Businesses with financial problems will have a choice between filing Chapter 7 or Chapter 11 bankruptcy. Chapter 11 is the most popular because it allows a business to continue to operate, which is not possible under Chapter 7.
Chapter 7 Basics
A business that files for Chapter 7 has either accepted that it is no longer viable or the judge from a Chapter 11 case transfers a case to Chapter 7 status. Unlike a personal Chapter 7 which discharges personal debt, a business filing Chapter 7 is purely liquidating assets so they can pay as many creditors as possible.
Filing the Petition
Any type of business formation can file for Chapter 7 including corporations, limited partnerships, and sole proprietors. Getting the process started requires filing a petition in the court where the principal place of business is located. Typically there is a filing fee of $245, an administrative fee of $46, and a trustee fee of $15. Along with the petition, the business will have to file the following documents:
- A schedule of assets and liabilities
- A schedule of current income and expenses
- A statement of financial affairs that lists any open contracts or ongoing leases
Just as in all bankruptcy petitions, once filed, an automatic stay protection kicks in. While a business is under this protection, creditors are prevented from taking any collection action including phone calls, lawsuits or garnishments.
Chapter 7 Process
After the petition is filed the court will appoint a trustee. The trustee is in charge of handling the liquidation of business assets and distribution of funds from the sale. The business debtor will have a meeting with the trustee and creditor in which all creditor questions regarding the financial condition of the business have to be answered. Once the trustee has identified and sold the assets, he will pay creditors according to their rank.
Secured creditors are paid first. A secured creditor extends credit based on taking an interest in some sort of collateral. This includes banks, tax debt, or bondholders. Unsecured creditors are paid out of any remaining funds and can include banks, suppliers, and credit card companies. Finally, after everyone is paid, stockholders will get whatever is left over, if anything.
Chapter 11 Basics
Businesses filing Chapter 11 bankruptcy have to go through the complicated process of reorganizing their debt. However, unlike a Chapter 7 bankruptcy, a business continues to operate and earn revenue.
Taking the Chapter 11 bankruptcy route has its fair share of advantages and disadvantages.
Advantages
As far as advantages go, Chapter 11 is often a more attractive choice for businesses for a number of reasons including:
- The ability to continue to earn revenue
- Automatic stay protection which prevents creditors from taking any type of collection action
- Ability to negotiate the reduction of interest rates
- Rejection of unprofitable contracts
- Ability to propose reorganization plan that pays debts and allows for the business to once again become a viable profitable entity
Disadvantages
There are disadvantages to filing Chapter 11 bankruptcy that can make it a prohibitive process.
- Your business will have to pay all of its attorney's fees plus those of the creditors. If you are unable to do this, it could make your business ineligible for filing a Chapter 11 bankruptcy.
- When it comes to decisions beyond the common operations of your business, the judge, trustee (person appointed to oversee the progress of the case), or creditor committee (a group of your largest creditors that closely monitor the day to day operations of the business) will be in charge.
- Under Chapter 11, the actions of a business management and/or leadership can come into question.
Chapter 11 Process
Understanding the basic process of Chapter 11 bankruptcy can make filing much less daunting. Once you file for bankruptcy, your business becomes what is called a debtor in possession. There are a number of documents called schedules that must be filed along with your business bankruptcy petition. Filing fees are approximately $1046.
Disclosure Statement
Before you can file a reorganization plan, you must file a disclosure statement. Disclosure statements are sent to the creditors to give them a breakdown of your business assets and liabilities. In addition, the disclosure statement will give creditors the time limit set by the court for approving or disapproving the plan.
Reorganization Plan
After you file the bankruptcy petition, you will have 120 days to submit a reorganization plan to the court. This time frame can be extended for up to 18 months, with court approval. Once the 120 days is up, creditors and even the trustee will be able to file their own version of the reorganization plan.
Reorganization plans classify debts into certain categories and then restructure the method in which the debt is repaid. For example, loans that are secured by real estate are usually extended and other secured loans get a repayment based on the estimated life of the collateral securing the loan. Normally unsecured creditors will only get a percentage of the debt they are owed.
There are three major steps in the plan process:
- A debtor in possession develops a plan with the assistance of financial and legal professional advice, and then sends the plan to the creditor committee and other creditors.
- A confirmation meeting takes place in which the plan is voted on. In order for the plan to be confirmed, one of the groups of creditors will have to agree to the terms.
- Bankruptcy court must find that the plan is feasible, proposed in good faith, and compliant with bankruptcy code.
Confirming the Plan
Unless a creditor files a valid objection to the plan, the court will confirm it. Once confirmed, all debt is discharged including any debts in which the creditors did not file a claim with the court. In addition, all of your business property will be returned free from any liens that are not specifically included in the reorganization plan. If for any reason the plan is not confirmed, your business will be in the same positions as if you had not filed. However, you will still have the option to file a Chapter 7 bankruptcy.
Small Business Distinction
Small businesses are those whose debts are less than 2.19 million dollars, and that are not in the business of owning or operating real property. Small businesses filing a Chapter 11 are required to provide the following information:
- Certificate of credit counseling
- Copy of any debt repayment plan developed through credit counseling
- Evidence of payment from employment
- Statement of monthly net income
- Anticipated increase in income
- Any interest the debtor might have in a qualified education or tuition account
Avoiding Bankruptcy
One of the best ways to avoid having to face either Chapter 7 or Chapter 11 bankruptcy is to stay on top of your business finances. Avoid entering into credit arrangements that are financially prohibitive regarding interest rates. Create a business budget and adhere to it.
Do not wait until you are drowning in debt to start addressing the issue. When you see the water filling up the boat, you can seek the expertise of an attorney who might be able to renegotiate some of your debt before filing becomes a necessity.
