30 Nov 2012
- Written by Carlee McCullough
Our month-long focus on bankruptcies concludes with a focus on the Chapter 11 version. The key word is reorganization. Under Chapter 11, the debtor – commonly referred to as the debtor in possession (DIP) – retains control of the business and the assets. Individuals with high levels of debt also may file under Chapter 11.
The automatic stay is in effect on all bankruptcies. Upon the filing of a petition for relief in the bankruptcy courts, the automatic stay prevents any creditor from proceeding to collect a debt.
Chapter 11 vs. Chapter 7
Remember, under the Chapter 7 bankruptcy, the individual is liquidating assets in an effort to satisfy debt. However under Chapter 11, the business owner or individuals wish to reorganize in order to maintain their assets and avoid liquidation. Many companies that file Chapter 11 bounce back and become profitable again. The court looks carefully at the plan and if approved expects the DIP to adhere to the plan. If the DIP deviates from the plan or a plan is unacceptable, Chapter 7 liquidation could be on the horizon.
Chapter 11 vs. Chapter 13
Chapter 11 and Chapter 13 are similar in many ways. While there is a plan under both chapters, the court approves the plan under Chapter 13. Creditors vote to approve or reject the reorganization plan under Chapter 11 and may even submit their own plan for consideration. Once the plan is approved, the DIP has a fiduciary duty toward its creditors and must submit monthly financial operating reports with the bankruptcy court.
A sole proprietorship, partnership or corporation may file Chapter 11. The DIP must complete certified credit counseling and pay the appropriate filing fees, which tends to be higher than other chapters.
Small business bankruptcy
Under a Chapter 11, there are typically no limits to the amounts of debt allowed. In cases where the DIP has non-contingent liquidated secured and unsecured debts of $2,343,300 or less (as of 2012), the DIP may qualify under the "Small Business Bankruptcy" (SBB) Chapter 11, which tends to move faster than the standard Chapter 11.
Under a SBB, the court will not appoint a creditors' committee as in a traditional Chapter 11. The petition must include: a balance sheet, statement of operations, and a copy of the company's most recent tax return. Unfortunately, real estate companies do not qualify for the Small Business Bankruptcy Chapter 11, but can file under the standard Chapter 11.
Individuals with high debt
If an individual has more than $360,475 in unsecured debt (which includes judgments, credit cards, personal loans, medical bills, etc) and/or more than $1,081,400 in secured debt (which includes mortgages, car loans, boats, and any other collateralized loans), the individual may not qualify to file a Chapter 13 Bankruptcy and will be forced to file under a Chapter 11.
A DIP, unfortunately, will have a multitude of debts, which may include unpaid payroll taxes. By law, employers are required to withhold payroll taxes from employees' earnings. The IRS considers payroll tax violations a serious issue and may resort to seizure of business assets, penalties, interest and fines. While taxes generally are not discharged under Chapter 11 Reorganization, they are paid over a period of time with interest but without penalties.
Denials by the court
Under certain circumstances, the court may deny a discharge if the DIP is found to have concealed property, destroyed or falsified records or committed fraud. In addition to providing the court reasons to deny discharge, these actions may also be considered criminal.
The court may also deny confirmation of the plan. After a hearing, if the court believes the proposed plan is not feasible, not in the best interest of the creditors, not proposed in good faith or out of line with required amounts under the law, then the court may deny confirmation.
Completing the plan
Chapter 11 Reorganization requires payment over a certain period of time. The amount of income and debt will determine the amount of the fixed monthly payments for an agreed upon time. At the end of the term and completion of the plan, the remaining debts to those creditors will be discharged.