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Updated on Friday, November 16, 2018
Business owners struggling to keep their companies afloat don’t necessarily want to close down and liquidate assets or sell the business to the highest bidder. Instead, many may want to create a plan that helps them reduce debt and deal with the issues that caused the financial distress they are currently facing, ultimately saving their company. Any rates or fees listed below are accurate as of the date of publishing.
For these business owners, filing Chapter 11 bankruptcy may be the right solution. According to the American Bankruptcy Institute, there have been over 70,000 Chapter 11 filings across the U.S. since 2009; nearly 4,000 companies have filed in the first three quarters of 2018. In recent years, you may remember hearing about large companies like Sears and Toys “R” Us filing for Chapter 11. But what about you and your company? Could Chapter 11 be a viable option?
How Chapter 11 bankruptcy works
Like Chapter 13, Chapter 11 bankruptcy is a reorganization. Unlike Chapter 13, Chapter 11 is mainly for businesses and related to business debt.
“The filer can be a sole proprietor, S corporation, an LLC,” Robert W. Dremluk, a New York-based partner at the law firm Culhane Meadows, told MagnifyMoney. “Any format is okay, but the [filer] will primarily be addressing the business-related activities of the individual.”
While many business owners file a voluntary petition for Chapter 11, creditors can also file against a debtor, which turns it into an involuntary petition. Unlike Chapters 7 and 13 bankruptcy, there isn’t usually a trustee appointed at the start of a Chapter 11 filing. Instead, after filing, the business owner becomes the “debtor in possession” (DIP), allowing the debtor to retain control over the business assets during the term of the reorganization, which can take months or years to execute. This also allows them to make decisions about what to do with assets.
As an example, Dremluk mentioned a retailer who can choose to close underperforming stores and have a sale on the inventory but to continue operating successful locations.
Once a business owner has filed a petition for bankruptcy, an automatic stay is enacted, ensuring that collection activities, repossessions and foreclosures are suspended. In some cases, however — such as when the underlying property in question isn’t necessary for the reorganization or the owner has no equity in it — a creditor may request that the court lift the stay and allow them to foreclose.
While they are the debtor in possession, the business owner has 120 days to create and submit a plan for reorganization. The plan, which will outline how each class of claims (secured and unsecured) is to be handled, must then be filed with the court. A disclosure statement is then sent to creditors to allow them to evaluate the plan. Creditors who, according to the plan, will not get the full value of the debt they are owed or whose contracts are going to be modified under the reorganization, can vote against the plan.
When developing the plan, a business owner doesn’t go it alone. In addition to having their attorney to help, there is also a creditors committee comprised of representatives of the seven largest unsecured creditors. The committee helps to develop the plan and investigates the conduct of the business owner to help ensure proper management of assets.
Generally, a business owner’s personal assets are left out of a Chapter 11, but, as Dremluk noted, that’s not always the case. “Sometimes, an individual personally guarantees or pledges personal assets on behalf of the company, in a closely held company. An aggressive lender may call collateral, it depends,” he said. In addition, if the business is a sole proprietorship or a partnership, personal assets may be at risk.
When to consider filing Chapter 11
According to Dremluk, there are a number of events that can prompt a company to file for Chapter 11. In some cases, it could be due to the company facing financial difficulties or operational issues.
“Companies [sometimes] end up considering bankruptcy because they are in financial distress, and part of the reason for that may be that management is unable or unskilled in grappling with problems the company is facing,” said Dremluk. Whether the issue is that company management isn’t proficient at solving problems or that the company has overexpanded and isn’t able to correctly operate a business this large with their current structure, Dremluk said that bankruptcy gives them the opportunity to correct their course.
“Bankruptcy gives the business a chance for a pause and to reassess what they’re doing and how to do it better,“ he said.
What debt is erased in Chapter 11?
“Secured and unsecured debt whether public or private can be discharged,” said Dremluk. Unlike Chapter 7 bankruptcy, where unsecured creditors often walk away without receiving payment, Chapter 11 allows a business to set up a reorganization that pays creditors, although sometimes they receive less than the company owed them or the debt is paid over a longer period of time than the original contract specified. While secured creditors are prioritized in the reorganization, vendors who supply services and materials that are integral to the ongoing operation of the company (called “critical vendors”) may see their unsecured debt getting paid off during the bankruptcy.
What makes Chapter 11 so powerful is that it allows a company time to get their business on the right footing. With Chapter 11, said Dremlock, “[a] company can deal with asset/secured claims and sell assets over a period of time instead of in fire sale situation.”
How to file Chapter 11 bankruptcy
The first step a filer should take is reaching out to an attorney; as Dremluk noted, it is mandatory that a business owner filing for Chapter 11 “must be represented by counsel.” In addition, because each district court may have its own added requirements, an attorney can ensure you file everything necessary.
