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Business Bankruptcy

In Chapter 11 of the Bankruptcy Code, Congress provides businesses, including small businesses, a way to restructure their debts and business operations and to emerge as stronger and viable entities, or a way to efficiently and rationally cease operations and maximize asset value. Chapter 11 also is an option for individuals who do not qualify for Chapter 13 because they have too much debt or because Chapter 7 is not appropriate for their situation.

In business Chapter 11 cases, we help to stabilize business operations, address any immediate issues that threaten to undermine the reorganization process, negotiate with key creditor constituencies, prepare and file a reorganization plan and disclosure statement, and work tirelessly to obtain Bankruptcy Court approval for the plan. We are different from other bankruptcy firms because we frequently help businesses file for Chapter 11 relief. Chapter 11 is not an adjunct to our consumer practice. Instead, our Chicago Chapter 11 Bankruptcy attorneys have a keen understanding of the Bankruptcy Code and the nuances of Chapter 11 and bring those resources to the table when helping our clients.

The Chapter 11 Process

A Chapter 11 case is commenced by filing the same bankruptcy forms that are used to file under Chapter 7 and Chapter 13. Also, individuals who file for Chapter 11 have to complete the same credit counseling course as individuals who file for Chapter 7 or Chapter 13.

Once the case is filed, the business can operate in the ordinary course, but needs court approval to take certain actions. For example, in most Chapter 11 cases the business needs to obtain court approval to use cash in its bank accounts. Similarly, the business needs court approval to pay employees for pre-bankruptcy work. Accordingly, immediately after a business case is filed, our business bankruptcy attorneys frequently appear in court and ask the judge to enter certain first day orders.

As in Chapter 7, there is an initial meeting of creditors that takes place within 4 to 6 weeks after the bankruptcy commences. And in that initial meeting, unsecured creditors may have an opportunity to form a committee of creditors and to hire a lawyer and other professionals who get paid by the company in bankruptcy.

The goal of a Chapter 11 case is to negotiate, prepare, file, and confirm a reorganization plan. The reorganization plan is a blueprint explaining how the company will repay its creditors over time.

Once the bankruptcy plan has been proposed and filed, creditors have the right to vote for the plan or against the plan. If a sufficient number of creditors vote in favor of the plan and the plan otherwise meets certain legal criteria, the bankruptcy judge usually approves the plan and it is then implemented. If creditors do not vote for the plan, it can still be approved by the court through an option known as “cramdown.” Under the cramdown option, a reorganization plan can be approved over the objection of creditors, if the plan is fair and equitable and does not discriminate unfairly. Frequently, the bankruptcy court may conduct a trial to determine if the plan meets the requirements for a cramdown.

Chapter 11 is also used as a vehicle to conduct a “going concern” sale of a business. Businesses can be sold in Chapter 11 either through a reorganization plan, or through what is known as a Section 363 sale.

Chapter 11 Myths

There are a wide range of business bankruptcy myths that continue to circulate. These myths include:

Chapter 11 is too expensive for my business.

Not true. In 2005, Congress amended the Bankruptcy Code by enacting special provisions that focus on streamlining the Chapter 11 process for small businesses. At FactorLaw, we often take advantage of these provisions to guide clients through the Chapter 11 process quickly and economically.

A Trustee is automatically appointed once a business files Chapter 11.

Not true. A business that files for relief under Chapter 11 of the Bankruptcy Code becomes a “debtor-in-possession.” Existing management and ownership remain in control of the business operations and in possession of the business assets and are permitted to operate in the ordinary course of the business. Non-ordinary course actions and certain other actions — e.g., retaining lawyers and accountants — require prior court approval. Thus, there is no bankruptcy trustee in most Chapter 11 cases, although the Bankruptcy Court can appoint a trustee “for cause,” which usually requires proof that existing management is not capable of managing the business mainly due to incompetence or dishonesty.

All payments received within 90 days of bankruptcy can be recovered as a preference.

Not true. There are several defenses that can be asserted if a company or a trustee demands repayment of transfers made within the 90-day period prior to a filing. For example, payments made in the ordinary course of business generally cannot be recovered, although proving this can be difficult. Similarly, cash on delivery payments or payments that are substantially contemporaneous with the delivery of goods or services may not be recoverable. The same is true for payments that are followed by the delivery of new goods or services.

Creditors can automatically stop doing business with a customer in Chapter 11.

This is not always the case. The Bankruptcy Code prevents creditors from terminating an agreement based upon a customer filing for bankruptcy, or failing to pay because of a bankruptcy. If a supplier of goods or services has a contractual duty to ship goods or provide services, it usually must continue to do so, even after bankruptcy.

An insolvent business should file for Chapter 7.

Usually not true. Most businesses do not need to be liquidated under Chapter 7 of the Bankruptcy Code and there usually are less expensive and more effective means for accomplishing this objective. Unlike individuals, the debts of a business are not discharged in Chapter 7. Alternatives to Chapter 7 include an assignment for the benefit of creditors or state law dissolution.