Bankruptcy Basics: How Chapter 11 Works for Businesses

Every business goes through hard financial times. Some are able to recover relatively quickly with the right strategies, but others are unable to reverse that negative momentum. No entrepreneur likes to think about the option of bankruptcy—not only is it a lengthy, complicated process, but it could negatively affect your future endeavors—but in times of dire financial stress, it may be your company’s only option.

Even if you feel there’s a good chance you’ll make it past this round of financial uncertainty, it pays to know how Chapter 11 bankruptcy works—and what you can do to prepare for the process to make it as smooth as possible.

An Overview of Chapter 11

Chapter 11 provides bankruptcy relief to major corporations, and generally begins with a filing of a (usually) voluntary petition in bankruptcy court. After filing, all your assets and liabilities are then transferred to a separate business entity that’s created solely for the bankruptcy process. This is known as the “debtor-in-possession” (DIP), or the “Estate.”

Continuing Operations

During the bankruptcy process, your business will likely be allowed to continue operations as normal, with a few special provisions. Your creditors will be prevented from pursuing collections on your debts, which will give you some much-needed breathing room for reorganizing your financial assets and liabilities. During the bankruptcy period, you’ll be prohibited from paying your creditors for any goods and services you received before the petition date, but responsible for any post-petition obligations (including taxes).

You may be allowed to pay for pre-petition items if it’s necessary to keep the business running. Approved payments often include things like trust-fund taxes, insurance, employees, utilities, critical vendors, and your cash management system.

According to Bridgepoint Consulting, your business will have the statutory responsibility to continue operating your business in a way that maximizes your credit payments (once you’re able to make them). Because of this, all your officers and directors will be tasked with operating in a way that aligns with the best interest of your stakeholders—which now include your creditors. It’s an important change in your company’s direction you’ll need to address.

Creditor Negotiations

Early on in the process, representatives from the DIP will meet with the US Trustee, who serves as a mediator to help you align your company’s goals and vision for resolving the bankruptcy case. The US Trustee will then meet with the creditors involved in the case, who will get to ask questions about the state of the company and your plans for making payments. Loans that have been secured with collateral or a lien may need to be negotiated; some creditors may release this obligation in the interest of eventually reclaiming what is owed. Others may seek Court approval to claim the collateral. Unsecured creditors will also be involved in the negotiation process for restructuring and paying off owed debts.

Reporting and Reorganization

During the bankruptcy process, you’ll be responsible for several regular reports, including statements and schedules (to be filed within 14 days of the petition date), monthly operating reports (which include income statements, cash activity, and balance sheets), and weekly cash flow reports (if any creditors have a lien on cash).

At this point, and within 120 days of the initial petition, the DIP will need to submit a formal plan of reorganization, which serves as a contract between the DIP and its creditors. The plan should describe exactly how the DIP plans to operate, including whether there’s a liquidating plan, merger, or recapitalization involved. The end goal is to have a plan to pay back creditors as completely as possible in a reasonable timeframe. Together with a disclosure statement, which will outline the plan (including what’s already been achieved), the reorganization plan will be submitted to the Court and to the creditors’ committee for voting. If a majority vote approves the plan, you will then be held responsible for following that plan through to completion.

Bankruptcy as a Last Resort

Chapter 11 bankruptcy isn’t a get-out-of-jail-free card for companies that can no longer operate profitably. It’s a matter of last resort for businesses that are truly desperate. For some businesses, the process can last years, and result in tremendous stress for all parties involved. Make sure you’ve exhausted all other options for your business before proceeding, and if you do file for chapter 11, do your research and prep work ahead of time to make the process as smooth as possible.

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October 20, 2017 Bankruptcy Basics: How Chapter 11 Works for Businesses