A Brief Explanation of Chapter 11 Bankruptcy

The last two years have seen several of America’s largest companies file for bankruptcy.  General Motors, Chrysler, Washington Mutual, CIT Group and many others have found themselves unable to meet creditor’s demands and have been left with no other option but to declare bankruptcy.  Some of these companies such as GM and Chrysler continue to operate while others were forced to liquidate and no longer exist.  The one thing they have in common is their filing of Chapter 11 bankruptcy.

Who Can File

A chapter 11 bankruptcy, often called reorganization bankruptcy, is the type most commonly used by large corporations, partnerships and businesses.  Small businesses and individuals are also allowed to file Chapter 11, but are usually advised to file under another chapter more beneficial to their situation.  Under Chapter 11, corporations are allowed to maintain control of its assets and are allowed to operate under the supervision of the court.

The Plan

Once Chapter 11 paperwork is filed, the corporation presents a reorganization plan.  Its creditors vote on whether the plan is acceptable.  If the plan is confirmed, the corporation continues to operate and pay off the creditors.  If not, the creditors can ask the court to order the liquidation of the corporation.

The Committee

The court appoints a committee made up of the 20 largest creditors of unsecured debt which represents all creditors having a claim.  This committee monitors the corporation’s implementation of the plan and its progress.  If the court decides that the corporation isn’t managing the reorganization effectively, it can appoint a trustee to oversee the process, though this is very rare.

Automatic Stay

Immediately upon the filing of bankruptcy, the court issues an automatic stay which protects the filer and the filer’s assets from collection attempts by creditors.  Creditors are allowed to petition the court to order the corporation to liquidate assets under Chapter 7, but the court will only do this if they believe that liquidation is in the best interest of all creditors involved.  Often the corporation willingly liquidates some of its assets without being ordered by the court since it will likely receive more for the assets than it would with forced liquidation under Chapter 7.

Cancellation of Contracts

A corporation that files Chapter 11 can be given relief from contracts if the court believes doing so would benefit the corporation and its ability to repay creditors.  Often, labor union contracts, leases on real estate and contracts with suppliers can be cancelled without repercussions.

Who Gets Paid

The corporation’s creditors are divided into classes according to their priority in being repaid.  Creditors with secured debt generally are repaid first, followed by suppliers and employees and finally other creditors with unsecured debt.  The corporation must first pay off all creditors in a particular class before beginning to repay creditors in the next class.

By allowing a corporation to continue to operate instead of dissolving and liquidating its assets, the corporation hopefully can recover and repay its creditors.  Though Chapter 11 has its critics, a corporation’s recovery is usually the best outcome for all involved.


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