What is Chapter 11?

Chapter 11 is a chapter the United States Bankruptcy Code that controls the reorganization of a business that is no longer able to pay its creditors with its current financial burden. The actual Bankruptcy Code of the United States is called Title 11 and has various chapters within it. For example, Chapter 7 deals with the process of liquidation bankruptcy.

When a business finds that it is in trouble and no longer able to pay its creditors or maintain its debts, it can file with a bankruptcy court for protection under Chapter 11. This type of filing means that the business intends to continue trading while the bankruptcy court supervises the company's debt and contractual obligations. The court has the power to cancel all or some of the company's debts. With this financial relief, the company has the chance to make a fresh start.

Depending on the size of the company and the complexity of the bankruptcy, a company that files under Chapter 11 may become debt free within a few months to several years. Some of debts and contracts that can be canceled include unsecured loans, vendor and customer contracts, and real estate leases. Often, the company's debts may far outweigh its assets. If this is the case, the end result will be that the company's present owners or stockholders end up with nothing.

If the company is unable to recover from its debt, the ownership of the reorganized company will transfer to the company's creditors. The new owners may be able to make a success of the company as a compensation for their initial losses. The rationale behind this type of bankruptcy is that the ailing company should have a chance to pay its creditors if they are still a going concern. If the company eventually ends up in the hands of its creditors, the scenario is often more favorable to the original owners than selling off the company piece by piece.

Passing company ownership to creditors means that jobs may be saved and assets retained, and the business can continue debt free. Creditors can make more money if the company files for Chapter 11. If the company is placed into liquidation, bankruptcy creditors may end up with nothing.

Critics have claimed that this form of bankruptcy is too lenient, allowing incompetent managers to continue working and acting as a convenient escape route if things go wrong for a company. Even so, many companies, including many major airlines in the United States, are operating under Chapter 11. By stopping debt payments, these companies are able to expand their routes and battle price wars against their competitors. Filing for bankruptcy is sometimes the first step in a failing business returning to success.