Summary. Chapter 11 is not a going-out-of-business sale; it is a court-supervised negotiation in which a company keeps operating while it restructures obligations it cannot pay. This article walks the filing and the automatic stay, the first-day motions that determine whether the business survives its first month, cash collateral and DIP financing, and the treatment of contracts and leases under § 365 that decides whether a counterparty is paid in full or holds a rejection claim worth pennies. It then covers claims and the priority waterfall, § 363 sales and credit bidding, and the plan process — disclosure, voting, cramdown, and absolute priority — plus avoidance actions, subchapter V, and what a creditor should do in the first two weeks.

A regional restaurant group with 22 locations files a Chapter 11 petition on a Sunday night. On Monday morning three things happen at once.

Its food distributor, owed $840,000, stops shipping and demands cash in advance. Its landlords, holding leases at 22 sites, start calculating what they can recover. And a competitor that had been circling for two years calls the company's investment banker to ask what the assets might go for.

Every one of those parties is now operating under a set of rules most of them have never read. The distributor's refusal to ship may violate the automatic stay. The landlords are about to learn that their claims are capped by statute. And the competitor is about to learn that buying assets in bankruptcy is faster, cleaner, and more litigated than buying them outside it.

Chapter 11 rearranges the ordinary rules of commercial life for a period of months. Understanding which rules changed — and which did not — is the difference between recovering fifty cents on the dollar and recovering four.

The short answer

What Chapter 11 is. A reorganization proceeding under title 11 of the United States Code in which a business (or, less often, an individual) continues to operate while it restructures its debts under court supervision. Management usually stays in place as the debtor in possession, with the rights and duties of a trustee, 11 U.S.C. § 1107.

What it does immediately. The automatic stay under § 362 halts virtually all collection activity — lawsuits, foreclosures, repossessions, setoffs, lien enforcement, and even informal collection calls — the instant the petition is filed. No order is required.

What it does over time. It sorts every claim into a priority order, gives the debtor tools to shed burdensome contracts and leases, permits asset sales free and clear of liens, and ultimately confirms a plan of reorganization that binds every creditor, including those that voted against it.

What creditors get. Whatever the priority waterfall leaves for them. Secured creditors are paid from their collateral. Administrative expenses and priority claims come next. General unsecured creditors share what remains, which in most cases is a fraction of face value. Equity is usually wiped out.

The single most important creditor deadline. The bar date for filing a proof of claim. Miss it and the claim is generally disallowed, no matter how valid.

Who files, and why

Companies file Chapter 11 for four broad reasons, and knowing which one you are looking at predicts how the case will go.

Balance sheet distress. The business is viable but over-levered — it generates enough cash to operate but not enough to service debt. These cases produce genuine reorganizations, often with a prenegotiated plan and a debt-for-equity swap that hands the company to its lenders.

Operational distress. The business loses money at the operating level. Chapter 11 buys time to shed leases, renegotiate contracts, and shrink, but the underlying problem is not a balance sheet problem, and many of these cases convert to Chapter 7 or end in a liquidating plan.

A single catastrophic liability. Mass tort exposure, an adverse judgment, or a pension obligation. The filing is a mechanism to aggregate and cap the liability, often through a trust. These cases are long and heavily litigated, and courts have grown more skeptical of aggressive uses — Harrington v. Purdue Pharma L.P., 603 U.S. 204 (2024), held that the Code does not authorize nonconsensual releases of claims against non-debtors in a plan.

A sale. The company files in order to sell its assets under § 363, free and clear of liens and successor liability, faster and more cleanly than an out-of-court sale allows. Many modern Chapter 11 cases are sale cases from day one.

The filing and the automatic stay

A voluntary petition is filed in the district where the debtor is domiciled, resides, has its principal place of business, or has its principal assets, 28 U.S.C. § 1408 — a venue rule that has produced persistent complaints about forum shopping into Delaware and the Southern District of Texas.

The automatic stay arises immediately, § 362(a), and it is broad. It stops:

  • commencing or continuing a lawsuit against the debtor on a prepetition claim;
  • enforcing a judgment;
  • any act to obtain possession of, or exercise control over, estate property;
  • creating, perfecting, or enforcing a lien;
  • setoff of a prepetition debt against a prepetition claim; and
  • collection efforts of any kind, including demand letters and calls.