Business debtors who wish to file will be utilizing a multitude of forms in the 200-series, beginning with Official Form 201, “Voluntary Petition for Non-Individuals Filing for Bankruptcy.”
Next, business owners need to compile a list of the names and addresses of all their creditors. This list should be formatted however the court in your district requires.
Another official form that needs to be completed is Form 204, “Chapter 11 Cases: List of Creditors Who Have the 20 Largest Unsecured Claims Against Debtor and Are Not Insiders.”
“The list of creditors is submitted to the court for purposes of selecting a potential creditors committee,” said Dremluk. “You don’t want people on that committee who are conflicted because they are an officer or shareholder.”
Finally, for those business owners required to file periodic reports with the Securities and Exchange Commission (SEC), Form 201A, “Attachment to Voluntary Petition for Non-Individuals Filing for Bankruptcy Under Chapter 11,” should be completed.
Within 14 days of filing Form 201, the debtor will need to file the rest of the forms for their bankruptcy, which are:
- Official Form 206, “Schedules of Assets and Liabilities”
- Official Form 206A/B, “Schedule A/B: Real and Personal Property”
- Official Form 206D, “Schedule D: Creditors Who Have Claims Secured by Property”
- Official Form 206E/F, “Schedule E/F: Creditors Who Have Unsecured Claims”
- Official Form 206G, “Schedule G: Executory Contracts and Unexpired Leases”
- Official Form 206H, “Schedule H: Codebtors”
- Official Form 206Sum, “Summary of Assets and Liabilities for Non-Individuals”
- Official Form 202–Declaration, “Declaration Under Penalty of Perjury for Non-Individual Debtors”
- Official Form 207, “Statement of Financial Affairs for Non-Individuals Filing for Bankruptcy”
- Director’s Form 2030 (unless your court requests otherwise), “ Disclosure of Compensation to Debtor’s Attorney”
If the business owner declaring Chapter 11 meets the criteria to be considered a small business debtor, they must also include a balance sheet, statement of operations, cash-flow statement and federal income tax return. If the small business owner doesn’t have these documents, they can submit a statement under penalty of perjury that they have not prepared the documents or filed a federal tax return.
To determine whether a filer is a small business debtor, the criteria they must meet involves two elements. First, it must be ensured that the debts are no more than $2,566,050, and the business cannot be focused primarily on owning or operating real property. Second, a creditors’ committee has either not been appointed to the case, or has not properly provided necessary oversight, as determined by the court.
When filing, business owners can expect to be charged a $1,167 filing fee and $550 as a miscellaneous administrative fee. On top of that, a debtor must pay attorney fees, which can get weighty.
“Chapter 11 has become too expensive for most companies to file, and lenders have also reached the point in their analysis where they don’t want to support a company for a long time. They’d rather have a company liquidate and take their losses,” said Dremluk, who added that fee arrangements and advanced budgets for attorney fees might help a filing company’s chances of success.
Within 120 days of petitioning the court for Chapter 11 bankruptcy, the company needs to submit its plan for reorganization. The plan will generally include provisions for how the reorganization will be implemented, including how business will continue, how funding will occur, how each class of creditor will be paid, the interest paid to them and so on.
One important aspect of the reorganization plan is that it needs to be in the best interest of creditors in order to get approved. “The plan needs to be in the best interest of creditors, so treatment of creditors under the plan must be better than they’d get in a liquidation,” said Dremluk.
Dremluk added that, ideally, through the reorganization “the company will be able to discharge debt, resolve claims and emerge with a cleaner balance sheet and a lot of its other issues behind it.” Small businesses can submit this plan on Form 425A, “Plan of Reorganization for Small Business Under Chapter 11,” along with the disclosure 425B, “Disclosure Statement for Small Business Under Chapter 11.”
Official Form 201
Voluntary Petition for Non-Individuals Filing for Bankruptcy
Compile a list of the names and addresses of all their creditors.
