Chapter 11 is a chapter of the United States Bankruptcy Code,
which permits reorganization under the bankruptcy
laws of the United States. Chapter 11 bankruptcy is available to any business, whether organized as a corporation or sole proprietorship, or individual with unsecured debts of at least $336,900.00 or secured debts of
at least $1,010,650.00, although it is most prominently used by corporate entities. In contrast, Chapter 7 governs the process of a liquidation bankruptcy, while
Chapter 13 provides a reorganization process for the majority
of private individuals with unsecured debts of less than $336,900.00 and secured debts of less than $1,010,650.00 as of April 1,
2007.
Definition
When a troubled business is unable to service its debt or pay its creditors, it or its
creditors can file with a federal bankruptcy court for protection under either chapter 7 or chapter 11. In chapter 7, the
business ceases operations and a trustee sells all of its assets and distributes the proceeds to its creditors. This is done in
accordance with statutory defined priorities. A chapter 11 filing, on the other hand, is usually an attempt to stay in business
while a bankruptcy court supervises the "reorganization" of the company's contractual and debt obligations. The court can grant complete or partial relief
from most of the company's debts and its contracts, so that the company can make a fresh start. Often, if the company's debts
exceed its assets, then at the completion of bankruptcy the company's owners (stockholders) all end up with nothing; all their
rights and interests are terminated and the company's creditors end up with ownership of the newly reorganized company.
Rationale
In enacting chapter 11 of the Bankruptcy code, Congress concluded that it is often the case that the value of a business is
greater if sold or reorganized as a going concern than the value of the sum of its parts if the business's assets were to be sold
off individually. It follows that it may be more economically efficient to allow a troubled company to continue running, cancel
some of its debts, and give ownership of the newly reorganized company to the creditors whose debts were canceled. Alternatively,
the business can be sold as a going concern with the net proceeds of the sale distributed to creditors ratably in accordance with
statutory priorities. In this way, jobs may be saved, the engine of profitability which is the business is maintained rather than
being dismantled, and, as a proponent of a chapter 11 plan is required to demonstrate as a precursor to plan confirmation, the
business's creditors end up with more money than they would in a chapter 7 liquidation.
Details
All creditors are entitled to be heard by the court which is responsible for determining whether the plan of reorganization
complies with the purposes of the bankruptcy law and provides for fair and equitable treatment of all parties in interest.
Some contracts, known as executory contracts, may be rejected if canceling them would be financially favorable to the company
and its creditors. Such contracts include labor union contracts, supply or operating contracts (with both vendors and customers)
and real estate leases. The standard feature of executory contracts is that each party to the contract has duties remaining under
the contract. In the event of a rejection, the remaining parties to the contract become unsecured creditors of the debtor.
Chapter 11 is reorganization, as opposed to 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. Debtors in Chapter 11 have the exclusive right
to propose a plan of reorganization for a period of time. After that time has elapsed, creditors may also propose plans. Plans
must satisfy a number of criteria in order to be "confirmed" by the bankruptcy court. Among other things, creditors must vote to
approve the plan of reorganization. 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 nonbankruptcy law in order to satisfy their
claims.
As with other forms of bankruptcy, petitions filed under Chapter 11 invoke the automatic stay of § 362. The automatic stay
requires all creditors to cease collection attempts, and makes post-petition debt collection void. Under some circumstances,
creditors or the United States Trustee can ask the court to convert the
case to a liquidation under Chapter 7, or to 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, 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. Appointment of a trustee requires some
wrongdoing or gross mismanagement on the part of existing management, and is relatively rare.
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 secured creditors -- creditors who have a security interest, or collateral, 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 lowest priority level may receive payment.
Stock
If the company's stock is publicly traded, a Chapter 11 filing generally causes it to be delisted from its primary stock exchange if listed on the New York Stock Exchange, the American Stock
Exchange, or the NASDAQ. On the NASDAQ the identifying fifth letter "Q" at the end of a
stock symbol indicates the company is in bankruptcy (formerly the "Q" was placed in front of the pre-existing stock symbol; a
celebrated example was Penn Central, whose symbol was originally "PC" and
became "QPC" after the company filed Chapter 11 in 1970). Many stocks that are delisted quickly resume listing as
over the counter (OTC) stocks. In the overwhelming majority of cases, the
Chapter 11 plan, when confirmed, terminates the shares of the company rendering shares valueless.
