What Is Chapter 11?

Chapter 11 is a form of bankruptcy that involves a reorganization of a debtor’s business affairs, debts, and assets, and for that reason is known as "reorganization" bankruptcy. 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 its 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 early part of 2020. On Jan. 23, 2020, CNBC reported that Fairway Market, a grocery chain based in New York City, filed for Chapter 11 bankruptcy and was shuttering five of its 14 stores and a distribution center while putting its other stores up for auction.

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 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 to a press release by Gymboree, the company had 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.” If the court approved of this financing plan, the funds would support the company during the Chapter 11 process. CEO Shaz Kahng said 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 was the second time in two years that the Gymboree Group Inc. had filed for bankruptcy Chapter 11. The first time occurred in 2017, but at that time the company was able to successfully reorganize and significantly lower its debts.

Special Considerations

The Small Business Reorganization Act of 2019, which went into effect on Feb. 19, 2020, added a new subchapter V to Chapter 11 designed to make bankruptcy easier for small businesses, which are “defined as entities with less than about $2.7 million in debts that also meet other criteria,” according to the U.S. Department of Justice. The act “imposes shorter deadlines for completing the bankruptcy process, allows for greater flexibility in negotiating restructuring plans with creditors, and provides for a private trustee who will work with the small business debtor and its creditors to facilitate the development of a consensual plan of reorganization.” 

The Coronavirus Aid, Relief, and Economic Security (CARES) Act, signed into law by the president on March 27, 2020, raised the Chapter 11 subchapter V debt limit to $7,500,000. The change applies to bankruptcies filed after the CARES Act was enacted and sunsets one year later.