“Bankruptcy” is a misunderstood term. Generally speaking, society gives a negative stigma to the term “bankruptcy.” However, bankruptcy is a financial tool that all business owners should understand. It provides a mechanism to save businesses and jobs while maximizing recovery for creditors.
As we have seen over the past couple of years, even established businesses are affected by pandemics, severe weather and changes in consumer habits. Growing companies may not see revenue realized as quickly as it is needed to service debt. Whatever the reason, not all companies that use bankruptcy as a financial tool are “dishonest,” “mismanaged” or “looking to stiff creditors.” There are legitimate reasons why bankruptcy is a necessary tool and it is important for businesses to have the facts.
CHAPTER 7 versus CHAPTER 11
Business structure (how the company is set up) matters when a company is considering filing for bankruptcy. Corporations, limited liability companies and other formal business entities must obtain approval from the board or governing body authorizing the company to file bankruptcy. Owners of d/b/a’s (doing business as) have to file bankruptcy personally because a d/b/a does not create a separate legal entity.
A business generally has two options for filing bankruptcy, and which option the company chooses depends on whether the company will continue to operate or end.
Chapter 7 Bankruptcy
Chapter 7 allows a company to liquidate. A company looking to formally close its doors and operations will file under chapter 7 and will ultimately cease to exist. Once the chapter 7 bankruptcy is filed, an independent trustee is appointed to liquidate or administer any company assets for the benefit of creditors. In a chapter 7 case, the company essentially hands the keys to the business over to the trustee.
Chapter 11 Bankruptcy
Chapter 11 allows a company to reorganize its debts and continue operations. The goal of filing chapter 11 is to propose a plan of reorganization that provides for the repayment of all creditors. Depending on the size of the company and the number and type of creditors, the reorganization process can take time. The formulation of a plan to repay creditors requires negotiation with creditors to reach agreements on repayment terms and litigation when agreements cannot be made. Companies seeking to liquidate are also eligible to file a chapter 11 case which allows for a more orderly liquidation than under chapter 7 in which the company’s management retains control of the wind-down process.
CURRENT QUALIFICATIONS FOR CHAPTER 11 SUBCHAPTER V
Congress recently enacted subchapter V of chapter 11 to assist small businesses achieve reorganization more quickly and less expensively than in a typical chapter 11 case. Until March 27, 2022, companies with debts lower than $7.5 million qualify for subchapter V. Unless this law is extended, after March 27, 2022, the debt limit for companies to qualify for subchapter V will decrease to $2.75 million.
Among other things, subchapter V eliminates the requirement to pay quarterly fees, eliminates many of the blocks to confirmation of a plan, and appoints a neutral trustee to assist in reaching a consensual plan. For companies that meet the debt limitations, subchapter V provides an excellent opportunity for small businesses to reorganize.
It is important to be aware that filing a bankruptcy case for a company does not shield the owners or any other individuals who might have guaranteed company debts. The assets of the individual owners or officers of the company are not part of the bankruptcy proceeding. Any collection of a personal guaranty must be done independently of the bankruptcy proceeding. If the company is a d/b/a, then all of the individual’s assets would be part of the bankruptcy because a d/b/a does not create a separate entity apart from the individual.
THE IMPORTANCE OF BANKRUPTCY COUNSEL
Due to the complexities of the bankruptcy rules and laws, it is important to hire counsel that specializes in bankruptcy law. In addition to the bankruptcy rules, bankruptcy courts have local rules that must be followed. Hiring counsel that specializes in bankruptcy will ensure that your company’s interests are protected and give you the best chance of achieving a successful reorganization.
Langley and Banack have an active business bankruptcy practice with extensive experience. Contact us if you need assistance.