What Is Chapter 11 Bankruptcy? Definition, Pros & Cons

What Is Chapter 11 Bankruptcy?

Chapter 11 bankruptcy allows a debtor—typically a corporation, a sole proprietorship, or a partnership—to outline a plan of reorganization that allows it to continue operations while paying creditors over time.

Companies that are overwhelmed by debt and don’t have the financial resources to pay their debts—which might result from a bad quarter due to supply disruptions in their manufacturing operations, or weak sales leading to net losses—could be compelled to file Chapter 11. Some of the largest U.S. corporations, such as American Airlines and General Motors, have filed Chapter 11 bankruptcy but managed to crawl back into profitability.

According to Debt.org, there were only 4,836 filings for Chapter 11 bankruptcy in 2021, representing 1.2% of the total of 413,616. The majority of filings for Chapter 11 bankruptcy are by companies, but some individuals do file.

How Does Chapter 11 Bankruptcy Work?

A Chapter 11 bankruptcy is filed in federal courts under rules outlined in the U.S. Bankruptcy Code. A debtor filing for bankruptcy would have to take into account the costs involved, including filing fees and the hiring of an attorney specializing in bankruptcy.

Unlike Chapter 7 and Chapter 13 bankruptcies, Chapter 11—also known as “reorganization bankruptcy”—is generally geared toward businesses. Under a debt restructuring plan, companies are allowed to maintain their businesses but work out a deal with creditors to repay what was borrowed.

Typically, a company may have more debt than either assets or equity, or both, and may face difficulty with repayment of debt on time, putting it at risk of default. Creditors are typically the first to get repaid in a bankruptcy, and while a complete liquidation may get them a partial payment of what they are owed, it may serve in the best interests of creditors for a company to remain in business and be able to pay the entire amount or a large portion of debt under a debt restructuring plan.

Under Chapter 11 bankruptcy, some assets may be liquidated as part of a plan worked out with creditors to repay debt, but in general, a Chapter 11 bankruptcy prevents entire assets from being seized and sold to pay off debt. A Chapter 11 filing does provide an immediate stay of any action against a debtor from a creditor, including seizure of assets.

How Does Chapter 11 Bankruptcy Differ From Chapters 7 and 13 Bankruptcies?

When a company or a person files Chapter 11 bankruptcy, debts are restructured and a repayment plan is worked out, but the debtor’s assets are protected to prevent them from being sold off to pay off creditors.

Under Chapter 7, assets that can be used to pay off debts are liquidated. Under a Chapter 13 bankruptcy, a debtor typically has three to five years to settle payments with creditors, compared to Chapter 11, which may allow for a longer repayment period.

It may be better for a creditor to follow a debtor’s debt restructuring plan under Chapter 11 instead of Chapter 7 because a Chapter 7 proceeding would lead to a liquidation of a debtor’s assets, and sales from the proceeds might be a fraction of what a creditor would recover if they had followed through with a Chapter 11 filing.

What Are the Pros and Cons of Filing a Chapter 11 Bankruptcy?

Each debtor filing Chapter 11 bankruptcy will have their own reasons for filing, and sometimes the advantages of filing under this particular type outweigh the disadvantages.

Advantages of Filing for Chapter 11 Bankruptcy

Once a company files for Chapter 11, a stay is automatically triggered, which means any creditor is prevented from taking action, including trying to take over a debtor’s assets.

• A debtor is given time to restructure debt and to convince creditors to abide by a repayment plan. Repayment plans could be as short as a few quarters or stretch into multiple years.

Disadvantages of Filing for Chapter 11 Bankruptcy

• Any alteration to a debt restructuring plan would require approval from the bankruptcy court, and additional fees may be incurred for filing motions.

• A bankruptcy judge’s ruling that failure to meet the requirements outlined in a reorganization plan could lead to a Chapter 7 bankruptcy, which could result in creditors going after all of a debtor’s assets. Still, it might serve the best interest of creditors for a debtor to continue operations in order to recover as much of the debt as possible, rather than retrieve a fraction of the total owed via liquidation of all assets..

Frequently Asked Questions (FAQ)

The following are answers to some of the most common questions investors ask about Chapter 11 bankruptcy.

What Does “Debtor in Possession” Mean in Chapter 11 Bankruptcy?

A debtor in possession is a company or person who filed for Chapter 11 bankruptcy and has assets, such as property, that can be used to meet creditor claims. Typically, these assets remain in the control of the the debtor and are used to produce income that can be used to repay creditors, as outlined in the reorganization plan. The debtor serves as a de facto trustee on behalf of creditors.

How Long Does Chapter 11 Bankruptcy Last?

The length of a Chapter 11 bankruptcy depends on the debt restructuring plan set out by a debtor unto their creditors. A reorganization may take anywhere from a few quarters to multiple years to complete.

How Much Does It Cost to File a Chapter 11 Bankruptcy Application?

The cost of filing includes a $1,167 case filing fee and a $571 miscellaneous administrative fee, as of 2023.