In the past, Chapter 11 of the Bankruptcy Code has been used primarily by corporations hoping to reorganize and stay in business. However, with the real estate market downturn, more individuals have taken advantage of Chapter 11 to reorganize and retain their investment property and other property.
Most individuals are familiar with Chapter 7 of the Bankruptcy Code. Fewer are familiar with Chapter 13. These two chapters of the Code are used most often by individuals seeking to file bankruptcy. For example, during the last twelve months, there were approximately 1.5 million individual bankruptcy filings. Of this amount, 71% were filed under chapter 7, while 28.8% were filed under chapter 13. The remaining cases, 1,958, to be exact, were filed under chapter 11, representing a little more than 1/10th of 1% of all filings. Over the last 10 years, however, Chapter 11 filings have been on the rise. In 2000, only 711 individuals filed under chapter 11, so the 2011 figure represents an almost 300% increase!
With almost 2,000 individual filings under chapter 11 last year, there must be some benefit for individuals under this chapter of the bankruptcy code. To understand the possible advantages to a chapter 11 filing it’s important to have a basic understanding of how chapter 7 and chapter 13 work.
Under chapter 7, the person who files bankruptcy (the debtor) files a petition and schedules listing out all of their assets and debts. The Court appoints a bankruptcy trustee who takes the debtor’s non-exempt assets and sells them for the benefit of the creditors. Assets are determined to be exempt under either state or federal law. In exchange for turning over their property, the debtor receives relief from their debts, called a discharge. A debtor who has a large amount of non-exempt assets will normally not elect to file under chapter 7. In addition, individuals with large incomes normally do not qualify under the “means test,” a new test established by Congress in 2005.
For those individuals who do not want to file, or who do not qualify for filing, under chapter 7, they may proceed under chapter 13. Under this chapter, debtors, in most cases, retain their non-exempt property. However, to keep their property the debtors are required to repay all of their “disposable income” over a three to five year period of time. After all of their payments are made, the debtors are entitled to receive a discharge of their debts. As stated above, most debtors who do not elect to file under chapter 7, or who do not qualify, will file for chapter 13. However, there are some debtors who do not qualify for filing under chapter 13 because they have too much debt. The current debt limitations for filing chapter 13 are $360,475 in unsecured debt and $1,081,400 in secured debt. In addition, debtors in chapter 13 are in most cases not permitted to modify mortgages on investment property or other long term debt in chapter 13.
For these debtors, chapter 11 is an excellent alternative to simply surrendering everything to the bank or a trustee in chapter 7. In extreme cases, a debtor who has significant income and debt may not qualify for chapter 7 or chapter 13, leaving chapter 11 as the only option. Under chapter 11, the individual debtors file bankruptcy and become “debtors in possession.” This basically means that they remain in control of all of “their” assets. However, the assets are not really “theirs” any longer. Rather, the property is now what is known as “property of the estate.” The “estate” is comprised of all of the debtor’s rights in any property existing at the time of the bankruptcy filing. In addition, other property, such as the debtor’s future earnings also become property of the estate. The bankruptcy code permits the debtor to remain in possession of this property, and imposes on the debtor a fiduciary duty to use this property for the benefit of the estate’s creditors by formulating a plan of reorganization.
As part of the process, the debtor is provided 120 days from the filing to date in which it is the only person or entity who may submit a plan of reorganization. This period is called the exclusivity period. This period provides the debtor with a short “breathing spell” from its unsecured creditors so that it can evaluate its financial condition and submit a plan. The bankruptcy code provides the debtor with the ability to “cram down” and “strip” a mortgage and repay what is owed based upon the value of the real property, the debtor wishes to retain.
For example, if a debtor owns a commercial building that is worth $500,000, with a first position lien owed to the Bank of $700,000, and a second position lien owed to the seller of the building for $200,000, the debtor may propose a plan that “crams down” the Bank by repaying it the sum of $500,000 as a secured debt, with the difference becoming an unsecured debt of $200,000. The plan could further provide to “strip” the second position lien from the property and treat it entirely as an unsecured debt. The debtor’s plan can be approved provided that it complies with the other provisions of the bankruptcy code, including paying the secured creditor a market rate of interest, paying into the plan all of the debtor’s disposable income for a five year period, and securing the vote of at least one creditor class in favor of the plan.
While obviously not for everyone, Chapter 11 provides high income, high debt individuals who own property they want to keep a less well known, but excellent alternative to either chapter 7 or 13. Just a few of the advantages of Chapter 11 over Chapter 7 or 13 is that it allows debtors to keep their property, restructure long term debts and obtain a breathing spell from creditors to enable them to reorganize. Individuals with high income, debts, or investment property, should consult with an experienced bankruptcy attorney who is familiar with all chapters of the bankruptcy code to best determine their available options.
If you have questions about bankruptcy, we encourage you to attend one of our free seminars or contact us at 800-899-2730 for a free personalized consultation. For more information about our seminars please visit http://www.freearizonabankruptcyseminar.com/.