The second type of bankruptcy is REORGANIZATION. With reorganization, the goal is much different than with liquidation. Instead of having to sell assets, the debtor negotiates with the creditors to reorganize finances and to reschedule the payment of the debt. In such cases, individuals use Chapter 13 bankruptcy, while companies use Chapter 11.
Chapter 13 bankruptcy requires an individual debtor to work with a trustee to create a budget and a repayment plan that will enable the debtor to repay all or, at least, part the debts within a specified amount of time (usually 3-5 years). This plan must be approved by a bankruptcy judge and by the creditors. As such, Chapter 13 is used primarily by people who have a regular income.
The advantage of a Chapter 13 reorganization over a Chapter 7 bankruptcy is that the debtor is able to keep property that would otherwise be liquidated, such as his home, a second car, investments, and family heirlooms. The disadvantage is that the debtor must have the resources to service the repayment plan and must, ultimately, pay back the money. With Chapter 7, most of the debts can be discharged completely without paying back anything. However, the debtor will end up losing most of his property.
Chapter 13 bankruptcy for individuals is straightforward. Chapter 11 bankruptcy, used by companies, works differently and is, in fact, a lot more complicated.
Chapter 11 was created for the practical reason that many insolvent companies are worth more if they are allowed to remain in business than if they are forced to liquidate. From the creditor's point of view, the possibility exists that, if the company is allowed to stay in business, it will be able to pay back more of its debts than if it is forced to close down and liquidate.
Chapter 11 requires the company to create a plan that describes how they will reorganize their finances, including which debts they intend to pay and when. The plan must then be approved by a bankruptcy judge as well as the creditors. In most cases, once the court approves the plan, there is no need for a bankruptcy trustee: the company simply keeps operating according to the details of the plan. If problems arise, the court can always appoint a trustee to oversee the bankruptcy process.
A Chapter 11 bankruptcy plan is a blueprint for how the company will organize itself in the future. As part of the plan, Chapter 11 allows the company to repudiate a great deal of debt, including obligations such as labor agreements (including union contracts), health care costs, pension responsibilities, vendor contracts, customer contracts, and real estate leases. In addition, filing for Chapter 11 bankruptcy automatically halts all pending litigation.
Once a company has filed for Chapter 11, it is allowed to keep operating under the PROTECTION (supervision) of the bankruptcy court and the trustee. Then, once the reorganization plan is approved and implemented, the company changes from being bankrupt back into a regular, non-bankrupt business. Now, however, the company is free from the onerous obligations that caused the bankruptcy in the first place. When this happens, we say that the company EMERGES from bankruptcy. The time it takes for a company to emerge from bankruptcy depends on the size and complexity of the bankruptcy. Typically it will be from a few months to several years.
As you can imagine, being able to shed such obligations can make a huge difference to the financial well-being of a company suffering under the burden of insolvency. This is usually good for the company and the executives who manage the company.
At the same time, however, Chapter 11 restructuring can create serious financial problems for creditors. For example, suppliers will not be paid for goods they have already shipped. In many cases, the people who suffer the most are the employees and retired employees, who often lose all or part of their pensions and their health care benefits.
Still, at least the company is in business. In many cases, a forced Chapter 7 liquidation would end up causing even worse problems, not only for creditors and employees, but for shareholders, customers and suppliers.
An interesting question is, who runs a company after it files for Chapter 11 bankruptcy?
In most cases, especially with large companies, the existing management stays and continues to run the company. This is why, after a large company files for Chapter 11, business seems to continue as usual, even after going bankrupt.
In other cases, the creditors will take over ownership of the company. When this happens, they often appoint a new management team of their own.
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