No business ever plans for or seeks to file for bankruptcy protection. Yet, no business planned for the struggles COVID-19 brought to countless industries, markets, and services. Now, with COVID-related restrictions mostly in the rearview mirror, business leaders face new challenges such as inflationary pressures, increased payroll expenses, rising materials costs, interest rate hikes, and COVID-related debt. Depending on your business’s financial situation, restructuring under Chapter 11 may be an option, but it's important to first understand what Chapter 11 bankruptcy is, and what it means for your business and you personally.
Just as there are varying sizes of businesses, there are different "versions" of Chapter 11. This article will walk you through the basics of what Chapter 11 bankruptcy is, with a focus on how it works for small and medium sized businesses.
What is Chapter 11 Bankruptcy?
Chapter 11 bankruptcy is a type of business bankruptcy that allows businesses to reorganize their debts while continuing to operate. Also known as the "reorganization bankruptcy", Chapter 11 is different from Chapter 7 bankruptcy. Chapter 7 bankruptcy, known as the "liquidation" bankruptcy, forces businesses to sell assets to pay creditors and close the business. Chapter 11, on the other hand, stops creditors from seizing or liquidating assets, giving the business time and the power to renegotiate payment amounts and terms all while the business stays open.
While bankruptcy is typically a business' last resort, if your business is struggling to make payroll, or is being pursued by adversarial creditors, Chapter 11 bankruptcy can provide the space and time you need to determine how best to reorganize and repay your debt. A traditional Chapter 11 can be used by all types and sizes of businesses and has no debt limit.
For smaller businesses with under $7 million in non-contingent debt, there is a new, streamlined and affordable type of Chapter 11 bankruptcy called Subchapter 5. Developed specifically for small businesses, Subchapter 5 is a fast, affordable option that can help small businesses restructure, wipe out, or reorganize debt, while saving the owners' equity and from filing personal bankruptcy.
How Does Chapter 11, Subchapter 5, Bankruptcy Work?
A Chapter 11 bankruptcy for small and medium businesses (Subchapter 5) starts when your business bankruptcy attorney files a bankruptcy petition. This puts your bankruptcy into motion, kicking off the following order of events:
- Automatic Stay. Once the business files for bankruptcy protection, all collection processes come to a halt. The automatic stay will temporarily stop payment requests, any eviction or foreclosure, or bank levies (see more information on What Do I Do When My Bank Account is Frozen?)
- You retain business control. Unlike other types of bankruptcy where a controlling trustee is put in charge to make decisions for your business, in a Chapter 11, Subchapter 5 bankruptcy, a trustee is only made available to monitor progress, make recommendations, and assist you and your attorney. You are still in control of all business operations.
- You and your attorney develop a reorganization plan. The goal of a Chapter 11 bankruptcy is to reorganize business debt so that your business can become profitable again. To do so, it is your responsibility — with the help of your business bankruptcy attorney — to develop a reorganization plan that outlines how you will pay back, modify, or eliminate the business’s debt. Your reorganization plan could include:
- Modifying interest
- Modifying payment due dates
- Eliminating debt
- Downsizing plans
- Reorganization plan. Once your business reorganization plan is submitted, your creditors are provided an opportunity to vote and approve it. In the event a majority fails to vote for the plan, the court can approve the plan anyway (sometimes known as a "cram down"). If you can show how your plan is better than liquidating the business, the court will approve your plan regardless of the outcome of the voting.
- Discharge of debt. Debts that are unaffordable or will prevent the business from returning to profitability will be scheduled for discharge or discharged immediately.
- Your business begins making payments in accordance with the approved plan. A short time after the business’s reorganization plan is approved, it is responsible for making the payments outlined in that plan. This will continue until your reorganization plan is complete.
Though a Chapter 11 bankruptcy is much more involved than other bankruptcy chapters, it is one of the few options that allows you to retain control of your business and business operations.
In What Situations is Chapter 11 Bankruptcy Used?
While it's always best to speak to an attorney before deciding whether to declare bankruptcy and what type of bankruptcy is best for your situation, it can be helpful to know in what situations Chapter 11 bankruptcy is most often used.
In general, a Chapter 11 bankruptcy is used to help businesses that are highly motivated to continue operating. Common signs that a business may benefit by leveraging bankruptcy may include:
- The business is generating income, but lacks enough funds to meet payroll
- Overdue payments and the business is unable to catch-up
- The business will soon be unable to afford required and scheduled debt payments
- Creditors are freezing or threatening to seize business assets
Chapter 11 bankruptcy can help reduce or eliminate both secured and unsecured debt, and simultaneously provide financial breathing room to prioritize negotiations with critical vendors or creditors. If bankruptcy is the right solution for your business, a Chapter 11 bankruptcy can take back control of frozen bank accounts or assets due to UCC liens. At a minimum, it gives your business time and a fighting chance to restructure operations and map out a path to profitability.
Will Creditors Agree to Chapter 11 Bankruptcy?
Many business owners wonder if their creditors — many of whom have been aggressive in attempting to receive payment — will agree to a reorganization plan.
In a Chapter 11, Subchapter 5 bankruptcy, creditors must agree to the court-approved reorganization plan under penalty of law.
If you're wondering how creditors feel about Chapter 11 bankruptcies, it's helpful to know that most secured creditors are relieved as they know the Chapter 11 bankruptcy will prioritize their debt over unsecured or "bad debt". For unsecured creditors, Chapter 11 bankruptcy offers a chance to receive something, rather than nothing, as would likely be the case if the business is closed or liquidated.
(Having trouble with aggressive creditors attempting to collect on a merchant cash advance? Our blog How Can I Get Out of a Merchant Cash Advance? can help.)
How Do I File for Chapter 11 Bankruptcy?
If you think a Chapter 11 bankruptcy is best for your business, it's still important to speak with a qualified business bankruptcy attorney. As you know, bankruptcy is a serious decision, and you'll want to make sure you've thoroughly considered options before seeking bankruptcy protection for your business.
An experienced business bankruptcy attorney has the experience and knowledge to help guide your business through a Chapter 11 bankruptcy, which is the most complex type of bankruptcy. They will work to ensure you have all the proper documentation to file and will make sure your rights are protected as you move through the bankruptcy process.
If your business is considering bankruptcy, and facing a time-sensitive pressure to repay a debt or business assets may be seized, don't wait! Contact an attorney today. An experienced business bankruptcy attorney can offer an emergency filing to quickly enact the automatic stay.
If your business is dealing with creditor harassment, or your bank account is in danger of being frozen, it's important to speak with an experienced bankruptcy law firm as soon as possible. The Lane Law Firm's business attorneys are here to help. With years of experience in business bankruptcy, business litigation, and debt relief, our team is here to discover the best solution for your business. Contact us online or give us a call today at 866-292-7107.
