Bankruptcy

What Is an Individual Chapter 11 Bankruptcy?

By Paul Geilich | Updated by Cara O'Neill, Attorney
If you have significant assets or debt you might receive a better outcome under Chapter 11 than Chapter 7 or 13 bankruptcy.

Chapter 11 is intended to help businesses and individuals with significant debt. A filer who has income but can’t keep up with current debt payments can use Chapter 11 bankruptcy to create an affordable payment plan. The plan might include longer terms, a more favorable interest rate, or a reduced debt balance.

Since this chapter is more complicated and expensive than other bankruptcy types, only a small fraction of bankruptcies are filed each year under Chapter 11, and most are business cases. Individuals usually find filing Chapter 7 or 13 more affordable, and rarely use this chapter unless the filer:

  • makes too much to qualify for a Chapter 7 discharge, and
  • has debt that exceeds the amount allowed in Chapter 13 bankruptcy.

In this article, you’ll learn about the Chapter 11 process and requirements, creditor voting, and plan confirmation.

Why File for Chapter 11 Instead of Chapter 7 or 13?

It’s unlikely that you’d choose to file for Chapter 11 voluntarily. Even though it has some unique benefits—such as reducing the amount owed on a car purchased less than 910 days before filing bankruptcy to its actual value—it’s likely that the savings wouldn’t outweigh the cost.

Here’s a brief description of the chapters an individual would want to rule out before filing a Chapter 11 case.

  • Chapter 7 bankruptcy. A Chapter 7 bankruptcy provides relief for people who don’t own much property and whose disposable income is too low to make meaningful payments to creditors. You qualify by passing the Chapter 7 means test. The trustee will sell most of your nonexempt property (non-essential assets) to pay creditors, and you’ll receive a discharge (forgiveness) of your qualifying debts.
  • Chapter 13 bankruptcy. If you don’t qualify for Chapter 7 bankruptcy, you might be able to file a Chapter 13 case. Or, you might choose this chapter because it offers benefits that Chapter 7 doesn’t, such as the ability to catch up on a house payment. You’ll file a simplified repayment plan that uses your disposable income to pay creditors over three to five years. Any remaining balance on qualifying debt is discharged (gets wiped out). To qualify for Chapter 13 bankruptcy, you must have sufficient income to pay required obligations, and the amount of your debt can’t exceed certain limits.

This is a cursory explanation of these bankruptcy types. A bankruptcy lawyer will be in the best position to help you decide which chapter would be best for you.

The Chapter 11 Bankruptcy Process: An Overview

When you file an individual Chapter 11 bankruptcy case, you might feel overwhelmed by the requirements. But you’ll get the benefit of the automatic stay. The stay will delay collection actions, lawsuits, and other debt collection efforts so you have time to negotiate repayment with your creditors. The automatic stay remains in effect until the court approves your plan of reorganization.

Here’s a synopsis of what you can expect.

  1. Negotiating with creditors. After you file your Chapter 11 case, you’ll disclose your income, assets, and debts on official bankruptcy forms, and begin negotiating your reorganization plan. If you’re wondering why your creditors would be willing to negotiate with you, it’s because they know that if they’re too aggressive, they might force you into Chapter 7 liquidation and receive little or nothing.
  2. Preparing your plan of reorganization. Unlike a standardized Chapter 13 plan that requires you to pay a particular amount to certain types of creditors, a Chapter 11 reorganization plan is a customized document designed to solve your unique financial problems. Your job as a Chapter 11 filer is to propose a plan that preserves important assets while allowing you to pay your debts over time using your available income.
  3. Voting on your plan. Once you have negotiated a manageable plan, you’ll file it with the court and your creditors will vote on whether to accept or reject it. Not all creditors will negotiate easily. If a reluctant creditor won’t agree to a reasonable restructure of its claim, you might be able to “cram down” a plan over the creditor’s objection, if you can prove to the judge that your proposed treatment of that creditor’s claim is fair and reasonable.
  4. Confirmation of your plan. To be confirmed (approved by the court), a Chapter 11 plan must be accepted by at least one-half of the number of creditors in each class of claims, and two-thirds of the dollar amount of claims in each class. Once accomplished, you’ll receive a court order confirming your plan of reorganization.
  5. Discharge of your debt. If you fail to complete the plan as agreed, you’ll remain responsible for the balances on any outstanding obligations that would otherwise qualify for discharge.

