Individual Reorganization Bankruptcies: Chapter 13 and Chapter 11

• Author: By Nicole S. Zellweger and Rakhee V. Patel
• Pages: 233-266

233

Chapter 13 of the Bankruptcy Code1 allows individuals with regular

income who meet certain criteria to create and propose a plan to repay

all or part of their debts in installments over a specic period of time

(no more than ve years) and to retain some or all of their property.

Chapter 11 of the Bankruptcy Code also allows individuals to create and

propose a plan to reorganize their debts. However, there are key differ-

ences between these bankruptcy chapters, including the ability to retain

property when creditors are not paid in full, which will be explored in

further detail in this chapter.

The individual debtor’s objective in a Chapter 13 proceeding is to

obtain court approval—called conrmation—of a plan that provides for

the repayment of as little debt as possible to creditors such that, at the

end of the process, the debtor has retained as much property as pos-

sible with relatively little remaining debt. If the plan is conrmed and ful-

lled, the debtor will obtain a discharge of all eligible debts. By contrast,

a creditor will certainly seek to minimize its losses by obtaining repay-

ment of as much of the outstanding debt owed as possible. In a Chapter

11 proceeding, the desire to obtain conrmation of a plan that repays as

little debt as possible to creditors remains; however, the requirements

for conrmation in a Chapter 11 individual bankruptcy prohibit the

result of repaying little to no debt in exchange for retaining some or all

of the debtor’s property coupled with a bankruptcy discharge of debts

at the conclusion of the bankruptcy.

Chapter 11 and Chapter 13 bankruptcy protection is much differ-

ent from Chapter 7, which involves liquidation by the trustee of the

debtor’s assets and possible distribution to the creditors in a congres-

sionally mandated priority scheme in exchange for a discharge of all

debts incurred prior to the bankruptcy ling.

1. 11 U.S.C. §§ 101 et seq.

IndIvIdual ReoRganIzatIon BankRuptcIes:

chapteR 13 and chapteR 11

By Nicole S. Zellweger and Rakhee V. Patel

11

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234 Chapter 11

Focusing on the franchise context, a nancially distressed individual who is

the named franchisee under a franchise agreement (or who executed the agree-

ment using an unincorporated business name) may be a candidate to le Chap-

ter 13 bankruptcy protection if he or she meets the criteria discussed below, or

to le Chapter 11 if Chapter 13 is an unavailable remedy. Similarly, a nancially

distressed franchisee owner who personally guaranteed a registered company

franchisee’s obligations under a franchise agreement may also qualify under

either Chapter 11 or Chapter 13.

If an individual (or unincorporated company) franchisee has led for bank-

ruptcy under Chapter 11 or Chapter 13, there are several things that the franchi-

sor should quickly assess. Initially, the franchisor should review the bankruptcy

court lings, including the schedules and statement of nancial affairs. The fran-

chisor, or its counsel, should compare the franchisor’s calculation of the debt

owed to the franchisor (unpaid royalty and advertising fees, etc.) to what the

individual franchisee has included in his or her pleadings about that existing

debt and, perhaps more importantly, should review what the franchisee debtor

proposes to do with respect to future performance under the franchise agree-

ment. The franchisor can then determine a cost effective strategy to protect its

interests, including whether it should le a proof of claim, address the assump-

tion or rejection of the contractual agreement(s) between the franchisor and

the debtor, challenge the dischargeability of debts, and/or object to conrma-

tion of the plan.

Even if the franchisee is an incorporated entity and has not led bankruptcy

with the individual debtor, who presumably signed a personal guaranty (likely

for every contract related to the franchised business, including the franchise

agreement, the lease, and bank loans), the franchisor should consider monitor-

ing the individual debtor’s case in order to determine the impact of the plan on

obligations owed under the guaranty or franchise agreement.

I. THE PARTIES

A. DEBTOR

An individual initiates a Chapter 11 or Chapter 13 by ling a voluntary petition

with a bankruptcy court of competent jurisdiction. In Chapter 13, the individual

debtor is one with a regular income—a corporation, limited liability company,

or partnership may not le under this Chapter.2 Chapter 13 is, from time to time,

referred to colloquially as the “wage earner plan.” Nevertheless, individuals

who are self-employed and/or who run sole proprietorships or unincorporated

businesses may le under this chapter provided that they meet express criteria

2. 11 U.S.C. § 109(e).

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IndIvIdual reorganIzatIon BankruptCIes: Chapter 13 and Chapter 11 235

in the Bankruptcy Code.3 Any individual is eligible to le for Chapter 13 bank-

ruptcy relief as long as the individual’s unsecured and secured debts are less

than specically identied amounts. In 2017, noncontingent, liquidated unse-

cured debt had to be less than $394,725 and noncontingent, liquidated secured

debts had to be less than $1,184,200, for the individual to qualify.4

By contrast, there are no strict eligibility requirements for Chapter 11 indi-

vidual debtors. The typical Chapter 11 individual debtor is: (1) a high income

or high net worth individual; (2) ineligible for Chapter 13 due to the debt limita-

tions proscribed by statute; and/or (3) ineligible for Chapter 7.5

The typical individual debtor will elect either Chapter 13 or Chapter 7, if

either form of relief is available to the individual debtor, due in large part to the

additional administrative burden imposed on debtors ling under Chapter 11,

the requirement of payment in full of all creditors before the debtor can retain

property, and the cost and expense of a Chapter 11 case. There are reasons,

however, why a debtor might elect Chapter 11 over Chapter 13, including, for

instance, the ability to repay mortgage arrears over a longer period of time or a

recent discharge in another Chapter 13 or a Chapter 7 case, but they are gener-

ally of no import to a franchisor.

Additionally, irrespective of whether an individual les for Chapter 11 or

Chapter 13 bankruptcy, an individual is ineligible to be a debtor if they led for

bankruptcy under any chapter during the 180 days preceding the ling and that

prior bankruptcy was dismissed by the court for willful failure of the debtor to

abide by an order of the court, for a want of prosecution of the bankruptcy case,

or the debtor voluntarily dismissed the bankruptcy case following the ling of a

motion for relief from the automatic stay.6 Furthermore, under both bankruptcy

chapters, the individual debtor must have obtained credit counseling within 180

days before ling, unless the individual debtor qualies for an exception to the

requirement.7

In the franchise context, a debtor under Chapter 11 or Chapter 13 typically

is the owner of the franchisee entity who guaranteed the debt of the franchi-

see. Although not as common, the debtor may be the actual franchisee if the

3. See discussion below regarding self-employed debtors in Chapter 13.

4. 11 U.S.C. § 109(e). Pursuant to section 104(a), the section 109(e) eligibility amounts are

adjusted every three years with reference to the Consumer Price Index for All Urban Consumers,

published by the Department of Labor, with the last such adjustment on April 1, 2016.

5. In order to qualify to le under Chapter 7, an individual must have an income that is less than the

median income for a household of the same size in that individual’s state. This is known as the Chapter 7

“means test.” The “means test” is a formula that was designed to limit the use of Chapter 7 bank-

ruptcy to those who cannot pay their debts. Generally speaking, the formula requires a debtor to

deduct specic monthly expenses from his or her “current monthly income” (average income over

the six calendar months before the debtor led for bankruptcy) to arrive at a monthly “disposable

income.” The higher the disposable income, the more likely a debtor will not be allowed to proceed

in Chapter 7 bankruptcy because that disposable income could be used to repay creditors.

6. 11 U.S.C. § 109(g).

7. 11 U.S.C. § 109(h).

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