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Filing for bankruptcy is a difficult decision to make in any circumstance. When the bankruptcy filing is for a business the process can be even more challenging. Fortunately, the federal bankruptcy code doesn’t just set out options for individuals struggling with debt, it also sets out a procedure for struggling businesses to repay their debts. 

Business owners can get a second chance to get current with their debts by filing for Chapter 11 bankruptcy. Chapter 11 bankruptcy has many similarities and several key differences when compared with filing for Chapter 7 or Chapter 13. These differences should be reviewed in detail before making a decision to file.

Chapter 11 bankruptcy has several advantages for a business owner when compared to the more severe options of closing the business or liquidating its assets. Read on to find out more about who qualifies for Chapter 11 bankruptcy, the procedure itself and some important factors that may determine whether the proceeding will ultimately be successful.

What is Chapter 11 Bankruptcy?

Chapter 11 bankruptcy is typically referred to as a “reorganization” bankruptcy because it provides the business owner an opportunity to propose a plan that will allow the business to continue running while paying back a portion of its debts to creditors over a set period of time, essentially “reorganizing” the business’ debt obligations. 

Just like in Chapter 13, a Chapter 11 bankruptcy is meant to allow the filing party to maintain control of property and business assets, while reorganizing their debt obligations in a manner that will allow for consistent and timely payments. Filing for Chapter 11 also initiates the automatic stay, halting all collection attempts until a repayment plan can be developed and confirmed.

There have been several high-profile Chapter 11 bankruptcies over the years by companies like General Motors and Marvel Entertainment. While it’s encouraging to see businesses that are up and running at full speed after filing for Chapter 11, it’s important to note that these proceedings can be expensive, time-consuming, and without proper planning will usually not end successfully. 

Business owners thinking of filing for Chapter 11 should seriously consider sitting down with an experienced bankruptcy attorney before they file to discuss their likelihood of successfully developing and completing a plan to repay their creditors.

Eligibility and Requirements

Chapter 11 bankruptcies are typically filed by business owners, referred to during the proceeding as the “debtor in possession,” as they are still in possession of the business at the time of filing and throughout the proceeding. In some circumstances, it’s also possible that a business’s creditors will file the initial bankruptcy petition when it is evident to them that the business can no longer sustain its debts. 

Individuals can also file for personal bankruptcy through Chapter 11, although given the costs and lengthy procedure, it’s usually better for individuals to go through Chapter 13. However, a person whose debt exceeds the maximums allowed in a Chapter 13 proceeding may file under Chapter 11. Whether it’s an individual or a business, there are several requirements to filing that must be met:

1. Fees: Currently the cost of filing for Chapter 11 is $1,717: $1,167 filing fee + $550 miscellaneous administration fee. In some instances, these fees can be paid in installments, with the last installment being paid no later than 120 days after filing the petition.
2. Credit Counseling: As with filing for Chapter 7 or 13, anyone, whether an individual or a debtor in possession of a business, will still be required to attend an approved credit counseling program within 180 days prior to filing for bankruptcy, and attach any repayment plan developed during the counseling to their petition.
3. Disclosure Statement: Much like an individual laying out their personal finances in Chapter 7 or 13 proceedings, the debtor in possession of a business will need to file a disclosure statement with the court at the time of filing that lays out all of a business’s assets, liabilities and affairs generally to an extent sufficient to allow the business’s creditors to make an informed decision about the debtor’s reorganization plan.
4. The Plan: A debtor in possession will need to either layout their proposed plan for repayment of debts, or state an intention to file this plan in accordance with the timing rules laid out in Chapter 11 of the bankruptcy code.

Failure to accurately and promptly meet all prerequisites to filing will result in delays or dismissal of the bankruptcy proceeding. It’s best to consult with an attorney before filing the petition to ensure that everything has been prepared in a way that will result in a smooth and successful proceeding.

The Disclosure Statement

One of the most common ways a Chapter 11 bankruptcy gets delayed or dismissed is through filing an inaccurate or insufficient disclosure statement at the outset of the proceeding. This statement is the primary way that creditors will be able to judge a business’s financial strength, and to determine whether a proposed plan is feasible to the extent that it will be followed to its completion without any missed payments.

For these reasons the disclosure statement requires that a great deal of information about a business be compiled and presented, including:

• Description of the business: including date of formation, names of principals and their respective ownership percentages, a full description of the nature of the business, its market and clients before filing, as well as expectations for the business after the petition is filed.
• Financials: including the value and description of all assets, three years of historical financial statements, and projected financial statements for at least the next five years or through the length of the proposed plan. This disclosure will also require information about the accounting process used in making these statements and the bases for the valuation of all assets. In addition to this, the debtor in possession will need to provide information related to business finances:
  • An analysis of the effects of liquidating the business
  • A statement regarding any insider transactions
  • A disclosure of any professional fees that have been recently paid or are contemplated for the future
  • A description of any pending litigation
  • The tax consequences of the proposed plan
• The repayment plan: the debtor’s proposed plan to repay their debts, or a statement of intention to present such a plan within the allowed timeframe.

Under certain circumstances, a debtor may be classified as a “small business debtor,” where their total secured and unsecured debts is less than $2,566,050, and they meet other requirements laid out by the code. 

Small business debtors may be required to submit a less involved disclosure statement, but they are subject to more oversight than regular Chapter 11 cases. An experienced attorney will be able to determine whether a debtor should file as a small business or not, and will review the disclosure statement before filing to make certain that it is accurate and sufficient.