The Plan of Reorganization

Here’s an overview of the basic plan rules.

Classifying Claims and Proposing Payment Treatment

You’ll start by organizing your debts, or “classifying your claims.” In a Chapter 11 plan, you do this by grouping related debts together. Then you’ll propose a treatment for (how you intend to pay) each class.

  • You must pay “priority” debts—income taxes and child support payments, for example—in full.
  • You’ll have to pay secured debts (debts guaranteed by property, such as houses, cars, or equipment used in business).
  • Last in the payment order are general unsecured debts (debts that aren’t guaranteed by property) such as credit card balances, medical bills, and personal loans.

Because unsecured or “impaired creditors” have no property backing up their claims, you typically have more room to negotiate a discount than you would with your other creditors.

Negotiating With Creditors

You don’t write a Chapter 11 plan of reorganization on standard forms like in a Chapter 13 case. A Chapter 11 plan is a flexible document you can customize to solve your unique financial problems. With the help of your lawyer, you’ll negotiate with your creditors and describe any agreements you reach in different sections of the plan.

You can treat each class of claims in many ways (as long as all creditors in the same class are treated in the same manner), but the idea is to propose new repayment terms that give you significant relief from your original loan terms while still satisfying your creditors. For instance, you might suggest a longer payout period, a reduced interest rate, or even a reduction of principal.

Example of a Proposed Chapter 11 Plan

A small business person in need of bankruptcy help is a good illustration of someone who might benefit from a Chapter 11 plan. Take John, for instance, who owns a dry cleaning business as a sole proprietor.

John has many regular customers and usually makes a good income, but a recent uninsured fire left his equipment damaged and ruined many of his customers’ clothes. Before he can reopen for business, John will have to spend most of his available cash to repair the equipment and replace the clothing. But John owes money on his dry cleaning equipment and to his trade suppliers and won’t be able to make the repairs and continue paying his monthly obligations.

John filed for Chapter 11 bankruptcy after learning that it could help an ongoing business stay open by restructuring debt into a manageable payment plan. An outline of John’s plan of reorganization might look like this:

  • Class 1 – $20,000 priority claims (federal and state income taxes and past-due alimony). Treatment - paid in full upon plan confirmation.
  • Class 2 – $50,000 property tax debt. Treatment - paid in full over five years at 5% interest.
  • Class 3 – $400,000 secured debt on the house. Treatment – the past-due amount paid over two years at 5% interest. Future payments made as agreed in the original loan.
  • Class 4 – $600,000 secured debt on equipment used in business. Treatment - reduce the amount of the claim to the appraised value of the equipment. Reduce the interest rate from 12% to 5%. Extend payout from three to six years, payable in monthly installments.
  • Class 5 – $100,000 unsecured trade debt. Treatment – 50% of claims paid over four years with no interest.
  • Class 6 – $20,000 in customer claims. Treatment - paid in full upon plan confirmation.

Claim rules exist, and the judge will determine whether you’ve classified your claims correctly. This is merely an example. Your plan will be unique to your financial situation.

What Is a Disclosure Statement?

You’ll send more than just your proposed Chapter 11 plan to your creditors. You’ll also include a document called a “disclosure statement.”

The disclosure statement gives creditors background information about your financial situation and the nature of the claims against you. Also, it summarizes your plan in simple language with less legal jargon.

The disclosure statement must include the following:

  • a section that explains why the plan is better for creditors than a Chapter 7 bankruptcy (which would involve the selling of your assets), and
  • projections of your expected income and expenses throughout the plan.

The disclosure statement is your chance to “sell” the plan and convince creditors to vote for it.

Plan Voting, Confirmation, and the Discharge

Once you’ve negotiated the best plan of reorganization you can manage, you’ll file it with the court. Next, creditors will vote on whether to accept or reject the plan. If the judge approves the plan, you’ll receive a court order and will start making payments soon after that. Once complete, the unpaid debt will get wiped out (discharged).

Find out what to expect after a bankruptcy discharge.

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