Bankruptcy Chapter 11

Business, Corporations, Farmers, and Individual Reorganization Under Chapter 11

Bankruptcy law is the name given to the branch of civil law that covers federal bankruptcy and state insolvency laws and regulations as they apply to individuals, municipalities, and businesses. During bankruptcy, a court administers the estate (the property and other assets) of a debtor (a person or business who owes money to others) for the benefit of creditors (a person or business that is owed money).

In voluntary bankruptcy proceedings, individuals or businesses may file for bankruptcy in an attempt to resolve a hopeless financial situation; although, from time to time, a creditor may force the filing of an involuntary bankruptcy proceeding.  Federal bankruptcy law is organized into "Chapters," which govern specific types of bankruptcy proceedings. A business can file for bankruptcy under either Chapter 7 or Chapter 11. Chapter 7 or "straight bankruptcy" proceedings involve the complete liquidation of the debtor's estate. Chapter 11 or "business bankruptcy" allows business bankruptcy reorganizations.

When an individual who wants to reorganize has debts that exceed certain limits, the individual must file for reorganization under Chapter 11.

A family farmer may liquidate under Chapter 7 and may reorganize under Chapter 11 or Chapter 12.  However, Chapter 12 is specifically designed for family farmers and is better suited to a family farmer's needs.

Alan G. Tippie & David S. Kupetz wrote the following article which appears on Lawyers.com: 

    Businesses in financial crisis are often swirling in chaos. Managers get consumed with putting out fires. But when you're moving from one emergency to another, it's easy to lose track of the road ahead.

    Many managers make common mistakes, from letting go of the wrong people to misleading employees and creditors, to not carefully watching their money.  Managers frequently focus on cutting costs, but deciding that the accounting folks are expendable is a frequent error. Tracking financial data is crucial when you're trying to save a business. If the accounting personnel contributed to the financial crisis, it's better to hire replacements instead of sweeping out all the financial folks. Of course, where there's employee fraud, complete incompetence, intentional misreporting or other grievous woes, they've got to go.

    New accounting personnel, no matter how competent, need current employees to explain the existing systems, location of records, types of reports and any idiosyncrasies of the bookkeeping system. Without time to transition from old to new, the new number crunchers may have to do more forensic accounting - trying to reconstruct what has happened in the past - than regular financial reporting. Without good accounting folks, a business can easily lose the ability to get timely, accurate financial information.

    Whether a restructuring takes place out of court or through a reorganization plan in bankruptcy, keeping on good terms with company creditors is not only wise but could be the glue that makes a bad financial situation better. Even unfavorable news is better than no news at all: if no one's returning your creditors' calls, they will likely assume there's something more dastardly going on than them simply not getting paid.

    What's worse than not returning calls, however, is giving misleading information. The person who wants to stay in business usually thinks that any admission of financial distress is a bad idea, and that it's better to either say nothing or pass along inaccurate information in the hope that credit won't dry up. The theory seems to be that lack of information merely leads to nothing worse than speculation. But misleading information can be infinitely damaging, leading to distrust when the truth is eventually discovered.  Giving accurate financial information is crucial to keeping a good relationship with creditors, and increases the odds of a successful reorganization.

    Employees should be treated with no less respect than creditors. Rumors of financial distress within an organization are sure to trigger a mass mailing of resumes. Management in a financially challenged business should examine each segment of the company to see what can be changed or eliminated in order to better the odds of surviving.

    Those parts of the business that drain more from the bottom line than they contribute can be labeled "bleeders." Not staunching that negative cash flow - cutting costs and positions - could lead to the company's demise.

    Managers should also turn a careful eye to overhead, which includes things like travel, insurance, rent and utilities. Are there any sacred cow expenditures that could be sacrificed? For example, prestige alone may not be a good enough reason to remain in a high-rent district.  With financial woes, expect creditors to want cash for any deliveries.

    A struggling business also needs to stash some cash to cover potential bankruptcy costs, such as trustee and appraiser fees and deposits to keep utilities going.  There are a few ways to come up with the cash - borrowing, selling securities, liquidating property that isn't essential, keeping proceeds of accounts that would otherwise be turned over to a secured lender, and so on. But beware that some of these cash-producing methods are subject to the claims of third parties, and others may involve fraud or securities violations.

    While raising cash is crucial, avoid doing anything that gives rise to graver problems than just being broke.  Since companies pay government agencies from payroll withholdings, the temptation in financially troubled times is to treat such agencies as involuntary lenders. But those responsible face liability, and the unpaid taxes can later trip up a Chapter 11 bankruptcy reorganization plan.

