Can Small Businesses Benefit from filing for Chapter 11?
Bankruptcy comes in several flavors, and a Chapter 11 is the flavor that allows a business to reorganize and continue to operate. Can small businesses benefit from filing a Chapter 11 bankruptcy? YES! And here’s why:
- Immediately upon filing, the debtor is entitled to the protections of the automatic stay. This prevents creditors from taking any action to collect their debts. It puts all litigation on hold and can prevent a lender from proceeding with a foreclosure of its mortgage or a UCC sale of business assets. This provides a small business a little bit of breathing room.
- The debtor can also reject unfavorable contracts like leases or rental agreements. This allows a small business to close locations and get relief from above-market rent.
- The debtor can also borrow new money through a debtor-in-possession or DIP loan, and give the lender a super-priority lien, which puts them ahead of the business’ existing lenders.
- Debtors can also sell some or all of their assets (including real estate, machinery and equipment, vehicles, and even intellectual property) free and clear of liens and claims, with the liens attaching to the proceeds of the sale.
- The debtor also gets a reprieve from paying its pre-bankruptcy debts while it is in Chapter 11. During this time, the debtor can accumulate a surplus to help strengthen the business after bankruptcy. And while these debts must be addressed in a plan and a percentage paid over time, the total paid to unsecured creditors depends on the liquidation value of the business, which is generally much less than the total owed.
Can some or all of this be done outside of a bankruptcy? No - these protections only exist in bankruptcy.
Is Chapter 11 the answer for every small business that either can’t afford to pay its creditors or finds itself upside down? No, but it should be considered, along with several other less costly options. These options should be discussed with experienced bankruptcy counsel. Especially if the business is continuing to lose money and can only survive by increasing the debts to its trade creditors or failing to pay payroll taxes, both of which can subject the business owner to personal liability.
Some of the factors to consider include:
- Whether the business can break even or operate at a profit during the Chapter 11 process.
- Whether the business model is effective, e.g. do they offer goods and/or services which are in demand?
- What is the relationship between the debtor and its trade creditors?
- What is the relationship between the debtor and its lenders?
- Does the business own the real estate in which it operates and, if not, what is the relationship between the debtor and its landlord?
- What is the quality and loyalty of the work-force?
- Does the owner have access to cash or credit to put into the business?
- Does the business have non-essential assets which can be marketed and sold?
- Did the business owners take a lot of money out of the business during the prior year?
It is possible for struggling and cash-strapped businesses to change their business model, obtain new financing, restructure existing debt and negotiate payment plans with their creditors without filing a bankruptcy. But when all else fails, Chapter 11 should at least be considered as an option before shutting the doors.
And while Chapter 11 is expensive, the costs can be quite reasonable compared to the valuable benefits Chapter 11 can provide, not to mention the huge amount of debt which can be eliminated from a small business’ bottom line.ntact Ms. Yong at 312.696.2034 or Blyong@golanchristie.com to see whether your business might benefit from filing a Chapter 11 bankruptcy or pursuing one of the less costly reorganization alternatives.