Definitions

chapter 11

Chapter 11, Title 11, United States Code

Chapter 11 is a chapter of the United States Bankruptcy Code, which permits reorganization under the bankruptcy laws of the United States. Chapter 11 bankruptcy is available to any business, whether organized as a corporation or sole proprietorship, and to individuals, although it is most prominently used by corporate entities. In contrast, Chapter 7 governs the process of a liquidation bankruptcy, while Chapter 13 provides a reorganization process for the majority of private individuals with unsecured debts of less than $336,900.00 and secured debts of less than $1,010,650.00 as of April 1, 2007.

Definition

When a troubled business is unable to service its debt or pay its creditors, the business or its creditors can file with a federal bankruptcy court for protection under either chapter 7 or chapter 11. In chapter 7, the business ceases operations and a trustee sells all of its assets and distributes the proceeds to its creditors. A chapter 11 filing is usually an attempt to stay in business while a bankruptcy court supervises the "reorganization" of the company's contractual and debt obligations. In most instances the debtor remains in control of its business operations as a "debtor in possession", and is subject to the oversight and jurisdiction of the court. The court can grant complete or partial relief from most of the company's debts and its contracts, so that the company can make a fresh start. Sometimes, if the business's debts exceed its assets, then at the completion of bankruptcy the company's owners all end up without anything; all their rights and interests are ended and the company's creditors are left with ownership of the newly reorganized company.

Rationale

In enacting chapter 11 of the Bankruptcy code, Congress concluded that it is sometimes the case that the value of a business is greater if sold or reorganized as a going concern than the value of the sum of its parts if the business's assets were to be sold off individually. It follows that it may be more economically efficient to allow a troubled company to continue running, cancel some of its debts, and give ownership of the newly reorganized company to the creditors whose debts were canceled. Alternatively, the business can be sold as a going concern with the net proceeds of the sale distributed to creditors ratably in accordance with statutory priorities. In this way, jobs may be saved, the engine of profitability which is the business is maintained rather than being dismantled, and, as a proponent of a chapter 11 plan is required to demonstrate as a precursor to plan confirmation, the business's creditors end up with more money than they would in a chapter 7 liquidation.

Details

All creditors are entitled to be heard by the court which is responsible for determining whether the plan of reorganization complies with the purposes of the bankruptcy law and provides for fair and equitable treatment of all parties in interest.

Some contracts, known as executory contracts, may be rejected if canceling them would be financially favorable to the company and its creditors. Such contracts include labor union contracts, supply or operating contracts (with both vendors and customers) and real estate leases. The standard feature of executory contracts is that each party to the contract has duties remaining under the contract. In the event of a rejection, the remaining parties to the contract become unsecured creditors of the debtor.

Chapter 11 is reorganization, as opposed to liquidation. Debtors may "emerge" from a chapter 11 bankruptcy within a few months or within several years, depending on the size and complexity of the bankruptcy. Debtors in Chapter 11 have the exclusive right to propose a plan of reorganization for a period of time. After that time has elapsed, creditors may also propose plans. Plans must satisfy a number of criteria in order to be "confirmed" by the bankruptcy court. Among other things, creditors must vote to approve the plan of reorganization. If a plan cannot be confirmed the court may either convert the case to a liquidation under Chapter 7 or, if in the best interests of the creditors and the estate, the case may be dismissed resulting in a return to the status quo before bankruptcy. If the case is dismissed, creditors will look to nonbankruptcy law in order to satisfy their claims.

As with other forms of bankruptcy, petitions filed under Chapter 11 invoke the automatic stay of § 362. The automatic stay requires all creditors to cease collection attempts, and makes post-petition debt collection void. Under some circumstances, creditors or the United States Trustee can ask the court to convert the case to a liquidation under Chapter 7, or to appoint a trustee to manage the debtor's business. The court will grant a motion to convert to Chapter 7 or appoint a trustee if either of these actions is in the best interest of all creditors. Sometimes a company will liquidate under Chapter 11, in which the pre-existing management may be able to help get a higher price for divisions or other assets than a Chapter 7 liquidation would be likely to achieve. Appointment of a trustee requires some wrongdoing or gross mismanagement on the part of existing management, and is relatively rare.

Priority

Chapter 11 follows the same priority scheme as other bankruptcy chapters. The priority structure is defined primarily by § 507 of the Bankruptcy Code.

As a general rule secured creditors—creditors who have a security interest, or collateral, in the debtor's property—will be paid before unsecured creditors. Unsecured creditors' claims are prioritized by § 507. For instance the claims of suppliers of products or employees of a company may be paid before other unsecured creditors are paid. Each priority level must be paid in full before the next lowest priority level may receive payment.

Section 1110

Section 1110 generally provides a secured party with an interest in an aircraft the ability to take possession of the equipment within 60 days after a bankruptcy filing unless the airline cures all defaults. More specifically, the right of the lender to take possession of the secured equipment is not hampered by the automatic stay provisions of the U.S. Bankruptcy Code.

