Filing for Business Bankruptcy
Bankruptcy is when businesses can’t pay their debts and need help. It is like a safety net for those drowning in money problems. This can mean either starting over by paying back what they can and closing down or reorganizing their debt and continuing. The outcome depends on the type of bankruptcy. [1]
The process starts with filing a petition in the bankruptcy court, where you list all your assets, liabilities, income, and expenses. Once you file, an automatic stay kicks in, stopping all collection activities and giving you time to work on your case. Then, there’s a mandatory meeting called the 341 meeting, where creditors can ask about debts and property. Depending on the chapter filed, you either reorganize and pay back debts or liquidate assets to pay creditors. [1]
According to the Administrative Office of the U.S. Courts, there were 433,658 bankruptcy filings in the year ending September 2023, up from 383,810 cases the previous year. Business filings increased by 29.9 percent, going from 13,125 to 17,051. [2]
This marks the third consecutive quarter with an increase in total bankruptcy filings, reversing a decline that lasted over a decade. Bankruptcy filings dropped significantly after the pandemic started in early 2020, even though the economy faced disruptions due to COVID-19. [2]
A business can file bankruptcy under Chapter 7, Chapter 11, or Chapter 13. Let’s discuss them one by one.
Chapter 7
Filing bankruptcy under Chapter 7 is like a final goodbye for a business. It helps businesses who cannot pay their debts, no matter how much they owe or if they have money left. [3]
Filing for a Chapter 7 Business Bankruptcy
A Chapter 7 case starts when a company owner files a petition with the bankruptcy court in the area they live or where the business is located. Along with the petition, the business must file several documents: lists of assets and debts, a list of current income and expenses, a statement of financial affairs, and a list of ongoing contracts and leases. According to Fed. R. Bankr. P. 1007(b), these are all required. [3]
The business must also give the case trustee a copy of the latest tax return or transcript and any tax returns filed during the case, including those not filed when the case began, as stated in 11 U.S.C. § 521. [3] When a business files for Chapter 7 bankruptcy, a trustee is chosen. This person takes the debtor’s things, turns them into cash, and then shares the money among the people they owe. The business shuts down. [2]
Discharge of a Chapter 7 Business Bankruptcy
Filing for Chapter 7 bankruptcy involves liquidating assets to settle debts, effectively discharging most unsecured liabilities, and generally concluding within four to six months. While it provides a swift resolution to overwhelming debt, it necessitates ceasing business operations and permanently closing the business. Additionally, owners might lose personal assets pledged as collateral and face a significant negative impact on their credit scores. [3]
Chapter 11
When a business files for Chapter 11 bankruptcy, it is often called a “reorganization” bankruptcy. The business stays in control, acts like a trustee, can keep running its business, and might be able to borrow more money with the court’s permission. [4]
Filing for a Chapter 11 Business Bankruptcy
A Chapter 11 bankruptcy case starts when a business files a petition with the bankruptcy court in the area where it is located. The petition can be voluntary, meaning the business files it itself, or it can be involuntary, meaning creditors who meet certain rules file it (11 U.S.C. §§ 301, 303). A voluntary petition must follow the format of Form B 101, as prescribed by the Judicial Conference of the United States. [4]
Chapter 11 is more like a do-over. It allows the business to keep running while sorting out debts under a plan approved by the court. The aim is to come out stronger and more stable. The business comes up with a plan to reorganize, and creditors can vote on this plan. If it gets enough votes and meets certain legal rules, the court can approve it. [4]
Debtor in Possession
Chapter 11 is usually used to reorganize a business, which can be a corporation, sole proprietorship, or partnership. A corporation is separate from its owners, the stockholders. When a corporation goes through Chapter 11, the stockholders’ personal assets are not at risk except for their investment in the company’s stock. [4]
A sole proprietorship, on the other hand, is not separate from its owner(s). So, a bankruptcy case for a sole proprietorship includes both business and personal assets. Like a corporation, a partnership is separate from its partners. However, in a partnership bankruptcy, the partners’ personal assets might be used to pay creditors, and the partners themselves might have to file for bankruptcy. [4]
Section 1107 of the Bankruptcy Code makes the debtor in possession act like a trustee, with most of the same rights and duties. This includes keeping track of property, checking and objecting to claims, and filing reports as needed by the court and the U.S. trustee (11 U.S.C. §§ 1106, 1107, and Fed. R. Bankr. P. 2015(a). [4]
