Business Reorganizations White Paper

There are a number of different ways businesses can reorganize under the Bankruptcy Code. These reorganizations are typically available regardless of how the business is set up—sole proprietorship, partnership, corporation, or LLC—although the implementation and impact on the business owner can differ significantly.

Business Reorganization is
Challenging

The first question you need to ask whether the business should be reorganized at all. If the business is closed or will not continue to operate, or has only nominal assets, there usually is no need to reorganize. Liquidation or simply closing the doors and notifying creditors that the business has closed, letting them fight amongst themselves over whatever assets are left, and dissolving the corporation or LLC under state law, may be the best choice. (Note that if there are significant business assets, a Chapter 11 liquidation plan may also be an option, and it allows you more control and protection from creditors than a Chapter 7 liquidation—see below.) A business that is or will be closed and has no assets typically does not need to file for Chapter 7 bankruptcy, because corporate entities cannot receive a Chapter 7 discharge. This means that once the case is over, creditors can resume collection efforts.

 

Can a Corporation
or an LLC
Get a
Chapter 7 Discharge?

In some limited cases, a business may want to file a Chapter 7 even though it can't get a discharge. Typically, this will be where the business has assets and wants the Chapter 7 Trustee to sell them, take a commission and fees for doing so, and distribute the remaining proceeds to creditors. This may be a good option where there are trust fund taxes that the owner would be responsible for and you want to see proceeds go towards these taxes instead of to unsecured creditors. Another situation where a corporate Chapter 7 may make sense is where are many creditors with claims to business assets. Rather than having a fight over who gets what, the Chapter 7 Trustee, viewed as a neutral party, will sell the assets and distribute them fairly.

 

But these situations are fairly rare. Most small businesses either have limited assets or will close and there is no need of or benefit from a corporate Chapter 7. Due to personal guarantees of business debt, however, the owner may need to file individually.

 

If the business will remain open, the next question is whether reorganization will help. Reorganizations under Chapter 11 can’t help if the reasons the business is in trouble can’t be fixed by the bankruptcy. Examples:

 

  • I run a pizza shop, and nobody likes my pizza.

  • I don’t have enough customers to buy my product.

  • My rent is too high and I can’t move my location.

  • I have minimal debt, but I’m not bringing in enough money.

  • I’m not good at running a business.

 

Although it can give you some time to work on such issues, Chapter 11 can’t fix these fundamental problems for you.

 

What can Chapter 11 do? A number of significant things:

 

  • It can immediately stop all collection activities against the business—lawsuits, garnishments, attachments, liens (even IRS liens and levies), foreclosures, repossessions—as well as collection calls, letters, and bills.

  • It can give you five years to catch up on taxes without the risk of levies, liens, or attachments.

  • It can let you terminate leases on unproductive locations.

  • It can let you restructure secured debt (debt where there is collateral for the loan) by lowering the loan principal to the value of the collateral, potentially lowering the interest rate, and reamortizing the loan over a longer payout term. This applies not only to mortgages (including SBA loans) but to liens on your accounts receivable and other business assets.

  • It can let you pay your unsecured debt—credit cards, personal loans, trade debt, etc.—significantly less than you owe over time.

 

What you can actually do, of course, depends on the details of your situation. But in the vast majority of the Chapter 11 cases we file, our business clients can do all of these things.

 

There are four main types of business bankruptcy under Chapter 11:

 

  • Small Business Reorganization Act (SBRA or Subchapter V cases). The SBRA took effect on February 19, 2020, and has special provisions designed to make it easier for small businesses to reorganize.

  • Standard Small Business Reorganization (Small Business Case). You have to choose the SBRA provisions for them to apply. If you don’t, you file under the general Small Business provisions of Chapter 11.

  • Non-Small Business Chapter 11 (General Chapter 11). If you’re not a “small business,” you reorganize under the general Chapter 11 provisions.

  • Chapter 11 Liquidation. Business assets are sold and distributed to creditors, with you controlling the sale (subject to Court approval and oversight).

 

Small Business Reorganization Act. Unlike most of the provisions of Chapter 11, which were designed to help big business, the SBRA was enacted specifically to provide Main Street business debtors, both individuals and corporations, with a more streamlined path for restructuring their debt.