Willful violations expose a creditor to actual damages, costs, fees, and in appropriate cases punitive damages, § 362(k). The classic trap is a vendor that refuses to release goods already paid for, or a bank that freezes an account to protect a setoff right. The freeze itself is defensible in narrow circumstances; the setoff is not, absent relief from the stay.

The stay is not absolute. Section 362(b) excepts criminal proceedings, certain domestic support obligations, most governmental police and regulatory actions, and specified financial contracts. And a creditor may move for relief from stay under § 362(d) — for cause including lack of adequate protection, or, as to specific property, where the debtor has no equity in it and it is not necessary to an effective reorganization.

First-day motions: the first 72 hours

A company that files without a prepared set of first-day motions usually does not survive the month. The standard package:

  • Cash management. Authority to keep using existing bank accounts and intercompany arrangements rather than opening new debtor-in-possession accounts overnight.
  • Wages and benefits. Authority to pay prepetition employee compensation up to the § 507(a)(4) priority cap, and to continue benefit programs. Employees who are not paid on the first postpetition payday tend to leave.
  • Critical vendors. Authority to pay certain prepetition trade claims in full, in exchange for continued shipment on customary terms. Legally contentious — it pays some unsecured creditors ahead of others — but widely granted where the vendor is genuinely irreplaceable.
  • Utilities. Section 366 gives utilities the right to adequate assurance of payment within 30 days; the motion sets the form and amount before service is cut.
  • Customer programs. Authority to honor gift cards, warranties, rebates, and loyalty points, which is a going-concern necessity and a consumer-protection flashpoint.
  • Cash collateral or DIP financing. The most consequential motion of all.
  • Taxes, insurance, and shippers' and warehousemen's liens.

Practical point for creditors: the first-day hearing is often held within 24 to 48 hours, on limited notice, and the interim orders entered there frame the entire case. A creditor with a stake in cash collateral, critical-vendor treatment, or the sale timeline should appear, or should at least ensure counsel is monitoring the docket from day one.

Cash collateral and DIP financing

A business in Chapter 11 needs cash to operate, and its cash is almost always someone's collateral.

Cash collateral is cash, deposit accounts, receivables proceeds, and similar property subject to a security interest, § 363(a). The debtor may not use it without the secured creditor's consent or a court order, § 363(c)(2). To use it over objection, the debtor must provide adequate protection under § 361 — periodic cash payments, replacement liens, or the "indubitable equivalent" — sufficient to protect the creditor against the diminution in value of its interest.

DIP financing under § 364 lets the debtor borrow. The statute creates a ladder: unsecured credit in the ordinary course is automatically allowed as an administrative expense; beyond that the court may authorize a superpriority administrative claim, a lien on unencumbered property, a junior lien on encumbered property, and — only where the debtor cannot obtain credit otherwise and the existing lienholder is adequately protected — a priming lien senior to existing security, § 364(d).

DIP facilities are where much of the real negotiation happens, because the lender writes the case's operating rules into the order: budget covenants, milestones for filing a plan or running a sale, case-control provisions, roll-ups of prepetition debt, and challenge periods limiting how long a creditors' committee has to attack the lender's liens. A creditor reading a DIP motion should look past the interest rate and read the milestones — they usually determine whether the case is a reorganization or a sale.

A lender that finances in good faith is protected on appeal by § 364(e), which is why objections must be raised before the order is entered, not after.

Executory contracts and leases: Section 365

This is the provision that most directly affects ordinary counterparties, and the one they most often misunderstand.

An executory contract is one where material performance remains due on both sides. Section 365 lets the debtor assume it, assume and assign it, or reject it, subject to court approval.

  • Assumption requires the debtor to cure defaults (or provide adequate assurance of prompt cure), compensate for actual pecuniary loss, and provide adequate assurance of future performance, § 365(b)(1). Assumption is all-or-nothing: the debtor cannot cherry-pick favorable provisions.
  • Assumption and assignment lets the debtor transfer the contract to a buyer — and, critically, overrides most anti-assignment clauses, § 365(f). A carefully negotiated consent right in a supply agreement may simply not operate in bankruptcy.
  • Rejection is a breach deemed to occur immediately before the petition date, § 365(g). It is not a rescission: Mission Product Holdings, Inc. v. Tempnology, LLC, 587 U.S. 370 (2019), held that rejection of a trademark license does not terminate the licensee's rights, because rejection is breach, and breach does not vaporize rights the contract already conveyed.

