Why Chapter 11?
Chapter 11 allows companies to reorganize their financial affairs and emerge from bankruptcy with an improved balance sheet. Most large bankruptcies that make the news are Chapter 11 filings. For example, EZ Lube, which filed bankruptcy in December, is in Chapter 11, as is Circuit City, which filed in November. Most Chapter 11s are filed by companies, but individuals can also file Chapter 11. However, individual Chapter 11s are rare because there are other bankruptcy Chapters which are usually more appropriate for individuals.
Companies file Chapter 11 when they are unable to pay all of their creditors on a timely basis. Often this means that a loan has come due, and the Company does not have sufficient cash to pay what is owed. Or it can be when the company has fallen so far behind on its trade payables that it can no longer do business with its vendors or when the collection lawsuits are becoming so frequent that the company’s resources are being diverted from other important tasks.
A company in Chapter 11 generally maintains control of its assets and operations, and is referred to as the “Debtor in Possession.” The Debtor in Possession tries to work out an arrangement with its creditors that will allow the creditors to be paid or to accept less than full payment. This arrangement is effectuated through a Plan of Reorganization. If a bankruptcy judge finds that a bankrupt company’s management is unfit to handle the responsibilities of a debtor in possession, the judge can order the appointment of a Chapter 11 Trustee to take over management and the responsibility for filing a Plan of Reorganization.
A Chapter 11 can also be used as a vehicle to liquidate assets. Many large Chapter 11 filings begin with the idea of reorganizing through a Plan of Reorganization, but then end up as liquidations. For example, after a few months in Chapter 11, Circuit City announced that it would not be able to confirm a Plan of Reorganization and was therefore going out of business completely. From that point forward, Circuit City’s Chapter 11 became simply a vehicle for liquidating assets in a setting in which the company controls the liquidation process. Sometimes, the debtor’s knowledge of its operations allows it to maximize liquidation value better than a third party trustee, which would automatically be appointed in a Chapter 7. There are many aspects of Chapter 11. Future posts will explore some of those in order to help you gain a better understanding of what Chapter 11 entails.
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