8 Questions Business Owners Ask First: A Chapter 11 Bankruptcy FAQ

Chapter 11, or reorganizing the business in bankruptcy, can be used to help a company save a struggling business and allow the company to keep its doors open and operating. While a Chapter 11 bankruptcy filing provides powerful tools, including the ability to renegotiate loans and leases, it is not a cure-all and can have significant costs, financial and otherwise, for you personally. The key is to identify your underlying financial problems and make a realistic assessment of the future of your company.

When a company experiences a financial downturn, the first step is to figure out what caused the downturn. Was it a one-time problem, such as the loss of a large customer? Or does your company simply not make enough revenue, given its fixed costs? Reorganizing a business through bankruptcy costs money. You still have all the same expenses, but now you have additional legal and accounting costs to pay. Further, bankruptcy does not suddenly make your business profitable. It can reduce the obligations that your business must meet to keep operating, but it cannot force your business to be profitable. If your business cannot be profitable in the future, bankruptcy is not the solution.

If you do file, you as the owner, along with your chosen managers, are still in charge of operating the business. The company is called the “Debtor-in-Possession” or “DIP” for short. At the same time, bankruptcy will impose some limitations on your business operations. Company financial and operational decisions that could have a significant financial impact must be disclosed and in some cases approved by the bankruptcy court.

Any bankruptcy filing creates what is called the “automatic stay.” The automatic stay prevents most creditors from continuing to attempt to collect money from your company. This can be a useful tool for preserving your business, particularly if your business is threatened with immediate shut down because of one or a few debts. However, in some instances, the creditors may file a motion to lift the automatic stay.

If your company has debts that you guaranteed, you will generally still be personally liable, even if your company reorganizes through bankruptcy. If you signed on as a co-signer or guarantor of a loan, that obligation stays in place. During a bankruptcy case, the automatic stay ordinarily protects only the filing company and not its owners who signed guarantees on the company’s debts. Exceptions to that rule can apply in limited circumstances, one of which is the “co-debtor stay” available in Chapter 13 cases for consumer debts, but not for business debts.

In general, the law considers corporations and LLCs to be separate legal persons. That separation can shield their owners from business debts that they did not personally guarantee. If all you did was own the business, then you are generally protected. There are some exceptions, of course. An owner’s own legal wrongdoing can sometimes lead to claims against the owner. And, some states let creditors try to pierce the veil between owner and company. Sole proprietorship cases have the simplest structure, since sole proprietors have no separate company to file. Whatever the sole proprietor personally owns and owes is generally included in the bankruptcy case. But a business organized as a separate legal entity, such as an LLC, can generally file without its owners needing to file.

Chapter 11 has a special version that can make it easier, faster, and cheaper, for smaller businesses to file. However, it has some limits. Not all companies qualify. Only businesses that have no more than $3,424,000 in debts are eligible to file under the new Subchapter V of the Bankruptcy Code. The $3,424,000 limit counts only debts that are liquidated and non-contingent, and excludes debts that the company owes to affiliates or insiders. In addition, at least half of the company’s debts must have come from the business’s activities. Even if your company is too large for Subchapter V, that doesn’t mean your company can’t reorganize. The traditional version of Chapter 11 may still be available.

Bankruptcy is a federal proceeding, and the bankruptcy court charges fees for filing. In a business Chapter 11, those filing fees and costs amount to $1,738. Your lawyers and accountants will have their own fees and costs, which they can discuss with you. The company pays ongoing fees in the case too. These are federal charges that are collected for the U.S. Trustee’s office. These fees apply only to regular Chapter 11 cases, and not to Subchapter V cases. The quarterly fees are based on the amount of money that the company pays out, and can reach $30,000.

Chapter 11 requires a court-approved plan, which describes how you intend to save the company. The plan divides your creditors into different classes and explains to each class how it will be repaid. In a regular Chapter 11 case, the debtor can be the only entity that files a plan for the first 120 days after the case starts. That time can be extended up to a maximum of 18 months. A class of creditors accepts the plan if at least two-thirds of the amount of the votes and more than half of the creditors in the class vote to approve.

The rules are stricter in Subchapter V. In Subchapter V cases, the court holds a status conference with the company and its creditors within 60 days after the case is filed. Only the debtor may file a plan and it must do so within 90 days after the case starts. That deadline can be extended only for reasons not attributable to the debtor’s actions. The requirements to confirm a plan are strict. The plan can be confirmed over the objection of a class only if it meets the fairness and equity test, and commits all the business’s projected disposable income to plan payments over 3 years (or sometimes longer). If that test is not met, the court can convert the case to Chapter 7 or dismiss the case.

Paying money to your creditors just before the bankruptcy filing can create problems. If your company has paid certain creditors money in the 90 days before the bankruptcy filing, those payments can sometimes be reclaimed by the bankruptcy court. Payments made by the business to insiders shortly before filing are particularly suspect. The law can go back up to a year to capture such payments. There are defenses against clawbacks that can be used, such as proving that the payments were in the ordinary course of business. If the court finds out about a sale or transfer for too little value, or a transfer made with the intent to keep the assets from being repaid to creditors, that transfer can be reversed.

Before filing, you should identify what needs to be gathered and analyzed. Gather your current and recent financial statements, a cash-flow projection, lists of debts, loan papers and guarantees, lawsuits, asset records, and copies of key contracts. You will want to keep careful records of what happens with company money in the months and weeks before filing bankruptcy. Finally, before taking actions to sell assets or repay obligations to yourself, you should have an attorney review that transfer.