Bankruptcy occurs if a business or firm fails to control its debt and fails to pay the creditors it has. Once this situation arises, the business or its creditors can go to the court for protection. There is a special court constituted for this purpose which is called the Federal Court of bankruptcy. In case of bankruptcy, protection is sought under Chapter 7 or in some cases Chapter 11. While we will be focusing mostly on Chapter 11 bankruptcy, you must still know what Chapter 7 is. In this chapter, all the current and past operations of the company cease to function. A trustee is nominated who then sells all of the assets of the company. Once the assets are sold, the trustee pays the due amount to the creditor. Once the creditor’s bill is cleared, the remaining amount is paid to the owners of the company. This is how Chapter 7 deals with a case of bankruptcy.
The way Chapter 7 deals with bankruptcy can be a bit harsh on the owner of the business and its employees. Establishing a business takes a lot of time and effort and selling its assets is never a good option. This is where Chapter 11 comes in. Chapter 11 bankruptcy will be the point of our discussion today so let us consider it in detail.
Once a solution to a case of bankruptcy is sought through Chapter 11, the debtor holds the main control of the business operations under the jurisdiction and oversight of the court. The reorganization plan can only be started when the judge has approved it and all the creditors agree. If some creditors are against this idea, it can’t be started. In order not to approve the plan, that group of creditors must say why they are against the plan and should impose a version that is good for all the classes of creditors and must not discriminate against other class of creditors.
The right to propose a reorganization plan under chapter 11 belongs to the debtors who can propose it for a couple of days (most of times the amount of time is somewhere near 120 days). Creditors might also put forward plans after the time that has been established, has elapsed. To be approved by the court of bankruptcy the plans must meet a set amount of criteria. In the same time, the creditors have vote for the approval of the reorganization’s plan. If the plan doesn’t get confirmed then the court has two options: make it a chapter 7 case by converting it to liquidation or, in order to satisfy the estate and the creditors, the case might be returned to the standing before bankruptcy or even dismissed. If case gets dismissed the creditors will have to look forward to the non-bankruptcy law to satisfy the claims they have put forward.
Similar to other forms of bankruptcy, the Chapter 11 bankruptcy invokes the automatic 362 stay. Under these circumstances, United States Trustee or the creditors may ask the honorable court to change the chapter 11 to a case of liquidation as per 7th chapter, or employ a trustee who will mange with the business of the debtor. The honorable court will only convert the chapter or assign a trustee in case this is the best action that can be taken for all the creditor’s interests. There are times when a company liquidates under chapter 11 and the already existing management might be able to offer them the help they need in order to obtain a larger price for their assets and divisions, and after that liquidation under chapter 7 should be looked for.
There are times when some contracts, also called executory contracts will be rejected. This mostly happens in case their cancellation will be in favor of the creditors and the company. The main feature for this contract is that every party tied to the contract is bound to some duties while being a signatory to the contract. If the contract gets rejected the other parties depend on the debtor, becoming his unsecured creditors.
As other bankruptcy chapters, chapter 11 has the same principle and priority. Its priority arrangement is primarily defined by Bankruptcy code 507. Secured creditors who often have a collateral or security interest in the property of the debtor are to be paid prior to the unsecured creditors, as a rule established by the debtor. By § 507 unsecured creditors’ claims are prioritized. If you have an unpaid priority level, then you have to pay that one first, and after the lower levels.
If the company is listed on the stock exchange of New York, the NASDAQ or American Stock Exchange, a chapter 11 case will cause its delisting from the primary stock exchange. Many delisted stocks resume quickly listing as OTC stocks. In most cases, the shares of the company are terminated as soon as Chapter 11 plan is confirmed. This renders the value of the shares as useless.
Chapter 11 bankruptcy is quite expensive and complex. Therefore, people who are also eligible for relief under Chapter 7 or even Chapter 13 opt for those instead of Chapter 11.
From 1991 to 2003 cases related to chapter 11 had dropped by a percentage of 60%. A study made in 2007 had found out that this was due to the fact that businesses liked the proceedings related to bankruptcy under the law of the state, instead of federal bankruptcy actions, inclusive of the ones coming under chapter 11. Under the law of the state, insolvency proceedings are less expensive, faster, and private as the study stated. In fact court filings are not even required in some states. But, a study made in 2005 claimed that the drop might have increased due to the fact that a high number of cases were classified to the class of “consumer cases” instead of “business cases”.
We all know about the Lehmann Brothers bankruptcy. That was the biggest bankruptcy ever and they listed more than $639 billion as part of their assets in Chapter 11 bankruptcy filing..