What Is Chapter 11?

Chapter 11 is a form of bankruptcy that involves a reorganization of a debtor's business affairs, debts, and assets. Named after the U.S. bankruptcy code 11, corporations generally file Chapter 11 if they require time to restructure their debts. This version of bankruptcy gives the debtor a fresh start. However, the terms are subject to the debtor's fulfillment of his obligations under the plan of reorganization.

Chapter 11 bankruptcy is the most complex of all bankruptcy cases. It is also usually the most expensive form of a bankruptcy proceeding. For these reasons, a company must consider Chapter 11 reorganization only after careful analysis and exploration of all other possible alternatives.

How Chapter 11 Works

During a Chapter 11 proceeding, the court will help a business restructure its debts and obligations. In most cases, the firm remains open and operating. Many large U.S. companies file for Chapter 11 bankruptcy and stay afloat. Such businesses include automobile giant General Motors, the airline United Airlines, retail outlet K-mart, and thousands of other corporations of all sizes. Corporations, partnerships and limited liability companies (LLCs) usually file Chapter 11, but in rare cases, individuals with a lot of debt, who do not qualify for Chapter 7 or 13, may be eligible for Chapter 11. However, the process is not a speedy one.

Key Takeaways

  • If a company filing for Chapter 11 opts to propose a reorganization plan, it must be in the best interest of the creditors.
  • If the debtor does not suggest a program, the creditors may propose one instead.
  • The trend of retail companies filing for Chapter 11 has continued into the latter part of 2019. On August 6, 2019, the media reported that Barneys New York Inc., a luxury department store filed for Chapter 11 bankruptcy, and is shuttering many of its stores. 

A business in the midst of filing Chapter 11 may continue to operate. In most cases, the debtor, called a debtor in possession, runs the business as usual. However, in cases involving fraud, dishonesty or gross incompetence, a court-appointed trustee steps in to run the company throughout the entire bankruptcy proceedings. The business is not able to make some decisions without the permission of the courts. These include the sale of assets, other than inventory, starting or terminating a rental agreement, and stopping or expanding business operations. The court also has control over decisions related to retaining and paying attorneys and entering contracts with vendors and unions. Finally, the debtor cannot arrange a loan that will commence after the bankruptcy is complete.

Because Chapter 11 is the most expensive and complex form of bankruptcy, most companies explore all alternative routes, before filing for one.

In Chapter 11 bankruptcy, the individual or business filing bankruptcy has the first chance to propose a reorganization plan. These plans may include downsizing of business operations to reduce expenses, as well as renegotiating of debts. In some cases, plans involve liquidating all assets to repay creditors. If the chosen path is feasible and fair, the courts accept it, and the process moves forward.

An Example of Chapter 11

In January 2019, Gymboree Group Inc, a popular children's clothing store, announced that it had filed for Chapter 11, and was closing all of its Gymboree, Gymboree Outlet and Crazy 8 stores in Canada and the United States.

According a press release by Gymboree, the company stated it received a commitment for a debtor in possession in the form of financing ($30 million in new money loans) provided by SSIG and Goldman Sachs Specialty Lending Holdings, Inc. and a "roll up" of all of Gymboree's obligations under the "prepetition Term Loan Credit Agreement."

The company stated that if the court approved of this financing plan, the funds would support the company during the Chapter 11 process. CEO Shaz Kahng stated that the company is "continuing to pursue a going-concern sale of its Janie and Jack® business and a sale of the intellectual property and online platform for Gymboree®." This is the second time in two years that the Gymboree Group Inc. has filed for bankruptcy. The first time occurred in 2017, but at that time, the company was able to successfully reorganize and significantly lower its debts.