The debtor in possession can also hire professionals like lawyers, accountants, and auctioneers, with the court’s approval in order to help during the bankruptcy. Other duties include filing tax returns and reports required by the court. The U.S. trustee makes sure the debtor in possession follows the reporting rules. [4]
Small Business Debtors
The Bankruptcy Code provides two special categories under Chapter 11 for small business debtors to simplify processes and reduce costs. One is called a small business case, created in 2005, and the other is subchapter V, created in 2019. Debtors can choose either option based on eligibility. These cases differ from regular Chapter 11 mainly due to faster deadlines and quicker plan confirmation. They also have different debt limits. [4]
To file a small business case, the debtor must be engaged in business activities with total debts of $3,024,725 or less, with at least half of these debts from business activities. For subchapter V, the debt limit is $7,500,000, with the same requirement for business-related debts. [4]
In subchapter V cases, a trustee is appointed to manage the debtor’s estate and oversee reorganization, similar to roles in Chapter 12 or 13. The trustee helps develop the plan, attends major hearings, investigates the debtor’s financial state, and ensures payments are made under the plan, following 11 U.S.C. § 1183. The U.S. trustee has similar oversight responsibilities as in ordinary Chapter 11 cases, per 28 U.S.C. § 586. [4]
Small business cases usually move faster than other Chapter 11 cases due to stricter deadlines. Only the debtor can file a plan in the first 180 days, extendable to 300 days with court approval, per 11 U.S.C. § 1121(e). In subchapter V cases, only the debtor may file a plan, under 11 U.S.C. § 1189. In other Chapter 11 cases, the exclusivity period can be extended up to 18 months. [4]
Creditors’ Committees
Creditors’ committees can be very important in Chapter 11 cases. The U.S. trustee appoints the committee, which usually includes the seven biggest unsecured creditors of the debtor, as described in 11 U.S.C. § 1102. The committee talks with the debtor in possession about running the case, checks into the debtor’s actions and business operations, and helps make a plan. This is outlined in 11 U.S.C. § 1103. [4]
With the court’s approval, the committee can also hire a lawyer or other experts to help with their duties. The committee acts as a safeguard to ensure the debtor in possession manages the business properly. [4]
The Automatic Stay for Chapter 11
The automatic stay stops all judgments, collection activities, foreclosures, and repossessions of property when a bankruptcy petition is filed. This pause applies to any debt or claim that existed before the filing. For Chapter 11 cases, the stay happens as soon as the petition is filed, as per 11 U.S.C. § 362(a). Some actions, listed under 11 U.S.C. § 362(b), are not stopped by the stay. This period allows the debtor to work on fixing their financial issues. [4]
Who Can File A Repayment Plan?
A business typically 120 days to file a plan. The court can extend or shorten this period, but it cannot go beyond 18 months, including all extensions, as per 11 U.S.C. § 1121(d). After this exclusivity period ends, a creditor or the case trustee can file a competing repayment plan, but the U.S. trustee cannot, according to 11 U.S.C. § 307.
A Chapter 11 case might last many years unless the court, U.S. trustee, committee, or another party ensures it finishes on time. Creditors’ right to file a competing plan encourages the debtor to file within the exclusivity period, preventing delays.
In subchapter V cases, only the debtor can file a plan, as per 11 U.S.C. § 1189. [4]
Adversary Proceedings
Often, the debtor in possession will start a lawsuit, called an adversary proceeding, to get back money or property for the estate. These lawsuits can be to avoid liens, preferences, fraudulent transfers, or transfers made after the petition was filed. Part VII of the Federal Rules of Bankruptcy Procedure governs these actions. [4]
Sometimes, the bankruptcy court lets a creditors’ committee take these actions against people close to the debtor if the plan says so or if the debtor refuses to do it. Creditors can also start adversary proceedings by filing complaints to check a lien’s validity or priority, cancel an order confirming a plan, check if a debt can be discharged, get an injunction, or lower the priority of another creditor’s claim. [4]
Advantages of Filing Under A Chapter 11 Bankruptcy
Businesses that owe money have more choices than just Chapter 7. For example, those running a business, like companies, partnerships, and solo businesses, might want to keep their doors open and not sell everything off. These businesses should think about filing under Chapter 11 of the Bankruptcy Code. In Chapter 11, they can try to lower their debts, get more time to pay back, or even make bigger changes to their business setup. [3]
Chapter 13
Chapter 13 is generally not for businesses, but it can be used by individuals who are self-employed or running an unincorporated business, allowing them to reorganize their personal and business debts.