Stock

If the company's stock is publicly traded, a chapter 11 filing generally causes it to be delisted from its primary stock exchange if listed on the New York Stock Exchange, the American Stock Exchange, or the NASDAQ. On the NASDAQ the identifying fifth letter "Q" at the end of a stock symbol indicates the company is in bankruptcy (formerly the "Q" was placed in front of the pre-existing stock symbol; a celebrated example was Penn Central, whose symbol was originally "PC" and became "QPC" after the company filed Chapter 11 in 1970). Many stocks that are delisted quickly resume listing as over the counter (OTC) stocks. In the overwhelming majority of cases, the Chapter 11 plan, when confirmed, terminates the shares of the company rendering shares valueless.

Individuals may file Chapter 11, but due to the complexity and expense of the proceeding, this option is rarely chosen by debtors who are eligible for chapter 7 or chapter 13 relief.

Criticism

Some critics have claimed that Chapter 11 bankruptcy is excessively lenient in giving a needless "escape hatch" to the incompetent management of a failing company, damaging the efficiency of the economy as a whole and allowing poor managers to continue managing. It is unusual for the management of a company in Chapter 11 to be fired, as it is usually assumed that the present management team knows far more about the company and its customers than would a new set of management. These critics note that in Europe, bankruptcy law is far less lenient for failing companies.

Another efficiency criticism is that a company undergoing Chapter 11 bankruptcy is effectively operating under the "protection" of the court until it emerges, in some cases giving the bankrupt company a great advantage against its competitors, distorting the market and harming more competitive businesses. Where a key market participant (or more than one) goes into Chapter 11, it can also result in significant over-capacity in the industry. The most-cited recent example is the airline industry in the United States; in 2006 over half the industry's seating capacity was on airlines that were in Chapter 11. These airlines were able to stop making debt payments, freeing up cash to expand routes or weather a price war against competitors — all with the bankruptcy court's approval. This is especially important in the airline industry as fixed capital costs for the airplanes (and the debt on those costs) make up such a large part of the airlines' expenditures.

Others criticize the process on the basis that, by forestalling the creditors' rights to enforce their security in the event of non-payment, it reduces the economic value of collateral in the United States, and thereby increases the cost of secured lending. However, studies on the subject seem to reach different conclusions on the extent of this, or indeed whether it is in fact the case at all in practice.

Statistics

Bankruptcy frequency

Chapter 11 bankruptcy cases dropped by 60% from 1991 to 2003. One 2007 study found this was because businesses were turning to bankruptcy-like proceedings under state law, rather than the federal bankruptcy proceedings, including those under chapter 11. Insolvency proceedings under state law, the study stated, are currently faster, less expensive, and more private, with some states not even requiring court filings. However, a 2005 study claimed the drop may have been due to an increase in the incorrect classification of many bankruptcies as "consumer cases" rather than "business cases".

Cases involving more than US$50 million in assets are almost always handled in federal bankruptcy court, and not in bankruptcy-like state proceeding.

Largest bankruptcy

The largest bankruptcy in history was of the US investment bank Lehman Brothers Holdings Inc., which listed $639 billion in assets as of its Chapter 11 filing in 2008. The 15 largest corporate bankruptcies as of September 26, 2008:

Company Bankruptcy Date Total Assets Pre-Bankruptcy Total assets pre-bankruptcy in 2007 US dollars Filing Court District
Lehman Brothers Holdings Inc. 2008-09-15 $639,063,000,000 ? NY-S
Washington Mutual 2008-09-26 $327,913,000,000 ? DE
Worldcom Inc. 2002-07-21 $103,914,000,000 FY2007 US$119,716,589,862 NY-S
Enron Corp.* 2001-02-12 $63,392,000,000 FY2007 US$74,229,508,197 NY-S
Conseco, Inc. 2002-12-18 $61,392,000,000 FY2007 US$70,728,110,599 IL-N
Texaco, Inc. 1987-04-12 $35,892,000,000 FY2007 US$62,638,743,455 NY-S
Financial Corp. of America 1988-09-09 $33,864,000,000 FY2007 US$57,010,101,010 CA-C
Refco Inc. 2005-10-17 $33,333,172,000 FY2007 US$35,385,532,909 NY-S
Global Crossing Ltd. 2002-01-28 $30,185,000,000 ? NY-S
Pacific Gas and Electric Co. 2001-04-06 $29,770,000,000 Fy2007 US$34,859,484,778 CA-N
UAL Corp. 2002-12-09 $25,197,000,000 ? IL-N
Delta Air Lines, Inc. 2005-09-14 $21,801,000,000 ? NY-S
Adelphia Communications 2002-06-25 $21,499,000,000 ? NY-S
MCorp 1989-03-31 $20,228,000,000 FY2007 US$32,678,513,732 TX-S
Mirant Corporation 2003-07-14 $19,415,000,000 ? TX-N
* The Enron assets were taken from the 10-Q filed on 2001-11-19. The company announced that the annual financials were under review at the time of filing for Chapter 11.

Notes

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