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What Happens When a Corporation Enters Chapter 11 Bankruptcy?

What Happens When a Corporation Enters Chapter 11 Bankruptcy?

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Bankruptcy is the last resort for any business, but it is occasionally necessary. There are several different ways for a corporation to proceed once it has decided to declare bankruptcy. Chapter 13 bankruptcy is only available to consumers, so this is not an option for businesses save sole proprietorships. Corporations must either declare Chapter 11 or Chapter 7 bankruptcy. Most choose Chapter 11 for greater protection for the corporation’s assets and for the opportunity to continue operating. Chapter 11 allows the corporation to stay in business under the supervision of the court. Most businesses can operate as their own trustee, which means they are responsible for all of their own decisions. However, the court will sometimes appoint its own trustee.

The Utilities of Chapter 11 Bankruptcy

Chapter 11 bankruptcy is known for providing corporations with many different options when they are restructuring their debt. For example, a business in Chapter 11 can get loans at reasonable rates, because they can guarantee banks their first earnings after the loan has been processed. Also, Chapter 11 bankruptcy gives the company the right to reject and cancel legally binding contracts (at the court’s discretion). This can enable companies to get out of some unprofitable obligations. For example, many airlines have used this aspect of Chapter 11 bankruptcy to break contracts they had with their workers’ unions.

The “Automatic Stay” Provision: One of the Most Vital Facets of Corporate Bankruptcy Law

Perhaps the best known and most important part of Chapter 11 is the automatic stay provision. This prevents a great deal of legal action against the corporation that might otherwise occur. Those seeking to file legal action may file a complaint with the bankruptcy court. If the court finds in the complainant’s favor, the legal action may proceed. However, in practice, this does not happen very often. The court usually requires proof that the legal action is necessary due to gross negligence on the part of the bankrupt company. If the complainant cannot provide this proof, the lawsuit is either dismissed or put on hold until the company emerges from bankruptcy.

What Happens if the Company Does Not Successfully Emerge from Bankruptcy?

documentsWhile most corporations that enter Chapter 11 bankruptcy do eventually come out the other side, sometimes a payment plan cannot be worked out with a business’ creditors, or the business fails to make the payments, which invalidates the payment plan. When this is the case, several different things can happen. Often, the business can be restructured so that the original owners are cut out, and the creditors own the corporation and its assets.

Alternatively, the business may be liquidated and its assets sold off. In this situation, the court pays creditors as much as possible. How much the creditors get and in what order they are paid is up to the court.

Creditor’s Committees and Their Role in Determining the Payment Plan

The creditors of the business in bankruptcy proceedings form a committee to suggest a payment plan. The payment plan has to be ratified by the court before it goes into effect. There is usually no set time frame for the creditors to come up with the plan, and there is some controversy regarding how much information the creditors should give the court and the company regarding their proposal.

The Confirmation of the Payment Plan

After all of the creditors have agreed to a plan, the proposal is presented to the judge.  If one or more of the creditors changes their mind, as often happens, the judge may still approve the plan. The majority of creditors must be in agreement for this to happen, and the creditor(s) not in agreement must still be included in the proposal. When the court confirms the plan, it becomes legally binding, and the company must adhere to it. If it does not, it risks lawsuits for breach of contract from the creditors and a charge for contempt of court. This usually results in the liquidation of the company.

Emerging from Chapter 11 Bankruptcy

The time frame for a company to emerge from Chapter 11 bankruptcy varies widely. It is largely dependent on the amount of debt, the number of creditors, and the structure of the payment plan. Some companies are able to get out of Chapter 11 bankruptcy in only a few months, but the norm is closer to several years. It is important to note that the business may still operate with the court’s supervision during this period.

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