 

Initially, the SBRA let an individual or business with less than $2,725,625 in debt take advantage of its provisions. In response to the economic distress caused by the COVID-19 coronavirus pandemic, Congress passed the CARES Act on March 27, 2020, which increased this limit to $7,500,000 for the next year.

 

Much like a Chapter 13 case for individuals, the SBRA lets you spread the repayment of your debt out over 3 to 5 years, and the business must devote its disposable income to the repayment plan. In most cases, debts are not discharged, or wiped out, until you finish all of your plan payments. You usually need to file your reorganization plan within 90 days after filing, but the Court may extend this time.

 

Unlike a traditional Chapter 11 (see below), under the SBRA, the Court appoints a Bankruptcy Trustee, even though you keep control over your assets and operations. Although the Trustee has the authority to investigate your financial affairs, their main job is to oversee the case and provide input to the Court.

 

One new feature of the SBRA is the ability to modify a refinance or second mortgage on your residence used to fund the business. The SBRA also eliminates the Absolute Priority Rule, which normally requires business owners to provide “new value” if they want to retain their equity interest in the business, and voting on Plan approval.

 

Standard Small Business Reorganization. In a standard small business case, there are a number of initial requirements: when the case is filed, you must file with the Court the most recently prepared balance sheet, a statement of operations, a cash-flow statement, and most recently filed tax return (or provide a statement under oath explaining the absence of such documents). You must file regular statements with the court concerning your profitability and projected cash receipts and disbursements, and whether you have paid your taxes and filed all tax returns.

 

There is also additional oversight by the U.S. Trustee. The Trustee will evaluate the business’ viability and ask about its business plan, as well as monitor the case more closely to determine if it can confirm a reorganization plan.

 

A standard small business reorganization has must shorter deadlines than a typical Chapter 11, and extensions are more difficult to obtain.

 

General Chapter 11. If you don’t make an SBRA election, and aren’t a Small Business Case, then your case proceeds under the general provisions of Chapter 11. Chapter 11 lets you pay back your creditors, in whole or in part, over an extended period of time. Perhaps the biggest benefit of Chapter 11 is its ability to let you restructure mortgages on your investment property. You may be able to lower, or “strip down,” the principal balance of your mortgage to the current market value of the property, reduce the interest rate, wipe out arrearages and reamortize the loan over decades. You can remove second and third mortgages and judgment liens from underwater properties, including your home. You can stretch out repayment plans for your mortgage for up to 30 years, making those arrearage payments affordable. You can catch up payments owed to the IRS and state taxing authorities (including property taxes). Unlike Chapter 13, there is no limitation on the amount of debt, or its type, to qualify for Chapter 11.

 

The Automatic Stay that goes into effect once your Chapter 11 case is filed immediately stops most collection actions, including collection calls and letters, bills, foreclosures, lawsuits, garnishments, bank attachments, even IRS levies. There are things it doesn't stop, such as criminal cases and some child support actions. Under some circumstances the Automatic Stay may exist for only a short period of time.

 

A Chapter 11 starts when your petition is filed with the Court. Documents relating to income and expenses, debts, property (real estate as well as personal property—your “stuff”), and other financial disclosures must be prepared and filed.

 

Most Chapter 11 cases take between six and twelve months between filing and when your Chapter 11 Plan is approved, or confirmed, by the Court.

Chapter 11 Liquidation. You can file a Chapter 11 for the specific purpose of liquidating -- selling -- business assets. Why would you want to do this instead of letting creditors fight over them or filing a Chapter 7 and letting the Chapter 7 Trustee take care of this?

There are three main reasons. First, the Automatic Stay stops collection actions against the business. Instead of having a creditor sell the business assets at auction, or to a low bidder, its efforts to take and sell business assets are stopped, letting you do this.

And in most cases, this is the primary reason why you file a liquidating Chapter 11: You maintain control over the sale (subject to Court approval, of course). How much, when, and to whom assets are sold can maximize value and make sure that as much as possible (or all) business debt can be paid. Where there are trust fund taxes where you are personally liable if they are not paid, it can be particularly important to get top dollar for business assets. A liquidating Chapter 11 gives you the best chance to do this.

Finally, in a liquidating Chapter 11 you do not have to pay Chapter 7 Trustee fees and commissions. These can be significant, and the savings in a Chapter 11 can make it worthwhile.

 

Which provisions make the most sense for you and your business? It depends on your specific circumstances. Contact us and we can explore the options and let you know what makes the most sense.

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