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Chapter 11 bankruptcy is a type of bankruptcy typically reserved for large corporations but in the right circumstances, can be the best bankruptcy instrument for a small business. Small business owners filing for bankruptcy whose debt exceeds the limit for Chapter 13 and would like to keep operating their business under some degree of profitability should strongly consider Chapter 11 bankruptcy.

Key Takeaways

In this article, we will explain Chapter 11 bankruptcy and how it can be a viable option for small businesses in Illinois. We answer the following questions:

  • What is Chapter 11 Bankruptcy?
  • What are the benefits of Chapter 11 Bankruptcy?
  • What are the disadvantages of Chapter 11 Bankruptcy?
  • Are there special considerations for Chapter 11 Bankruptcy?
  • What fees, costs, and paperwork is associated with Chapter 11 Bankruptcy?
  • What should my plan look like after filing Chapter 11 Bankruptcy?

What is Chapter 11 Bankruptcy?

Chapter 11 bankruptcy is a type of bankruptcy typically reserved for large corporations but in the right circumstances, can be the best bankruptcy instrument for a small business. Small business owners filing for bankruptcy whose debt exceeds the limit for Chapter 13 and would like to keep operating their business under some degree of profitability should strongly consider Chapter 11 bankruptcy. Under Chapter 11 bankruptcy a Small Business is one in which the debts do not exceed $2,566,000. Upon filing Chapter 11 bankruptcy the debtor becomes what is called the Debtor-In-Possession (D.I.P.), with new bank accounts opened and designated as such. The goal of Chapter 11 bankruptcy is to allow the debtor(s) some breathing room to renegotiate contracts and reorganize debt into a plan which will be paid off over the number of years determined in the planning phase.

Chapter 11 bankruptcy

What are the Benefits of a Small Business Chapter 11 Bankruptcy?

Small Business Chapter 11 bankruptcy shares many of the benefits found in other types of bankruptcy, including:

  • Filing Chapter 11 triggers the Automatic Stay rule, effectively blocking all current creditors, including the IRS, from continuing debt collection activities;
  • The D.I.P. has all the powers of a trustee under Chapter 11, allowing her to object to claims, file motions to retrieve repossessed property, and sell unnecessary property;
  • Under the repayment plan worked out in Chapter 11 secured debts where the balance owed exceeds the value can be “crammed down” to the appraised value of the asset;
  • The debtor can get rid of or renegotiate unfavorable contracts;
  • Chapter 11 gives the business time to pay tax debts and unsecured debt over a longer period of time than other types of bankruptcy;
  • Most debts will be renegotiated to lower than their current amount; and
  • Chapter 11 allows your business to stay open and continue to operate, albeit with oversight.

What are the disadvantages of Chapter 11 Bankruptcy?

  • Chapter 11 bankruptcy can be a more lengthy, complex, and expensive process than Chapter 13 or Chapter 7 bankruptcy;
  • Your repayment plan is not a guarantee. The judge may reject your debt reorganization proposal if she feels it is not viable, compliant, realistic, or she feels your business is unlikely to return to post-bankruptcy profitability in a reasonable amount of time;
  • As part of the Chapter 11 bankruptcy negotiations, the court may impose strict limitations on the compensation of a debtor’s “insider” employees (officers, directors, etc.);
  • During the restructuring phase, and sometimes for a period after, the business will have to get approval from the court to move forward with certain actions, especially those outside the functions specified in the business’ restructuring and profitability plans.

Are There Special Considerations for Chapter 11 Bankruptcy?

  • Even though you can defer the payment of payroll taxes, sales tax, and unemployment taxes through Chapter 11, once the filing process has been completed and the automatic stay triggered you will need to keep current on those new taxes coming in.
  • Often, principals of a small business will have to trade liability to secure credit. The automatic stay will extend to those who have given a personal guarantee, but this means that creditors can go after those individuals if the debt is not paid in full through the repayment plan.
  • If there is any indication that the principals have used corporate funds to pay for nonbusiness essential items (a TV that they placed in their own house, or a trip that can’t be connected back to a specific business reason) there may be an attempt to “pierce the corporate veil,” by the trustee or creditors, which, if successful, might result in the creditors going after the principals for any debt left after the bankruptcy.
  • During the restructuring process, decisions on leases and executory contracts must either continue the contract or reject the contract. If the lease expired or was terminated prior to filing for bankruptcy the Automatic Stay will likely not stop the eviction process, as the landlord can file a Motion to Modify the automatic stay and it will probably be granted.
Bankruptcy law

What Fees, Costs, and Paperwork is Associated With Chapter 11 Bankruptcy?

Chapter 11 bankruptcy is a lengthy process and involves a lot of work, but the key to having a successful Chapter 11 filing is to have everything prepared before the actual filing.

Below is a list of documents and schedules to be included when filing Chapter 11 bankruptcy:

  • Schedule of all assets;
  • Schedule of all liabilities (debts);
  • A balance sheet that will be turned over to the US trustee;
  • A list of all the causes of action for the debtor;
  • A cash flow statement, or some kind of statement of operations;
  • A copy of the company’s most recent Federal Income Tax Return;
  • A statement of financial affairs; and
  • A schedule of executory contracts and leases

Having a good accountant, along with having a good bankruptcy attorney is very helpful in making sure you have the right schedules and documents and that everything is accurate. It’s also highly suggested to complete any pertinent appraisals before entering into Chapter 11 bankruptcy.

As of writing this, the filing fee for Chapter 11 bankruptcy is $1,717.00, which includes administrative charges. However, the bulk of the expense in Chapter 11 bankruptcy comes from attorney fees, accounting fees, and fees for any other help in preparing and overseeing the bankruptcy process. The average cost fluctuates significantly based on the size of the company, the value of assets involved, the number of principals, etc. 

Attorney fees will need to be paid prior to filing and any initial fees after filing will need to be approved by the bankruptcy court. The court will also evaluate the fees paid prior to filing, along with any other payment made prior to filing above $600, to check for preference transfers or fraudulent payments. Any other professionals hired after filing to help assist with Chapter 11 bankruptcy must be approved by the court. There is also a minimum fee of $325 that must be paid to the trustee on a quarterly basis. 

What Should My Plan Look Like After Filing Chapter 11 Bankruptcy?

If you’ve done your due diligence before filing you should have a pretty good idea of what your plan to get out of debt and back to profitability will look like before the official bankruptcy process even begins. Much of the success of Chapter 11 bankruptcy hinges on the judge believing your company will be able to pay its debts, climb out of bankruptcy, and into profitability. 

The plan rarely exceeds a period of five years, during which time the debtor will be making monthly payments to creditors or will have an agreement to make a future payment based on the sale of assets. The initial six months in a Chapter 11 bankruptcy sometimes acts as a trial period to see how the company performs and to what degree it can expect to pay back its creditors over the next 3 to 5 years. Creditors will be allowed to vote on the plan and if they vote to reject the plan the bankruptcy attorney must argue that the company is doing everything it can to pay back it’s debts and the proposed plan is optimal for all parties involved. 

Chapter 11 bankruptcy is not always the right fit for a small business. In fact, between Chapter 7, Chapter 11, and Chapter 13 bankruptcy it’s the least common option. However, for larger small businesses with an appropriate amount of debt, that feel they have a solid plan to get back to profitability, Chapter 11 bankruptcy can be a great option. Give us a call at 630-324-6666 to speak with one of our qualified team members and find out if Chapter 11 bankruptcy is right for your business.

November 16, 2020
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