    The pressures of debt can cause you to make decisions that may appear smart in the short term, but later turn out to be unwise. Think ahead.  By avoiding common mistakes, debtors have a fighting chance of avoiding bankruptcy. But even if you do end up in a Chapter 11 bankruptcy, your odds of recovery are better.


The Small Business Debtor.  Cathy Moran, a business and bankruptcy lawyer in the San Francisco Bay Area, was one of the first bankruptcy specialists certified by the California State Bar.  Her Web site: Bankruptcy in Brief includes a wealth of information on bankruptcy.  She wrote the following article, The Small Business Debtor which may be found on Lawyers.com.

    Several provisions in the Bankruptcy Code are designed to afford small businesses a faster, more efficient and less expensive mechanism for reorganizing their businesses by eliminating the requirement for the appointment of a creditors' committee and simplifying the disclosure statement and plan confirmation process.

    "A small business debtor is defined by the Bankruptcy Code as a person engaged in commercial or business activities, not including a person that primarily owns or operates real property, that has aggregate noncontingent liquidated secured and unsecured debts that do not exceed $2,000,000. If a debtor qualifies and elects to be considered a small business under the Bankruptcy Code, the case is put on a "fast track" and treated differently than a regular Chapter 11 case under the Code.

    Creditor Committee and Approval of Disclosure Statement

    In a small business case the appointment of a creditors' committee and a separate hearing to approve the disclosure statement are not mandatory. The approval of the disclosure statement may be combined with the plan confirmation hearing. Also a small business case proceeds faster than a regular Chapter 11 case because the court may conditionally approve a disclosure statement, subject to final approval after notice and a hearing and solicitation of votes for acceptance or rejection of the plan. Thereafter, the disclosure statement hearing may be combined with the confirmation hearing. In addition, the debtor has a shortened period of time within which only the debtor may file a plan. After the 100-day period expires, any party in interest may file a plan; however, all plans must be filed within 160 days from the date of the order for relief.

    The bankruptcy court may reduce or increase the 100-day and 160-day periods upon cause shown by any party. Small business debtors may solicit votes on a plan based on a disclosure statement that is conditionally approved by the bankruptcy court, so long as the debtor provides adequate information to each holder of a claim or interest that is solicited.

    Your business is in financial trouble. How do you figure out whether bankruptcy is necessary or helpful for your situation? Ask yourself the following questions:

    Is the business a corporation, partnership or proprietorship?  Corporations and partnerships are legal entities separate from their shareholders or partners, and can file Chapter 7 or Chapter 11 bankruptcy in their own right.  But be aware that in a partnership's Chapter 7 bankruptcy, the trustee can sue the general partners of the partnership if the partnership's assets are insufficient to pay partnership debts. As a result, partners may be facing a suit by a well-funded trustee suing for the benefit of all creditors of the partnership.  Get good advice before contemplating a partnership bankruptcy.

    Proprietorships are just an extension of the owner and can't file bankruptcy alone. The proprietor must file the bankruptcy, as the property and debts of the business are really just one form of assets owned by the proprietor. The individual owner may file a Chapter 7, Chapter 11 or Chapter 13 bankruptcy (if the debt limits are met).

    Should the business be reorganized or liquidated?  To answer this question, you have to know what has caused the problems the business now faces and the prospects for change. 
    Reorganization can't create a market, increase gross revenue or make up for a poor fit between the skills that are available and the skills that are required to run the business. But reorganization can:

• Free up cash from paying old debt to finance current operations;
• Make it easier to reject leases or contracts that are no longer advantageous (like an expensive facility lease or unfortunate equipment purchase);
• Prevent the loss of vital assets or cash to creditor collection actions.

    In between Chapter 7 liquidation and reorganization, a Chapter 13 or Chapter 11 bankruptcy could provide breathing space for you to sell the business as a going concern or jettison assets in something other than a fire sale. The resulting profit (called "proceeds") could pay taxes or unpaid salaries. Selling the business could mean ongoing jobs for your work force under new ownership. The bankruptcy could then be converted to a Chapter 7 bankruptcy, or dismissed if bankruptcy protection is no longer needed. The court will probably make you pay creditors from sale profits in order to get the bankruptcy case dismissed.

    How much of the business debt is "secured"? The division of debt between "secured" and "unsecured" guides what reorganization can do for your business. "Secured debt" is a creditor's claim that is secured by a lien of some type in your property, either by your agreement or involuntarily, such as with a court judgment or taxes.  Purchase money security interests (a security interest the seller of goods takes at the time the goods are purchased) can be avoided or "stripped down" to the current value of the purchased goods in Chapter 11 and 13 bankruptcies. Creditors with purchase money security interests in goods with lower value almost never file a lawsuit to enforce their interest in the goods.

