Making Sense of Bankruptcy: Can Filing a Chapter 11 Reorganization Save Your Business?

Wasson and ThornhillBusiness Bankruptcy

Chapter 11 is a powerful way to address a business debt crisis, but because of its detriments must be used extremely selectively.

 

Here’s the sentence that we’re explaining today:

Chapter 11—unlike Chapter 7 and 13—is primarily designed for businesses, almost any business can file one, it can protect the business from its creditors and reduce its debt burden, but because of its expense and other detriments Chapter 11 is only appropriate in select situations.

Chapter 11 Reorganization

Chapter 11 is the business “reorganization” option in the Bankruptcy Code. A business can use it to restructure its finances through a detailed plan of reorganization proposed by the business, voted on by its creditors, and approved by the bankruptcy court.  The Chapter 11 plan usually reduces the business’ debt burden, eases debt payment terms, and often buys time to allow for the orderly sale of certain business assets.  The goal is to enable the business to balance its income and expenses, return to profitability by re-focusing on its strengths, and continue its operation in a sustainable way.

Although you tend to hear about Chapter 11 when it is used by large corporations, most Chapter 11s are filed by much smaller businesses. It has special provisions for “small business debtors” intended to streamline the process and keep down its costs.

Eligibility for Chapter 11

Virtually all legal forms of business can file a Chapter 11 case, including corporations, partnerships, and limited liability companies. Individuals can also file under Chapter 11, to address both business and personal debts.

Chapter 11 is much broader in eligibility than Chapter 13 “adjustment of debts,” which can only be filed by individuals and not by corporations or other business entities. Also unlike Chapter 13, there are no debt or income requirements or limitations in Chapter 11.

If your business is a sole proprietorship—you operate the business under your own name or an assumed business name but not through a corporation or other legally established legal entity—then you are the direct owner of your business and all of its assets, and you directly owe the debts of your business. So you can file a single Chapter 11 case to address the debts of both your business and personal debts. Your sole proprietorship is not its own legal person so cannot file a Chapter 11 case without you.

However, if your business is established as a corporation or other legal entity, it can file its own Chapter 11 case. If so, you may need to deal with your personal debts through a personal bankruptcy (Chapter 7, 11, or 13) since the business’ Chapter 11 case will not do so.

The Benefits of Chapter 11

The main purpose of this legal option is to preserve a business which would otherwise not be able survive.  

Practically speaking, a Chapter 11 case is usually filed to get protection from some immediate threat to the viability of the business. Generally a major creditor has disrupted or is about to seriously disrupt or even destroy the operation of the business with some aggressive action to collect a debt or take possession of collateral. For example, a business landlord is about to terminate the premises lease, a lender is repossessing some key business equipment, or the IRS is garnishing incoming receivables.

Chapter 11 puts an immediate halt to all creditor collections, giving you time to put forward a plan to shrink the business’ monthly and overall debt payout and streamline the operations of the business to make it viable going forward.

Detriments of Chapter 11 Reorganization

Chapter 11 provides strong medicine, but comes with significant has serious side effects. It is very expensive, in both up-front costs for the filing fee and attorney fees as well as monthly fees. It requires a fair amount of time and attention of the business owner/manager and/or staff. It can be very tough on the reputation of the business, both as to ongoing and future suppliers as well as ongoing and future customers. Chapter 11 is almost always a solution of last resort, although one that should not be delayed beyond the point where it can no longer help.

In general your business may be a sensible candidate for Chapter 11 if it has a core operation that would be preserved and strengthened if the business were given a break from creditors’ collection actions. The business must have some strengths around which it can be reorganized. It usually has tangible or intangible assets of significant value that would be lost to collectors without bankruptcy intervention, and that value needs to be preserved for the immediate and long-term benefit of the business and its creditors.