How Does Chapter 11 Bankruptcy Work?

An Unpleasant Alternative

Bankruptcy is a legal procedure used by individuals and businesses that have no way to pay their obligations. Today, most filings result from events out of the control of the "debtors" who file them; businesses caught in an economic downturn, individuals with huge medical bills or whose debts have outrun their income due to loss of job or a depressed real estate market often have no alternative but bankruptcy. In the 18th century, such "banckrupts" would be sent to a "Debtor's Prison" or "Work House" to pay off their debts. The problem with the punitive Debtor's Prison was that the debtors could never catch up with their debts. Many English colonies were settled by such debtors who overwhelmed the system. This problem encouraged more enlightened laws in England in the 19th century and Americans followed the example with the federal Bankruptcy Act of 1898, revised by the Bankruptcy Reform Act of 1978. This law, along with 1984, 1986 and 1994 amendments and the Bankruptcy Prevention and Consumer Protection Law of 2005, make up the U.S. Bankruptcy Code. As with any legal procedure, bankruptcy should never be attempted without the counsel of a qualified attorney who will discuss fees and filing costs up front.

Restoring Equilibrium

Chapter 11 (of the Bankruptcy Code) bankruptcies are "rehabilitative" procedures, meant to restore the debtor's ability to pay some debts while "discharging" others. The process that a corporation follows is a bit more complex in practice than that of an individual but the concepts are the same. The debtor files a petition in bankruptcy court that includes a listing of debts and assets, requesting "relief" from debts. A "trustee" is assigned, who will go through the lists and help develop a plan to honor certain debts (including alimony, child support, taxes, fines and government loans) and to make a schedule of others that may be partially repaid. Certain assets (such as a primary residence and vehicle) are "protected." Others can be liquidated to pay debts. Assets and liabilities are balanced and a plan is drawn up to go forward. If the court approves the plan, it will issue an order listing debts to be liquidated and debts to be paid. During the period between the petition and the final hearing, all creditors must cease collection attempts. If, however, a creditor disputes a part of the plan, the debtor and trustee may have to work out a new plan with the creditor.

Additional Considerations

Corporations (and some individuals) that have more complex situations require closer supervision. In these cases, the trustee will actually take over operations of the corporation or debtor's assets. The court might also appoint an independent "examiner" whose job it is to oversee the corporation's activities. All shareholders of corporations must be notified as well as creditors---they own pieces of the indebtedness. The Code includes punishments for debtors who attempt to hide assets or lie. Ultimately, your attorney is your best source of information; confer with him to get a full explanation of the Chapter 11 of the Bankruptcy Code.