    In bankruptcy planning, it's important to know if judgment liens have been "perfected" (recorded with the right governmental agency), as secured debts are totaled separately from unsecured debts in calculating your eligibility for Chapter 13 bankruptcy. With a Chapter 13 proceeding, these debts can be "stripped down" to the value of the assets to which the lien attaches.

    Recording a tax lien gives a creditor a lien on all of the taxpayer's real estate and personal property. It can be eliminated in Chapter 13 bankruptcy if there isn't any equity in the property. But tax liens can even reach retirement savings and 401(k) plans that are beyond the grasp of other creditors.

    In most secured bank or SBA loans, the borrower gives the lender a security interest in all the borrower's personal property. This is called a "blanket security interest" because the lien "blankets" all the borrower's assets. ("Personal" here means everything but real estate, not "personal" as opposed to "business" assets.) Even things like accounts receivable and intellectual property can be covered by a blanket security interest. The agreement may also give the creditor a lien in assets purchased after the security agreement is signed.

    In Chapter 11 or Chapter 13 bankruptcies, the lien may be "stripped down" to the value of the property at the time the bankruptcy is filed. Since a lender has rights in the items themselves and in any profit from their sale, you may not be free to sell the asset and pocket the profits, or even use the profits to pay other business debts. Spending the profits without the lender's permission may be a form of fraud, creating a debt you can't rid yourself of in bankruptcy.

    Does management have the resources and desire to engage in the reorganization process?
    Bankruptcy reorganization in Chapter 11 requires a significant time commitment on the part of owners and managers. The "bankruptcy bargain" is that, in exchange for stopping collection of debts and other bankruptcy protections, you provide full disclosure of your company's financial condition to creditors and the court, both at the beginning of the case and on a monthly basis thereafter.

    While the bankruptcy is ongoing, you owe what's called a "fiduciary" duty to your creditors, which means you must keep them highly informed and be very honest and protective of their interests before your own interests.

    A reorganization can drain an already stressed business, because management personnel must take time to participate in bankruptcy proceedings. And the legal expenses are significant.
    Most reorganizations fail, usually for lack of a real plan to solve the underlying business problems.

    Is the business one that you could start up again after a liquidation of the current business?  Businesses that require little capital, have few assets, or are really just extensions of the owner's skills and personality are ones that it may not pay to reorganize. The owners may be better off liquidating the business, in or out of bankruptcy, and starting over in a fresh business entity. This can be a complex task and requires good professional advice to do correctly.

    A Chapter 7 may be the best choice when:

• The business has no future;
• There are no substantial assets or qualities that cannot be reproduced;
• The debts are so overwhelming that restructuring them isn't feasible.

    A Chapter 7 bankruptcy can provide a corporation with an orderly liquidation under the direction of the trustee and at no expense to shareholders. Creditors are assured that they will be paid to the extent of the available assets and the priority of their claim.  As former management, you're assured that the assets that are available go (after the expenses of the bankruptcy) to pay taxes for which you may be individually liable.

    Deciding whether bankruptcy is appropriate for your business may be one of the most difficult decisions you'll ever make. But having information about what could happen to you and your business in the bankruptcy process can help.


The absolute best thing you can do is consult an attorney who has experience in business bankruptcies.  Our firm has represented a number of small business bankruptcies, most of which have resulted in the successful reorganization of the debtor's business.  Reorganizations are expensive, however.

Fees and Costs

Our fees for business and individual reorganization under Chapter 11 are calculated on an hourly basis, in quarter hour increments, at the rate of $200 per hour.  We also charge for filing fees and incidental costs and fees charged by professional persons such as court reporters, appraisers and accountants.  We don't usually charge for copies unless the job involves more than twenty or thirty pages.  Postage is handled in the same manner, so as long as the mailing is under $5.00, we absorb the cost.  Over $5.00 is charged to the client.

Our usual retainer for a business or an individual reorganization under Chapter 11 is $7,500.  We also collect the filing fee which at this time is $1,080.  The retainer may be reduced or increased, depending upon the facts of each individual case.

Attorneys and professional persons, such as accountants, who are hired in the course of a Chapter 11 must be approved by the court.  No attorney's fees above the retainer can be paid without court approval.
 
While you or your company is in Chapter 11, you will be required to pay a quarterly supervision fee to the United States Trustee.  The fee is based upon the amount of your monthly disbursements; the minimum fee is $250 per quarter.

You are also required to pay all income, sales and employment taxes while you are in Chapter 11.  No more operating on the employee's withholdings, you must deposit the withheld funds and employer's matching contributions every pay period.  For more information go to http://www.usdoj.gov/ust/eo/ust_org/about_ustp.htm.