7 Code Sections in Chapter 11 Bankruptcy Laws That Protect an Operating Business

Seven sections of Chapter 11 protect a small business debtor in distress who will try to stay operating after filing. As a debtor in possession, a business borrower may maintain the protections afforded by the following provisions:

• § 362 the Automatic Stay;
• § 1107 Powers of Debtor in Possession;
• § 363 Use of Property and Cash Collateral;
• § 364 Obtaining Credit;
• § 365 Performance of Executory Contracts and Leases;
• § 366 Utility Service to a debtor;
• and § 1121, which creates the debtor’s exclusive right to file a plan.

The Automatic Stay

Your company is getting pummelled by creditors and competitors, deadlines and rulebooks. Simply filing will provide instant relief. Collection is stayed by Bankruptcy Code § 362(a) when a small business debtor files a voluntary petition for bankruptcy. This section of the U.S. Code stays, or holds back, a creditor from collecting debts incurred before the date of filing.

The automatic stay of creditor activity that follows the filing of the petition offers a debtor in a Chapter 11 case a precious chance to collect its thoughts and prepare for negotiations with creditors. § 362(b) lists some exceptions to what is stayed. The stay is not permanent. A secured creditor can ask the court to lift the stay if there is no equity and the property isn’t necessary for reorganization.

Debtor in Possession

Section 1107 of the Bankruptcy Code permits a business debtor to continue as a ’debtor-in-possession’ of assets, rather than have an independent trustee appointed to run the business of a debtor undergoing bankruptcy. Existing management oversees the operations of the business, generates revenue, and guards assets as a fiduciary. A small business debtor who remains in control of assets has duties under Chapter 11. It must be able to account for estate property, object to creditor claims that may be excessive, and file reports each month with the bankruptcy court to show if money is coming in and out. The U.S. trustee who follows a small business debtor through a case will also ensure that the debtor is compliant with provisions on business reporting.

A debtor in possession’s use of property in the ordinary course of business falls under § 363(c). A debtor in possession is able to pay expenses in the ordinary course of business. This provision is almost made for a small business operator. Small businesses generally go in and out of cash flow in the ordinary course of business, and they can continue to do so during the business reorganization. A debtor in possession who elects to sell in the ordinary course of business doesn’t have to ask the court for permission first, unless the court orders otherwise. If a sale falls outside the parameters of a normal course of business, prior approval must be sought from the court.

While a small business debtor has the power to use its assets when it’s in the ordinary course of business it’s very necessary to understand how cash collateral and business operating accounts differ from other assets. Use of cash collateral in reorganization means that permission from a lender with a lien or a bankruptcy judge is necessary. Until then, cash collateral, meaning accounts, rents, even cash from a sale, have to be segregated.

A debtor has to exercise special care if it intends to obtain credit during the case. When no lenders will help anymore, a business borrower who is operating during the reorganization process can seek financing under § 364 to keep the business moving along. A request for authority to get credit may be accompanied by a request to grant the lender a super-priority as against the claims of other unsecured creditors. This creditor would be near the front of the line for repayment.

Bankruptcy Code Section 365, Executory Contracts and Unexpired Leases, involves significant work for a small business debtor who relies on suppliers or has vendor agreements, service contracts, office leases. This effort requires the debtor to decide whether the unexpired lease, or other business arrangement is one that is burdensome or critical for the business debtor to hold on to. The debtor must declare whether it wants to assume or reject the executory contract or unexpired lease, subject to the court’s approval. It can reject the contract, and get out of it. This may happen when an ongoing contract is burdensome, expensive, or an unexpired lease is costly.

The other side cannot generally change or end the contract just because you filed bankruptcy or are insolvent. Exceptions include loan agreements. For a commercial tenant in a lease arrangement, you have up to 120 days to decide whether to reject or assume the lease, or by the date that the court confirms the plan, whichever is earlier. Failing that, it is deemed rejected, and you must leave the premises. You can request one extension of 90 days, but any request for more than that must be agreed to by the landlord in writing before it can be approved.

Your company also requires electricity, water, sewer, gas, or telephone to do business. Utility service to debtors in bankruptcy protection can’t be interrupted because of a pre-existing debt. Section 366 of the Bankruptcy Code protects a utility company’s customer who falls into arrears by providing for a 30-day grace period after filing in which the debtor must pay a reasonable deposit, or be subject to disconnection.

The Exclusive Right to File a Plan

Section 1121(b) of the Bankruptcy Code provides that in a Chapter 11 case, the debtor has the exclusive right to file a plan until 120 days after the date of the order for relief. However, this doesn’t prevent a Chapter 11 debtor from obtaining an extension of exclusivity, for as long as 18 months in total. This initial exclusivity period gives you an edge to come up with a plan that you then pitch to creditors in the hope that they will accept it. Only if the debtor fails to meet this deadline can a third party file a plan of its own. This party could be the creditors’ committee or a creditor. Subchapter V is a special Chapter 11 for small business debtors. One of its most important elements allows only the debtor to file a plan. A Subchapter V debtor in possession has 90 days from the order of relief to file a plan. This may be extended but only when the delay is beyond the debtor’s control.

A troubled but viable small business that needs some breathing room to negotiate a reorganization with creditors is well-served by many provisions of Chapter 11. These protections allow a debtor to maintain continuity in its business dealings, while pushing to resolve debt problems. Efforts to find a cost-effective solution to resolve your debt crisis can’t be put on hold forever.