This list should be formatted however the court in your district requires
Official Form 204
Chapter 11 Cases: List of Creditors Who Have the 20 Largest Unsecured Claims Against Debtor and Are Not Insiders
Official Form 201A
Attachment to Voluntary Petition for Non-Individuals Filing for Bankruptcy Under Chapter 11 (for those business owners who are required to file periodic reports with the SEC)
|Within 14 Days of Filing Form 201|
Official Form 206
Schedules of Assets and Liabilities
Official Form 206A/B
Schedule A/B: Real and Personal Property
Official Form 206D
Schedule D: Creditors Who Have Claims Secured by Property
Official Form 206E/F
Schedule E/F: Creditors Who Have Unsecured Claims
Official Form 206G
Schedule G: Executory Contracts and Unexpired Leases
Official Form 206H
Schedule H: Codebtors
Official Form 206Sum
Summary of Assets and Liabilities for Non-Individuals
Official Form 202–Declaration Official
Declaration Under Penalty of Perjury for Non-Individual Debtors
Statement of Financial Affairs for Non-Individuals Filing for Bankruptcy
Director’s Form 2030 (unless your court requests otherwise)
Disclosure of Compensation to Debtor’s Attorney
|Small Business Debtors|
If the small business owner doesn’t have these documents, they can submit a statement under penalty of perjury that they have not prepared the documents, nor filed a federal tax return
425A (within 120 days of filing form 201)
Plan of Reorganization for Small Business Under Chapter 11
425B (within 120 days of filing form 201)
Disclosure Statement for Small Business Under Chapter 11
|Within 120 Days of Filing Form 201|
Plan of reorganization (no official forms unless it’s a small business debtor)
After filing Chapter 11: What happens next?
One of the initial benefits a business owner will experience after voluntarily filing for Chapter 11 is that an automatic stay is placed on all collection, foreclosure and repossession activities. But this is no time to relax and enjoy that removed pressure — instead, it’s time to create a viable plan for a successful reorganization.
Creating this plan is the most important part of the process, according to Dremluk, because it gives the company a target to reach for. “Without a target or exit strategy, I’ve seen companies file Chapter 11 and then flounder because they are directionless,” he said.
Dremluk said that companies creating a reorganization plan need to explore all the what-ifs, including the possibility of selling or resolving outstanding litigation. If these options are part of the plan for reorganization and they fall through, Dremluk said that the reorganization plan may no longer be viable and this could mean the case is converted to a Chapter 7 and an appointed trustee may operate the business or liquidate assets and close the case, potentially leaving the business owner without the option of emerging with their business intact.
Ideally, the goal is to emerge from a Chapter 11 successfully — of course, success can mean different things to different companies. Dremluk noted that generally, the objective is to have a company able to reorganize its business and emerge from bankruptcy with its problems behind it.
But in some cases, it may be about reducing debt so the business can be sold. According to Dremluk, in those situations, “[the] company would file bankruptcy to clean up problems and become attractive to another buyer. Soon after filing it would put itself up for sale, more often than not have a stalking-horse bidder — a buyer who is prepared to buy.” When there is a stalking-horse bidder (one who is bidding on a bankrupt company’s assets), the offer is still presented to the court and subject to higher and better offers. In the end, the successful bidder would own the company and its assets and the debtor will be out of the picture.
Is it time to file for Chapter 11?
When a business is in financial trouble, it may not immediately be time to file for Chapter 11, but it could be time to contact an attorney and start reviewing options. “As soon as signs of financial distress appear, a company should consider its options. Bankruptcy may be one,” said Dremluk.
For some business owners, however, out-of-court workouts — where a debtor works out a deal with a creditor without involving the court, filing bankruptcy or selling the company — may be better alternatives. It depends on whether the business owner wants to keep going, how amenable their creditors are to a workout and how much money they might lose selling their company as-is, with all its current difficulties.
Dremluk noted that one of the biggest mistakes he sees business owners make is waiting too long to reach out to an attorney: “Waiting until the last minute to reach out [makes successful emergence] much more difficult. If you’re an owner of a company and you’re starting to see problems, reach out sooner rather than later.”
If the individual owner of a closely-held company made a personal pledge on a debt, that could impact their personal assets during the Chapter 11. Owners of sole proprietorships and partnerships may also have some personal asset exposure.
One of the most important things any business owner can do is get all their financial documents together. As Dremluk noted: “When you plan to file, gather key documents like leases, contact financial advisors to prepare income statements, list creditors and think about key suppliers and relationships and how they will be handled going forward.”
Time is of the essence, and the more time you give yourself, the better your chances are for recovery — so it’s best to reach out to an attorney as soon as your company starts having financial problems. Bankruptcy might not be the best solution at that time, but you can also discuss alternatives with counsel.
One of the most important factors, according to Dremluk, is the attorney’s level of experience. “Look for a professional that has experience with cases as opposed to someone in another practice area that occasionally does bankruptcy,” he said.
Dremluk also said to look for an attorney willing to make arrangements, and that business owners should be careful when comparing rates because an attorney with a below-market rate who charges for a high amount of hours can cost more than an attorney charging an average rate but who charges for a smaller number of hours.
The word bankruptcy conjures a lot of different feelings for people and very often those feelings are negative. But when it comes to a business filing Chapter 11, it’s hard not to see the positive potential in allowing that company the time and space to reorganize and find effective ways to deal with the problems that helped push it into financial distress.
Still, bankruptcy isn’t the right choice for every business owner, which is why it’s important to have an experienced attorney working on your case.