Individuals may also file Chapter 11, but due to the complexity and expense of the proceeding, this option is rarely chosen by
debtors who are eligible for Chapter 7 or Chapter 13
relief.
Criticism
Some critics have claimed that Chapter 11 bankruptcy is excessively lenient in giving a needless "escape hatch" to the
incompetent management of a failing company, damaging the efficiency of the economy as a
whole and allowing poor managers to continue managing. It is unusual for the management of a company in Chapter 11 to be fired,
as it is usually assumed that the present management team knows far more about the company and its customers than would a new set
of management. These critics note that in Europe, bankruptcy law is far less lenient for failing companies.
Another efficiency criticism is that a company undergoing Chapter 11 bankruptcy is effectively operating under the
"protection" of the court until it emerges, in some cases giving the bankrupt company a great advantage against its competitors,
distorting the market and harming more competitive businesses. Where a key market participant (or more than one) goes into
Chapter 11, it can also result in significant over-capacity in the industry. The most-cited current example is the
airline industry in the United States; as of 2006, over half the
industry's seating capacity is on airlines that are in Chapter 11 [1]. These airlines have been able to stop making debt payments, freeing up
cash to expand routes or weather a price war against competitors — all with the bankruptcy court's approval. This is especially
important in the airline industry as fixed capital costs for the airplanes (and the debt on those costs) make up such a large
part of the airlines' expenditures.
Others criticize the process on the basis that, by forestalling the creditors' rights to enforce their security in the event
of non-payment, it reduces the economic value of collateral in the United States,
and thereby increases the cost of secured lending. However, studies on the subject seem to reach different conclusions on the
extent of this, or indeed whether it is in fact the case at all in practice [2].
Statistics
Federal vs. state bankruptcies
Chapter 11 bankruptcy cases dropped by 60% from 1991 to 2003. One 2007 study[3] found this was because businesses were turning to proceedings under state
law, rather than the federal bankruptcy proceedings which include Chapter 11 filings. 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[3] 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 a state
proceeding.
Largest bankruptcy
The largest bankruptcy in history was of the US telecommunications corporation Worldcom,
Inc., which listed over 103 billion dollars in assets as of its Chapter 11 filing in 2002; the bankruptcy was triggered by
the discovery that in the previous several years, the company had fraudulently overreported its assets by an estimated 12 billion
dollars.
2003 Statistics
Bankruptcy filings by individuals:
- Chapter 7 filings: 1,156,284
- Chapter 11 filings: 959
- Chapter 13 filings: 468,562
Bankruptcy filings by businesses:
- Chapter 7 filings: 21,008
- Chapter 11 filings: 9,185
- Chapter 12 filings: 698
- Chapter 13 filings: 5,201
The total number of bankruptcies rose 7.4 percent over the previous twelve months. These totals were for the 12-month period
ending September 30, 2003.
Source: November 14, 2003
News Release, Administrative Office of the U.S. Courts. (PDF file)
2004 Statistics
Total bankruptcies:
- Chapter 7 filings: 1,153,865
- Chapter 11 filings: 10,368
- Chapter 12 filings: 238
- Chapter 13 filings: 454,412
Bankruptcy cases filed in federal courts fell 2.6 percent in fiscal year 2004 according to the Administrative Office of the
U.S. Courts. During the 12-month period ending September 30, 2004, 1,618,987 bankruptcies were filed, down from the 1,661,996
bankruptcy cases filed in fiscal year 2003.
Source: December 3, 2004
News Release, Administrative Office of the U.S. Courts. (PDF file)
See also
References
- ^ Delta and Northwest
airlines both file for bankruptcy. Retrieved on November 17, 2005.
- ^ The night of the killer zombies. Economist.com (2002-12-12). Retrieved on 2006-08-05.
- ^ a b (January 24, 2007), "Small Firms Spurn Chapter 11", Wall Street
Journal, page B6B
External links
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