Creating the Chapter 11 Plan

Much like in a Chapter 13 bankruptcy, anyone filing for Chapter 11 will need to propose a plan for repayment of some or all of their (or the business’s) debt. The debtor will have the exclusive right to propose a plan for the first 120 days after the filing of the petition, with the possibility of a 60-day extension if granted by the courts.

It’s important that the debtor put together a viable plan during this time period, as afterward the creditors will be able to propose their own plan, which typically involves a liquidation of assets to repay them in full. The plan will need to separate creditors into different classes and lay out how much each creditor will be repaid and how long it will take to complete repayment. The different classes of creditor are:

• Secured creditors: those holding a secured loan, which is a loan attached to some valuable piece of collateral.
• Priority unsecured creditors: these unsecured creditors are given an elevated status by law due to the nature of their debt, with some examples including domestic support obligations and certain income tax debts.
• Other unsecured creditors: these include debts like credit card charges, vendor bills and bondholders of the company.
• Equity holders: this includes stockholders or in the case of a partnership, the partners.

The above classes of creditors will be repaid with available funds in order of priority from secured creditors down to equity holders, who as “owners” of the company are the last to receive anything in a bankruptcy proceeding.

Confirmation of the Chapter 11 Plan

Before a Chapter 11 plan can go forward, it will need to be confirmed by the bankruptcy court. Plans that get confirmed will meet the following conditions:

1. The plan is feasible: first and foremost, a plan must lay out how will repay creditors in a way that aligns with the business’s financials and future prospects. If a plan is proposed that will require payments that appear to be too high to actually be achieved on a monthly basis, it will not be confirmed. 
2. Proposed in good faith: the plan will need to be proposed on good faith, meaning that its success cannot rely on anything that would be considered illegal such as fraud.
3. In accordance with the bankruptcy code: As mentioned above the code requires that creditors be classified and specific classes must receive payment in a certain order or amount:
   • Secured creditors: must receive at least the value of the collateral attached to the loan over the course of the plan
   • Equity holders: cannot receive anything unless all other classes of creditors receive payment in full.

Lastly, the plan must pass the “best interests” test. As its name implies, the plan will need to demonstrate that it, rather than a Chapter 7 liquidation, is in the best interests of the associated creditors. Meeting the requirements of this test is fairly straightforward: the plan must show that all creditors receive at least as much as they would have in a Chapter 7 proceeding.

In essence, the plan will need to show that staying in business and continuing to receive profits will provide the creditors with a better overall outcome than immediately closing the business and selling all of its assets, as would be the case in a Chapter 7 bankruptcy proceeding. 

To this point, the plan will need to be approved by at least one class of “impaired creditors,” or those creditors that will receive less than the full amount they are owed should the plan be confirmed. Creating a convincing and feasible repayment plan requires extensive knowledge of the bankruptcy rules as well as a business’s financials, and as such is best developed together by a business owner and their attorney.

Operating Under the Plan

Once the plan is confirmed, the debtor in possession will be allowed to continue operations of the business while following the plan and making timely payments to creditors. This differs from other bankruptcy proceedings where a “case trustee” is appointed to administer the process and collect and distribute all payments to creditors. If the debtor mismanages the business or fails to adequately follow the plan, a case trustee may still be appointed by the courts to take over the proceeding.

While the debtor is permitted to continue normal business operations throughout the course of the repayment plan, certain business decisions will need to be approved by the bankruptcy court before moving forward, including:

• Any sale of business assets
• Closing or expanding of business operations
• Entering into or modifying contracts with vendors or for the lease or purchase of real estate
• Hiring professionals like lawyers or accountants

These decisions can have major effects on the finances of the business, and hence its ability to follow the plan and make timely payments to creditors. Therefore it makes sense that the bankruptcy court will want to maintain oversight over such actions. 

In addition, creditors will be able to provide their input as to whether any proposed business decision should be approved or denied, so business owners should consult with their attorney while developing the plan to determine what sorts of decisions they may encounter in the future and their likelihood of approval once the bankruptcy proceeding has begun.

Other requirements of the debtor in possession while operating a business in a Chapter 11 bankruptcy proceeding include timely reports on the ongoing progress of the plan and applying for a final decree once the plan has come to completion. Any failure on the debtor’s part to follow the plan and provide these reports could result in a case trustee being appointed to take over these duties.

Other Considerations

Debtors in possession have many responsibilities in a Chapter 11 bankruptcy proceeding, and failing in any of them may result in a dismissal of the case or conversion to Chapter 7, where the business will be closed and its assets sold off to repay creditors. It’s also possible that certain creditors will object to elements of the plan or to operations of the business while operating under the plan. 

On top of all of this, a debtor in possession may be required to initiate a lawsuit during the bankruptcy, referred to as an “adversary proceeding.” These lawsuits can be filed for a number of reasons, including avoidance of liens, actions to avoid preferential or fraudulent transfers of business assets or actions to avoid transfers made after the petition has been filed.

Filing for Chapter 11 bankruptcy is a complex, lengthy, and often expensive endeavor. The best way to ensure that the proceeding goes forward smoothly and without issues like creditor objections or adversary proceedings is to consult with an experienced bankruptcy attorney before filing the petition.  

Qualified attorneys will be able to work alongside the business owner to compile accurate and complete information for the disclosure statement, and to use this information in developing a repayment plan that will be confirmed by the court. At Rosenblum Law our attorneys are ready to help, call us today.

Frequently Asked Questions

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