Corporate Bankruptcy: 7 Decisions the Board Makes Before Filing

Before a company is able to file for bankruptcy, someone - usually the company’s board of directors - has to make seven big decisions: who has the authority to file; whether the company should file at all; if so, when to file; what bankruptcy chapter to file under; whether to use the optional Subchapter V provisions; which state and court to file in and which lawyer to hire for the case; and how the company will handle cash, employee paychecks, corporate tax liabilities and payments to insiders and equity-holders during the case. This decision-making may be tense because bad choices can drain the company’s cash or get the bankruptcy thrown out altogether. Prepetition, filing is a business decision for the board. Postpetition, the bankruptcy court supervises company decisions and everything must be disclosed, so decisions like whether to continue to pay insiders must be carefully analyzed.

That decision belongs to the board in control of management. These powers are set out in the state corporation law or in the company’s charter documents. The shareholders cannot force a filing. If the filing is unauthorized, the bankruptcy court must dismiss it. Have ready the board resolution that authorized the petition, and proof that the person who signed the petition had the authority to do so.

There is no bright-line timing test for the right moment to file. Too early a filing makes unnecessary trouble for a business that might have negotiated a deal with its creditors. But filing too late can leave too little cash left for an orderly liquidation or reorganization. So, the company must make an effort to estimate its cash needs so that it can file at the right moment. Someone must learn the accounting system well enough to control the cash, and to predict whether the company can meet its new cash needs.

Chapter choice depends on the long-range goal. Chapter 7 is for windup. Chapter 11 is for sales and reorganizations. In both chapters, the petition stops many efforts to collect on the debt. Chapter 7’s goal is to sell the debtor’s assets and pay the creditors by priority. A trustee takes over, starts selling what it can. A corporation or partnership gets no discharge. This is usually the death of the company. Chapter 11 means to fix your cash flow by reorganizing your debts so you can keep running, without a trustee. In the usual case a company keeps running as the “debtor in possession” and files reports.

The debtor decides how to classify creditors. Once sorted, the plan proposes how to settle each claim or class. Every plan is different. You might have a chance to cut some unsecured debts or ask for more time to pay others. You might want to sell a division or bring in new financing. No creditors can file a plan for the first four months.

Can you file for Subchapter V? Total debts cannot be more than $3,424,000 on the filing date. Unlike a full-blown Chapter 11, only the debtor can propose a plan in Subchapter V. So that is always the debtor’s choice - when to propose a plan and what to put in it. Under Subchapter V, if you can get all the classed creditors to agree, a court can confirm the plan as a consensual plan. If the reorganizing company cannot persuade the creditors to consent to the plan, it must commit all projected disposable income for three years, or up to five, to pay plan creditors.

A company files in the place where its principal headquarters or assets have been for the 180 days before filing (or where there is a case pending for an affiliate). A corporation can only appear in court through a licensed lawyer. The filing fee for Chapter 11 is $1,167, plus an administrative fee. Whatever the board hopes to do, it needs a budget. Gather all bank statements, accounts receivable, balance sheets, cash-flow projections, creditor names and liens, leases, and all personal and corporate guarantees. You must list all the debtor’s assets for the court and for creditors. Get copies of leases, licenses, vendor contracts, lawsuits and judgments. These show up on the bankruptcy forms, so start early.

Federal law says any officer or board member who controls which bills get paid and directs that trust fund taxes not get paid can owe a 100% penalty. Trust fund taxes are the taxes that must be withheld from employees’ paychecks. If you have used corporate money to pay yourself back for any loan you made to the business, the trustee can recover your repayment if it happened within one year before the petition. The trustee can only recover if you were getting money back for a prepetition loan; if you were being paid as an insider; if the company was insolvent and if you were being paid an amount you would not get if the company was liquidated under Chapter 7. Any debtor must file all IRS returns for tax periods ending within four years before filing. You must reconcile any employment or sales tax matters before they get out of hand. So before the trouble starts, watch your payables. Keep a clear corporate ledger of cash.

The WARN Act’s goal is to give workers a heads-up for a mass layoff. In practice, that takes a plan. A covered employer has to give 60 days written notice of a closing or mass layoff. Check to see if any of the exceptions apply to the closing, like faltering business or unforeseeable business circumstances. Train managers how to answer questions, handle the shutdown announcement and address cash and payroll on the first day.

Debtor in Possession

The day after a bankruptcy filing, company executives still run the company, but now they must “protect and preserve” the company’s assets for the sake of the creditors. A debtor in possession must keep separate books for postpetition liabilities, create a designated bank account for these transactions, and prepare regular reports of receipts and disbursements for the court. Any deal outside the ordinary course must be approved by the court in advance. Companies in bankruptcy court worry about retaining the employees most responsible for the fate of the enterprise. Only if the insider has a competing job offer at equal or higher pay, if the services are essential to survival, and the payment does not exceed ten times the average similar payment to nonmanagement employees that year, can the bankruptcy court approve a retention payment.

Bankruptcy can preserve value, but only if chapter, timing and operating plan rest on reliable numbers. While numbers should not look worse than they are, they must support any plan to reorganize, sell or close. Setting out measurable conditions in advance, for reorganization or liquidation, needs real numbers, of monthly cash flow, customer payments and potential sales. You owe it to yourself to test your chance of reorganizing before your working capital runs out.