What a rejection is worth. The counterparty holds a general unsecured claim for damages — the same class as trade debt, paid in the same fractional currency. That is the whole point of rejection: it converts a full-value obligation into a discounted claim.

The landlord cap. A landlord's claim for damages from a rejected real property lease is capped by § 502(b)(6) at the rent reserved for the greater of one year, or 15 percent of the remaining term not to exceed three years, plus unpaid rent already due. A landlord holding a fifteen-year lease with ten years remaining does not have a ten-year claim. The same section caps employment contract termination claims at one year's compensation.

Timing. For nonresidential real property leases, the debtor must assume or reject within 120 days of the order for relief, extendable by 90 days for cause, and beyond that only with the landlord's written consent, § 365(d)(4). Until the decision is made, the debtor must timely perform obligations arising after the 60th day, § 365(d)(3). For other contracts in Chapter 11, the decision can be deferred to plan confirmation.

Ipso facto clauses — provisions terminating a contract on insolvency or a bankruptcy filing — are generally unenforceable, § 365(e)(1). Every commercial contract contains one; almost none of them work.

Intellectual property licenses. Section 365(n) allows a licensee of intellectual property (as the Code defines it, which notably excludes trademarks) to elect to retain its rights after rejection, paying royalties and forgoing the licensor's affirmative obligations. Mission Product extended comparable protection to trademark licensees by treating rejection as breach.

Claims: filing, priority, and what each layer gets

Filing. Creditors listed in the debtor's schedules as undisputed, liquidated, and non-contingent are deemed to have filed a claim in that amount. Everyone else must file a proof of claim by the bar date set by the court, Fed. R. Bankr. P. 3003(c). Missing the bar date is the single most common way a valid claim becomes worthless.

Allowance. A properly filed claim is deemed allowed unless a party in interest objects, § 502(a). Section 502(b) then lists the grounds for disallowance, including unenforceability under applicable law, unmatured interest, the landlord and employee caps, and property tax exceeding value.

The waterfall. In descending order of payment:

  1. Secured claims, to the extent of the value of the collateral. The undersecured portion becomes a general unsecured claim, § 506(a).
  2. Superpriority administrative claims granted to a DIP lender under § 364(c)(1).
  3. Administrative expenses under § 503(b) — the actual, necessary costs of preserving the estate, including postpetition goods and services, professional fees, and the § 503(b)(9) claim of a vendor for goods received by the debtor within 20 days before the petition, which is one of the more valuable and least known trade creditor protections.
  4. Priority unsecured claims under § 507(a) in statutory order: domestic support; then wages, salaries, and commissions earned within 180 days before filing, subject to a per-employee cap; employee benefit plan contributions; certain grain and fisherman claims; consumer deposits; and most tax claims.
  5. General unsecured claims — trade debt, rejection damages, judgments, deficiency claims.
  6. Subordinated claims, including those subordinated by agreement or by § 510(b) for claims arising from the purchase or sale of a security.
  7. Equity.

A creditor's entire strategic question is usually whether it can move up a layer: perfect a lien, establish a reclamation or § 503(b)(9) right, secure critical-vendor treatment, or convert a prepetition claim into a postpetition administrative one by continuing to ship on new terms.

Section 363 sales

Many Chapter 11 cases are, functionally, auctions.

Section 363(b) permits a sale of assets outside the ordinary course after notice and a hearing. The attraction for buyers is § 363(f), which permits a sale free and clear of liens, claims, encumbrances, and interests, with liens attaching to the proceeds. Combined with a finding of good faith under § 363(m) — which insulates the sale from being unwound on appeal — a bankruptcy sale gives a buyer a level of title comfort no out-of-court transaction can match.

The process. The debtor typically selects a stalking horse bidder, negotiates an asset purchase agreement, and moves for approval of bidding procedures: a break-up fee and expense reimbursement for the stalking horse, minimum overbid increments, bid deadlines, qualification requirements, and an auction date. The auction runs, the court holds a sale hearing, and an order enters. The whole sequence often takes 45 to 90 days.

