Our U.S. Constitution–in Article I, Section 8–gives Congress the right to “establish…uniform laws on the subject of Bankruptcy throughout the United States”.  Title 11 of the U.S. Code governs the ins and outs of bankruptcy law and is usually referred to as the “Bankruptcy Code.”  States also have the power to pass laws governing some aspects of relationships between debtors and creditors, though the power to regulate bankruptcy remains vested in the federal government.

Chapter 7 bankruptcy is often also known as liquidation bankruptcy.  If you file for this type of bankruptcy protection, you must first pass a two-part means test in order to determine that you qualify for liquidation as opposed to reorganization bankruptcy.  The means test is a formula meant to prevent higher-income individuals from filing for Chapter 7 bankruptcy in order to wipe out debts that they could actually afford to re-pay.

The first step of the means test compares your current monthly income to the median income of similarly-sized households in your state.  If your income is below that median income amount, you pass the first step of the means test and will automatically qualify to file for Chapter 7 protection.  If it falls above that median income amount, however, you must proceed to the second step of the means test.

The second step of the means test determines whether or not you have enough monthly income left over after paying your allowed monthly expenses (such as car and house loans and utilities) to pay off at least a portion of your outstanding unsecured debt (such as credit cards).  If your disposable income reaches a certain level, you will fail the Chapter 7 means test and will need to file for reorganization bankruptcy instead.

Our U.S. Constitution–in Article I, Section 8–gives Congress the right to “establish…uniform laws on the subject of Bankruptcy throughout the United States”.  Title 11 of the U.S. Code governs the ins and outs of bankruptcy law and is usually referred to as the “Bankruptcy Code.”  States also have the power to pass laws governing some aspects of relationships between debtors and creditors, though the power to regulate bankruptcy remains vested in the federal government.

Chapter 11 bankruptcy is one of the forms of reorganization bankruptcy open to individuals, corporations, and partnerships–though most individuals file for Chapter 13 reorganization bankruptcy instead.  One big advantage to Chapter 11 bankruptcy is that there are no limits placed on the amount of debt and thus is the typical choice for those large businesses who wish to restructure their debt.

During the Chapter 11 process, the debtor often retains possession of and control over its assets.  Business operates as usual–though under the supervision of the court and for the benefit of the creditors, rather than the company.  The debtor-in-possession operates as a fiduciary for the creditors.  If that debtor’s management is ineffective or dishonest, the bankruptcy court might also appoint a separate trustee.

Creditors committees are generally appointed by the U.S. Trustee and chosen from among the 20 largest, unsecured creditors who are not company insiders.  These committees represent all creditors as they provide oversight for the debtor’s operations.  They also serve as the body with whom the debtor negotiates to reach an acceptable reorganization plan.

In order for a proposed Chapter 11 plan  to be approved, the debtor must obtain an affirmative vote from the creditors, who will be divided into various classes based upon the types and amounts of their claims, and whose votes will function based upon the amount of their claim against the debtor.

The debtor can attempt to force a plan on creditors should they fail to get enough votes to confirm the proposed plan, but the debtor must meet certain statutory tests and obtain the approval of the bankruptcy court.

While Chapter 11 is usually viewed as the most flexible chapter of bankruptcy, it also has a depressingly low rate of success for the businesses using it to remain solvent:  sometimes estimated to be as low as 10% or so.  Still, for some debtors, it is a viable option so long as they go into the process with eyes open, a realistic reorganization plan, and expert legal advice.