targeting realistic growth in the future.

Chapter 11 Bankruptcy

Misconceptions

Chapter 11, bankruptcy means restructuring and not liquidation. A company may downsize its operations, but the stores and the assets remain operational and maybe under different ownership.

There have been instances where the timelines are too stretched for the outcome of bankruptcy proceedings. However, there are occasions where the preparation and finalization of plans happen before the proceedings get their way to the Court.

One may assume that the debtor has enough funds to operate a business in bankruptcy proceedings. Please note that even if the company can reduce its expenses substantially, it has to honor the costs associated with the proceedings in terms of fees of lawyers, professionals, etc., which can run into huge money in large cases.

Most vendors and customers become aware of the proceedings through the various notices they receive. It is a myth that these parties will flee away upon knowing the bankruptcy proceedings. However, it is pertinent to note here that these vendors and suppliers generally chose to continue their relationship as they become priority service providers in the claim priority scheme established by the Bankruptcy Code.

Also, read about What is Bankruptcy & its Types.

Chapter 11 in Bad Economic Times

Chapter 11 is expensive as it involves many stakeholders who, in turn, will employ professionals, each seeking to be paid by the debtor. Moreover, it distracts management focus, damages brand values, and makes normal operations difficult.

Unsecured Creditors

Firstly, the unsecured creditors have the only option to work with the company is filing litigation. It results in spending valuable money as courts may take a long time to decide, and thus recovery may be delayed. Moreover, the recovery itself will be very meager considering the costs involved and the success rate of Chapter 11 proceedings. More so, as their claim gets the priority next to the secured creditors.

Landlord / Tenants

Secondly, the tenancy cost is an important one after employee costs. Tenants should advise the Landlord of all measures taken to reduce costs. It may lead to tenancy termination, impacting both the parties, especially the Landlord, as he may not want to lose the tenant and as it will be challenging to get a tenant immediately at the same rent.

Banks & Borrowers

Banks may have to work with borrowers in restructuring the loans granted due to cash flow difficulties faced by the latter. It may impact the bank’s delinquency ratio, and they may need to seek relief under Chapter 11 of the Bankruptcy Code, which may be questionable in itself.

Differences in Proceedings

Under US Laws, there are three different chapters provided for the filings of bankruptcy. To further clarify, below is the summary of their nature, applicability, and differences.

Bankruptcy Under Chapter 7 Chapter 11 Chapter 13

Who can File?

Qualifying individuals, specific businesses, partnerships, LLC, corporations Business, large corporations. Persons not qualifying in Chapter 7 of 13 Individuals

Nature

Liquidation bankruptcy Reorganization bankruptcy Repayment bankruptcy

Cost

Affordable Expensive Affordable

Favored

Most common Uncommon and complicated Second most common

How is Settlement Done?

Sell assets and pay maximum creditors. Arrange a repayment plan without selling your assets, modify terms of debts and negotiate with creditors and continue the business operations Creates automatic stay and repayment plan for unsecured debts, including  credit card and medical bills due for a period of 3 – 5 years

Is Credit Impaired?

Yes Yes Yes

Read more on Chapter 11 vs. Chapter 13 Bankruptcy



Sanjay Borad

Sanjay Bulaki Borad

Sanjay Borad is the founder & CEO of eFinanceManagement. He is passionate about keeping and making things simple and easy. Running this blog since 2009 and trying to explain "Financial Management Concepts in Layman's Terms".

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