Credit bidding. A secured creditor may bid its debt rather than cash, § 363(k), which is a formidable advantage — unless the court limits it for cause. RadLAX Gateway Hotel, LLC v. Amalgamated Bank, 566 U.S. 639 (2012), confirmed that a plan cannot be crammed down over a secured creditor's objection by selling the collateral free of liens without allowing a credit bid.

Successor liability. Free-and-clear sale orders routinely purport to bar successor liability claims against the buyer. Courts generally enforce this as to contract and lien claims. Treatment of future tort claims, environmental obligations, and certain labor liabilities is less uniform, and a buyer should not treat the order's language as conclusive on every theory.

Sub rosa plans. Courts scrutinize sales that effectively dictate the distribution of proceeds among creditors, because that is a plan function requiring disclosure and voting. Czyzewski v. Jevic Holding Corp., 580 U.S. 451 (2017), held that a court may not approve a structured dismissal distributing estate assets in violation of the ordinary priority rules without the consent of the affected creditors.

Avoidance actions: clawing money back

The estate can recover certain prepetition transfers, and ordinary trade creditors are frequently the targets.

Preferences, § 547. A transfer to or for the benefit of a creditor, on account of an antecedent debt, made while insolvent, within 90 days before filing (one year for insiders), that enabled the creditor to receive more than it would in a Chapter 7 liquidation. Insolvency is presumed for the 90-day period.

The defenses matter more than the elements:

  • Ordinary course of business, § 547(c)(2) — the transfer was in payment of a debt incurred in the ordinary course and was either made in the ordinary course of dealings between the parties or according to ordinary business terms. The practical test is usually a comparison of days-to-pay before and during the preference period.
  • Contemporaneous exchange for new value, § 547(c)(1).
  • Subsequent new value, § 547(c)(4) — goods or services provided after the preferential payment, unpaid, offset the exposure. This is why a vendor that keeps shipping often has a smaller preference problem than one that stopped.
  • The small transfer floors in § 547(c)(9).

Since 2019, § 547(b) also requires the trustee to conduct reasonable due diligence, taking into account known affirmative defenses, before filing — a meaningful check on mass preference demand letters.

Fraudulent transfers, § 548 and, through § 544(b), state law under the Uniform Voidable Transactions Act. Actual intent to hinder, delay, or defraud; or constructive fraud where the debtor received less than reasonably equivalent value while insolvent, undercapitalized, or unable to pay debts as they matured. Section 546(e)'s securities safe harbor is narrower than it once appeared: Merit Management Group, LP v. FTI Consulting, Inc., 583 U.S. 366 (2018), directed courts to look at the transfer the trustee seeks to avoid, not intermediate conduit transfers.

Setoff, § 553, preserves valid prepetition setoff rights but subjects them to the improvement-in-position test.

Reclamation, § 546(c), gives a seller of goods a right to reclaim goods delivered within 45 days before filing, if written demand is made within the statutory window — a right that is often subordinate to a floating lien and therefore worth less than it sounds, which is why § 503(b)(9) is usually the better route.

The plan of reorganization

Exclusivity. The debtor has the exclusive right to file a plan for 120 days, and to solicit acceptances for 180 days, each extendable for cause up to 18 and 20 months respectively, § 1121. Loss of exclusivity is a genuine turning point: creditors can then propose competing plans.

Classification. The plan sorts claims into classes of substantially similar claims, § 1122. Gerrymandering classes to manufacture an accepting impaired class draws objections.

Impairment and voting. A class is impaired unless the plan leaves its legal, equitable, and contractual rights unaltered, § 1124. Unimpaired classes are deemed to accept. An impaired class accepts if creditors holding at least two-thirds in amount and more than one-half in number of the claims actually voting accept, § 1126(c).

Disclosure. Before soliciting votes, the proponent must obtain approval of a disclosure statement containing "adequate information" — enough for a hypothetical reasonable investor to make an informed judgment, § 1125.

Confirmation. Section 1129(a) sets sixteen requirements, including good faith, feasibility, payment of administrative and priority claims, and the best interests test: each dissenting creditor must receive at least what it would receive in a Chapter 7 liquidation, § 1129(a)(7).

