Whether you are a sole proprietor struggling with business in your own name, or the owner of a partnership, corporation or LLC with debt that may have been personally guaranteed, bankruptcy can help get a business back on its feet, buy time to complete a sale of assets or the company itself, or give a fresh start to the company’s owners. Although sole proprietors can still use Chapter 13 bankruptcy as other consumers, business entities such as corporations and LLCs are not eligible, and can only reorganize in Chapter 11. However, Chapter 11 has many advantages in that it allows the company (or owners) to stay in business, stay in possession of their assets, and direct the execution of their own plan. These advantages often make it advantageous for individual debtors to choose Chapter 11 over Chapter 13.
The automatic stay, just as in a consumer case, is a court order which automatically takes effect when a new bankruptcy case is filed, and prevents collection activities such as foreclosures, evictions, and lawsuits. For a business, bankruptcy can buy the crucial opportunity to reorganize these debts and present a plan that will pay key creditors while discharging others.
Chapter 11 vs. Chapter 7
Chapter 7 is only useful for a business entity in a very limited set of circumstances, because businesses cannot receive a discharge in Chapter 7, and there are no exemptions to allow the business entity or owners to retain any property from the business. However, corporations and LLCs can receive a discharge in a Chapter 11 reorganization, and this allows them to continue in business after the plan of reorganization has been confirmed. As long as the Chapter 11 plan pays creditors at least as much as they would receive if the business were liquidated, the company can retain assets and continue to operate the execute the plan.
The Chapter 11 Process
A debtor in Chapter 11 must disclose all debts and creditors, and unlike in other chapters of bankruptcy, this list of creditors becomes binding on the debtor. Unless the claim is listed as “disputed” or in an unknown amount, the Court will presume this list is accurate and creditors need only file a proof of claim if they believe the scheduled claim to be incorrect.
If they Chapter 11 debtor wishes to present a plan of reorganization, they must first (or in some cases simultaneously) present a Disclosure Statement, which can be viewed as a type of voter’s guide to the Plan. It must contain adequate information for creditors to make an informed decision about whether to support the plan.
Unlike in Chapter 13, in Chapter 11, in order for most plans to be confirmed, at least one class of creditors must vote in favor of the plan. Negotiations are often lengthy in order to find a plan that will please at least one creditor while still being feasible for the debtor.
Also, shareholders or owners of a business entity may be required to contribute money or assets to the plan in order to retain ownership of the reorganized company. This is because owners are the lowest priority of creditors in bankruptcy, so they can only keep their interest (without additional contribution) if everyone of higher priority gets paid in full. This is known as the Absolute Priority Rule.
The Trustee
Unlike other chapters, in Chapter 11, a trustee is not appointed to administer the case (unless requested to do so by one of the parties involved and the Courts sees cause to do so). Rather, the Debtor, with the assistance of their attorney(s), serve in the role as the Debtor-in-Possession, with many of the obligations and powers of a trustee. The Office of the United States Trustee serves a supervisory role, essentially policing bankruptcy cases to ensure compliance with three things: reporting obligations, maintenance of insurance, and payment of quarterly fees to the Unites States Trustee. In addition, the US Trustee will monitor a case for fraud and other issues, and will make sure debtors are promptly presenting plans and are not “parked” in Chapter 11 with no progress for an extended period of time.
The Chapter 11 Plan
A Chapter 11 Plan can do many things – sell or surrender to creditors unwanted or unneeded assets, allow for a refinance, and reclassify debt from secured to unsecured based on the value of collateral. For instance, if a debtor has a rental property valued at $200,000.00, but the total debt owing to the mortgage creditor is $300,000.00, then $100,000 of that debt will be classified as an unsecured claim and will be paid whatever percentage the class of unsecured claims is receiving. The secured amounts must be paid in full, but can be on terms other than those in the original loan, possibly at a lower interest rate and amortized over a longer period of time.
A Plan must pay creditors at least as much as they would get in a Chapter 7 liquidation, but can do so over an extended period of time. This can allow for a limited liquidation on the Debtor’s terms, so the Debtor, and not a trustee, is choosing what to sell to pay creditors. Business entities can receive a discharge of their unsecured debt upon confirmation of their Chapter 11 Plan or shortly thereafter, while individual Chapter 11 Debtors may be required to make payments to their unsecured creditors to 5 years before they are eligible for discharge.
Leases and Contracts for Services
Leases and other contracts can be rejected or sold in bankruptcy. This can become a powerful bargaining tool and can enable businesses to downsize while not being stuck with the obligation of a lease for years to come. It can also make a lease assignable when it would not otherwise be the case, allowing the Debtor to possibly sell an attractive lease as a way to pay other creditors.