How to Define "Chapter 11 Bankruptcy Protection"
Chapter 11 bankruptcy protection is the term commonly used for reorganizations under Chapter 11 of the United States Bankruptcy Code. Businesses and individuals may file Chapter 11 bankruptcy, although reorganizations under this chapter of the code are used by business entities, while individuals typically file under Chapter 13 of the Bankruptcy Code.
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Features
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A business typically uses Chapter 11 bankruptcy when it is unable to meet its debt obligations or to pay creditors. Bankruptcy proceedings may be brought before a federal bankruptcy court by either the business or by its creditors. In Chapter 11 bankruptcy, the debtor business continues to operate under the jurisdiction of the bankruptcy court and appointed trustees. The majority of firms will eventually emerge from bankruptcy protection and begin operating without the court's oversight.
Illiquidity
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In many instances a business entering into Chapter 11 bankruptcy protection may have sufficient assets to pay its creditors but holds those assets in an illiquid state. Illiquid assets are not easily converted into cash, which is required to pay creditors. Typical illiquid assets include business inventories, certain loans and fixed assets such as buildings and equipment. As the business continues to operate, it will eventually convert many of those non-liquid assets to cash.
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Reorganization
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Chapter 11 bankruptcy is a reorganization rather than a liquidation. In a liquidation, the assets of the firm are sold off and used to pay creditors immediately. In a reorganization, the firm continues to operate and attempts to eventually pay creditors according to a plan approved by the court. Many creditors prefer reorganizations as a way to recoup more of the debt owed to them. Often the value of a business's assets are worth more through continuing operations than if they are sold off at heavily discounted prices during a liquidation.
Plan
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One of the most significant features of Chapter 11 is the introduction of a bankruptcy plan. The bankruptcy plan, which creditors typically propose and confirm, is a strategic road map that allows the company to continue operating while repaying creditors. Eventually, the bankruptcy plan calls for the company to operate outside of bankruptcy protection. The plan has numerous rights for the debtor, including preferential treatment of new lenders and protections from litigation.
Alternatives
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Bankruptcy under Chapter 7 of the United States Bankruptcy Code is used by organizations ceasing operations. Chapter 7 is a liquidation and may be entered into voluntarily or may be the result of either creditor action or a failed Chapter 11 bankruptcy. In Chapter 7 bankruptcy, the business's assets are sold by a trustee who distributes the proceeds amongst the creditors. Chapter 13 bankruptcy is a reorganization by individuals, where a bankruptcy plan is proposed through which creditors are repaid.
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