Cramdown. If at least one impaired class accepts (excluding insiders), the plan may be confirmed over the dissent of other classes if it is fair and equitable and does not discriminate unfairly, § 1129(b). For secured claims, fair and equitable means retention of the lien plus deferred payments of present value, sale with a credit bid right, or the indubitable equivalent. For unsecured claims, it means the absolute priority rule: no junior class may receive or retain anything on account of its junior interest unless senior classes are paid in full.

Effect of confirmation. The plan binds all creditors and equity holders, § 1141(a), whether or not they voted or accepted. The debtor is generally discharged of prepetition debts on confirmation — except that a debtor that liquidates and does not continue business receives no discharge, § 1141(d)(3).

Subchapter V: small business reorganization

Subchapter V, added by the Small Business Reorganization Act, is a materially different and much cheaper process for eligible small business debtors.

Its principal features: a standing trustee who facilitates rather than displaces management; no creditors' committee by default; no disclosure statement requirement absent a court order; only the debtor may file a plan, and it must be filed within 90 days; no absolute priority rule, so equity holders can retain ownership if the plan commits projected disposable income for three to five years; and administrative expenses may be paid over the life of the plan rather than at confirmation.

The eligibility debt limit has moved repeatedly — it was raised temporarily and has reverted and been adjusted since — so confirm the currently effective figure before assuming eligibility. For a business with a few million dollars of debt and a viable operation, subchapter V is often the difference between a feasible restructuring and an unaffordable one.

A worked example

Meridian Outdoor Supply is a 90-employee manufacturer with $34 million in revenue. It owes $12 million on a revolving credit facility secured by all assets, $6.4 million in trade debt, and holds leases on a headquarters and three warehouses. A product recall and a lost anchor customer have made it unable to service the revolver.

Day 1. Meridian files. The stay stops a receivership action the lender had threatened. First-day motions are heard on day 2: wages, utilities, cash management, and interim use of cash collateral on a 13-week budget.

Week 2. The lender agrees to a DIP facility that rolls up part of the prepetition revolver and includes milestones — a plan or a sale motion within 75 days. The creditors' committee is appointed and immediately negotiates a challenge period to investigate the lender's liens.

Week 4. Meridian rejects two warehouse leases it no longer needs. One landlord had eight years remaining at $480,000 a year — a $3.8 million contract claim outside bankruptcy. Under § 502(b)(6), the claim is capped at the greater of one year's rent ($480,000) or 15 percent of the remaining term (15 percent of $3.84 million, or $576,000, which does not exceed three years' rent), plus arrears. The landlord's claim is roughly $600,000 of general unsecured debt, not $3.8 million.

Week 6. Its largest supplier, which delivered $310,000 of components in the 18 days before filing, asserts a § 503(b)(9) administrative claim. It is allowed. The same supplier receives a preference demand for $900,000 paid during the 90 days before filing; it defends with ordinary course evidence showing consistent 41-to-46-day payment history for three years, and with $420,000 of subsequent new value. The exposure collapses.

Week 10. Meridian markets the business. A strategic buyer signs a stalking horse agreement at $14.5 million. The lender is permitted to credit bid. At auction, a second bidder pushes the price to $16.2 million in cash.

Week 14. The sale closes free and clear. The lender is paid in full. Administrative and priority claims are satisfied. The estate holds roughly $1.9 million against $6.4 million of general unsecured claims plus rejection damages.

Month 6. A liquidating plan distributes to unsecured creditors at approximately 24 cents on the dollar, plus a share of preference recoveries. Equity receives nothing.

Every creditor's outcome traced to a decision made in the first six weeks: the supplier that kept shipping preserved new value and secured an administrative claim; the landlord whose lease was rejected discovered a statutory cap it had never read; and the lender's DIP milestones, not the debtor's business plan, set the case's direction.

What a creditor should do in the first two weeks

  1. Stop collection immediately and instruct everyone at the company to do the same. A single automated dunning email can support a stay violation motion.
  2. Read the docket. Register for electronic notice. First-day orders, the bar date, and the DIP milestones are all set early.
  3. Quantify your position. Are you secured? Perfected? Is your UCC-1 current, correctly naming the debtor? An unperfected lien is a general unsecured claim.
  4. Preserve § 503(b)(9). Identify every delivery of goods received by the debtor in the 20 days before filing, with proof of receipt.
  5. Consider reclamation within the statutory window, in writing, even if it may be subordinate.
  6. Decide whether to keep shipping. Postpetition sales are administrative expenses and are usually paid; continued shipment also builds subsequent-new-value defense against a later preference claim.
  7. Seek critical vendor treatment if you are genuinely irreplaceable, and be prepared to commit to customary terms in exchange.
  8. Calendar the bar date and file a proof of claim with supporting documentation.
  9. Evaluate committee service. The creditors' committee has real leverage, its professionals are paid by the estate, and members owe fiduciary duties to the class.
  10. Assess preference exposure now, and assemble the payment history that supports an ordinary course defense before a demand arrives two years later.

