Filing for bankruptcy under Chapter 11 of the U.S. Bankruptcy Code has been the most common strategy for financially stressed companies that seek to reorganize and stay in business. With the recent passage of the Small Business Reorganization Act, small businesses now have two avenues for reorganizing under the bankruptcy laws.

Here are overviews of these two approaches.

Chapter 11 Bankruptcy – Overview

Chapter 11 bankruptcy is available to individuals, corporations, partnerships and limited liability companies.  It is primarily a means by which larger businesses can restructure their debts.  The goal is to keep business active while payment is made to creditors over a set period. 

There are no limits on the amount of debt, which is unlike the situation in the Chapter 13 bankruptcy.  A Chapter 11 petition may be voluntary or involuntary.  It can be filed where the debtor’s primary place of business is located or where the debtor is incorporated.

The debtor in a Chapter 11 proceeding usually remains in possession of its assets and operates the business under the supervision of the bankruptcy court and for the benefit of creditors.  If the “debtor in possession” mismanages this fiduciary responsibility, a trustee may be appointed.

The creditors in a Chapter 11 proceeding are secured creditors and unsecured creditors.  A creditors committee is usually appointed by the United States Trustee from among the 20 largest unsecured creditors who are not insiders.  The unsecured creditors committee provides oversight for the debtor’s operations and is an entity with whom the debtor can negotiate an acceptable plan of reorganization. 

The debtor has approximately four months to develop the reorganization plan after its petition for bankruptcy protection is filed.  An extension may be provided to complete the reorganization plan for up to 18 months.  Additionally, creditors dissatisfied with the debtor’s progress toward the reorganization plan can move to dismiss or convert the case to a Chapter 7 (liquidation) bankruptcy.

A Chapter 11 plan will be confirmed only upon the affirmative votes of the creditors.  If the debtor cannot obtain votes to confirm a plan, the debtor can attempt to “cram down” a plan on creditors and get the plan confirmed by the bankruptcy court — despite creditor opposition — by meeting certain statutory tests.  To confirm a Chapter 11 plan, a court must find the plan is feasible, presented in good faith, is fair and equitable and is in the best interests of the creditors.

While Chapter 11 is flexible compared to other bankruptcy chapters, it is generally more expensive to the debtor.  Chapter 11’s complex rules and requirements are likely to increase the costs to file the case and complete a plan to confirmation beyond those costs found in other forms of bankruptcy, such as a Chapter 7 liquidation.

The debtor ordinarily continues in business after it files a Chapter 11 proceeding.  However, the debtor loses control over major decisions to the bankruptcy court.  For instance, the court must approve any sale of assets, the entering or breaking of leases, mortgages or secured financing arrangements, and the shutting down or expansion of business operations.

Overview – Small Business Reorganization Act (Chapter 11, Subchapter 5)

The act became effective in February 2020.  It added a Subchapter (No. 5) to Chapter 11.  The act was enacted to streamline the costs and expenses for small businesses to reorganize under Chapter 11. 

To qualify under Subchapter 5, the debts of a company (secured and unsecured debts) must not exceed $2,725,625 (temporarily increased for one year to $7.5 million by the CARES Act of March 2020).  Additionally, Subchapter 5 requires that the business must file a Chapter 11 plan within 90 days of filing for bankruptcy, but there are no disclosure statement filing requirements.  A plan under Subchapter 5 will also be confirmed provided the business contributes all disposable income for three to five years to make its plan payments.

Every case under Sub-Chapter 5 will have a Trustee appointed, also known as the Small Business Trustee, by the United States Trustee.  Creditors committees are eliminated under Sub-Chapter 5.

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Neil D. Schor is a lawyer with Harrington, Hoppe & Mitchell. His practice areas include bankruptcy, public sector law, civil litigation and commercial law. He can be reached at nschor@hhmlaw.com or at (330) 744-1111.

HHM is a debt relief agency, as it helps people and businesses file for bankruptcy relief under the U.S. Bankruptcy Code.