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Any legal partnership, corporation, individual, or LLC is permitted to file under Chapter 11, although many smaller and medium-sized businesses have chosen to file in state courts (where possible) in recent years. It is usually too expensive for a small, unincorporated business to file for Chapter 11 protection. It is much less costly for the small businessperson to file a Chapter 13 personal petition to reorganize his/her debt payments. State court filings tend to be less expensive and often result in a much faster hearing and disposition than federal bankruptcy court proceedings. A business in cash flow or debt trouble can benefit greatly from the speed of receiving protection from creditor actions.
Chapter 11 bankruptcy law allows the filing company to devise a plan to pay off former creditors while continuing to operate. This plan is considered a “reorganization” of the company's operating strategy and financial status, which serves to satisfy former creditors and future creditors at the same time. Instead of simply ordering the company to liquidate all of its assets to pay old debts and cease doing business (Chapter 7), this chapter of the federal bankruptcy code is designed to save a company from extinction. This section of the bankruptcy code has proven to be critical to many U.S. businesses, e.g. Chrysler Corporation, allowing them not only to exist, but to prosper over the long term. The rationale for this section is that a company may be worth much more to its creditors if considered a “going concern” rather than a dead entity whose assets are sold at “fire sale” prices.
Chapter 11 petitions apply to the reorganization of a business that is unable to meet its debt obligations with its projected income . Unlike a Chapter 7 bankruptcy filing which specifies a liquidation of assets, Chapter 11 is focused on designing a way for the business to avoid liquidating its assets. The debtor designs a plan that will protect the company from their former creditors and continue operating, while coming to an agreement to pay off old debts over time. Therefore, a Chapter 11 bankruptcy is much more like a personal Chapter 13 petition, which provides a plan for the individual to pay his/her creditors an agreed amount over a specified time period.
As of November 17, 2005, the U.S. Congress modified Chapter 11 bankruptcy regulations. One of the major changes is the time period within which a business must have its reorganization plan confirmed by the bankruptcy court. In the past, the “requirement” specified a shorter time, but bankruptcy court judges routinely granted more time, often much more time to file the plan. Former creditors have heavily criticized this practice for obvious reasons and competitors have also filed numerous complaints, stating that this gives competing companies a strong advantage in the fight for consumer dollars. Another change attempts to close the door for companies formerly using Chapter 11 to force employee or union cost cutting concessions, to gain a competitive edge, or to simply build up their cash position. New regulations require companies to justify every portion of their reorganization plan in light of their claim that they can no longer operate without bankruptcy protection.
Chapter 11 bankruptcy is the exact opposite of a Chapter 7 action, which calls for liquidation of all assets of the debtor, the proceeds of which are then divided amongst the creditors. A company getting relief under Chapter 11 is allowed to continue operating as a going concern. Its former creditors are supposed to receive payment in full (or sometimes an agreed upon percentage) of all debts owed prior to the filing of the petition over a pre-arranged payment schedule. In this way, Chapter 11 is somewhat like a Chapter 13 bankruptcy, wherein creditors agree to accept payments on outstanding debts over time without demanding a full liquidation of all assets. Individuals are technically allowed to file a Chapter 11 petition also but few do. The cost and paperwork requirements are normally too daunting for an individual, so Chapter 13, which accomplishes much the same result, is selected in most cases.
Should a business find itself in serious financial trouble with no projections showing it has a solution, its creditors have the right to “force” the company into bankruptcy. If a debtor has 12 or more creditors, at least three creditors, who have unsecured claims which total $10,000 or more, can file a petition to force a Chapter 7 or 11 bankruptcy. If the company has less than 12 creditors, one creditor can precipitate the petition if owed at least $10,000. However, in both cases, the monies owed must not be the subject of a dispute. The debt owed must be agreed to on the part of both parties.
Creditors will sometimes take this action if they see the debtor dissipating company assets that might be used to pay outstanding debts. Should creditors take this action and have the ability to prove that some company assets were diverted to other entities in the 90 days previous to filing the action, some or all of those assets may be ordered returned to company ownership and become part of the bankruptcy proceeding.