Frequently asked questions

Does Chapter 11 mean the company is going out of business? No. Chapter 7 is liquidation. Chapter 11 contemplates continued operation, though a substantial share of Chapter 11 cases end in a sale or a liquidating plan.

Can we terminate our contract because they filed? Almost certainly not. Ipso facto clauses are unenforceable under § 365(e)(1), and acting on one violates the stay.

They owe us for goods delivered last month. Are we paid? Possibly in part. Goods received by the debtor within 20 days before filing get administrative priority under § 503(b)(9). Older deliveries are general unsecured claims.

We were paid in full 60 days before the filing. Can they take it back? They can try, under § 547. Ordinary course and subsequent new value are the usual defenses, and the 2019 due diligence requirement discourages indiscriminate demands.

Can we set off what they owe us against what we owe them? Only with relief from the stay, and only for mutual prepetition obligations. Do not self-help.

Our lease has ten years left. What is our claim worth? Capped by § 502(b)(6), and payable in the same fractional currency as trade debt.

Should we buy their assets? A § 363 sale gives excellent title protection, but it is an auction — expect competition, and expect the process to be run to maximize price, not to reward the first mover.

How long does a Chapter 11 case take? Prepackaged cases can confirm in weeks. Sale cases often run three to six months. Contested reorganizations run a year or more. Subchapter V is designed to move faster than all of them.

What happens to equity? In most cases, nothing survives. The absolute priority rule bars distributions to equity unless senior classes are paid in full — subject to subchapter V's different treatment.

Conclusion

Chapter 11 does not suspend commercial reality; it reorders it. The company's obligations are sorted into a queue whose order was fixed by Congress, its burdensome commitments become discounted claims, and its assets become salable in a way they never were outside court.

For a creditor, almost everything that determines recovery is decided in the first month, before the plan is drafted and long before anyone votes. Whether you are perfected. Whether you can document deliveries in the 20-day window. Whether you keep shipping. Whether you appear at the first-day hearing when the DIP milestones — which will govern the entire case — are being set.

The parties that do badly in Chapter 11 are rarely the ones with weak claims. They are the ones who treated the filing as someone else's problem for the first six weeks, and then discovered that the rules had already been written.

A note on venue, professionals, and cost

Two practical realities shape every Chapter 11 case and rarely appear in the statute.

Venue. Section 1408 lets a debtor file where it is incorporated, which is why so many operating companies with no Delaware presence file in Delaware. For a creditor, this means the case may be administered a thousand miles from the business, on a docket with its own local rules, complex case procedures, and expectations about hearing practice. Retain counsel admitted there or prepared to associate promptly; a missed local-rule requirement is an expensive way to learn the difference.

Professional fees. Debtor's counsel, financial advisors, investment bankers, committee professionals, and often an examiner are all paid from the estate as administrative expenses, ahead of general unsecured creditors. In a mid-sized case, professional fees routinely consume seven figures. This is the arithmetic behind the standard advice to resolve distress out of court where possible: an out-of-court restructuring that achieves eighty percent of the same result at a tenth of the cost usually leaves creditors better off than a confirmed plan.

Conversion and dismissal. A case that cannot reorganize does not simply continue. Section 1112(b) permits conversion to Chapter 7 or dismissal for cause, including continuing loss to the estate with no reasonable likelihood of rehabilitation, gross mismanagement, failure to file required reports, or failure to pay quarterly United States Trustee fees. Creditors frustrated by a case that is burning value should understand that a motion to convert is available and is granted more often than they expect.

Related articles

This article is provided for general informational purposes and does not constitute legal advice. Bankruptcy practice is deadline-driven and varies by district and by judge, and eligibility thresholds change. Consult qualified bankruptcy counsel immediately upon learning that a counterparty has filed or is likely to file.