A Chapter 13 bankruptcy, also known as a wage earner’s plan, helps people with regular income create a plan to pay back all or part of their debts. In this plan, debtors suggest a way to make payments to creditors over three to five years. If the debtor’s monthly income is below the state median, the plan lasts three years unless the court agrees to a longer time “for cause.”
If the debtor’s income is higher than the state median, the plan usually lasts five years. No plan can go beyond five years, as stated in 11 U.S.C. § 1322(d). During this period, the law stops creditors from starting or continuing collection efforts. [4]
Filing for a Chapter 13 Bankruptcy
A business can file bankruptcy under Chapter 13 if its total secured and unsecured debts are less than $2,750,000 on the filing date (11 U.S.C. § 109(e).
It cannot file for Chapter 13 or any other chapter if, in the past 180 days, a previous bankruptcy was dismissed because the business representative did not show up in court, failed to follow court orders, or if a bankruptcy was voluntarily dismissed after creditors tried to recover property with liens. This is detailed in 11 U.S.C. §§ 109(g), 362(d) and (e).
Also, before filing for Chapter 13, credit counseling must be completed with an approved agency within 180 days. There are exceptions in emergencies or if there are not enough approved agencies available, according to 11 U.S.C. §§ 109, 111. If a debt management plan is made during counseling, it must be filed with the court. [4]
How Chapter 13 Works
When a company files a Chapter 13 petition, an impartial trustee is assigned to handle the case. According to 11 U.S.C. § 1302, this trustee is appointed to manage things fairly. In some areas, the U.S. trustee or bankruptcy administrator appoints a standing trustee for all Chapter 13 cases, as stated in 28 U.S.C. § 586(b). The Chapter 13 trustee checks the case and acts as a disbursing agent, gathering payments from the debtor and distributing them to creditors, following 11 U.S.C. § 1302(b). [4]
Automatic Stay in Chapter 13
When a business files a Chapter 13 petition, it automatically stops most collection actions against them or their property, according to 11 U.S.C. § 362. This filing does not stop certain actions listed under 11 U.S.C. § 362(b), and in some cases, the stay might only last a short time. The stay happens by law and needs no court action. While it is in effect, creditors cannot start or continue lawsuits, garnish wages, or even call to demand payments. The bankruptcy clerk notifies all creditors whose names and addresses are given by the debtor. [4]
For debt solutions for your business, call Frego & Associates.
FAQs
There are three main types: Chapter 7, Chapter 11, and Chapter 13. Chapter 7 means selling off assets to pay debts. Chapter 11 involves reorganizing the business to keep it going. Chapter 13 is mainly for individuals who are self-employed or run unincorporated businesses.
At the 341 meeting, also known as the creditors’ meeting, creditors can ask the debtor questions about their debts and property. This is a mandatory meeting where creditors gather information about the debtor’s financial situation.
Chapter 7 bankruptcy involves selling a business’s assets to pay off debts. This process results in the business closing down, with a trustee appointed to sell the assets and distribute the proceeds to creditors.
Chapter 11 bankruptcy, also known as reorganization bankruptcy, allows a business to keep operating while restructuring its debts. The business proposes a reorganization plan that must be approved by creditors and the court.
In Chapter 11, a debtor in possession (DIP) is a business that continues to operate while undergoing bankruptcy. The DIP retains control over the business assets and has duties like a trustee, such as managing property and filing reports.
Small business debtors in Chapter 11 are businesses with debts below certain limits, qualifying for streamlined processes to reduce costs and speed up the bankruptcy proceedings. Special provisions like the small business case and subchapter V apply to these entities.
Initially, only the debtor can file a reorganization plan within the first 120 days, extendable up to 18 months. After this exclusivity period, creditors or the case trustee can propose competing plans.
Chapter 11 lets businesses restructure debts, continue operations, and potentially come out stronger. It offers flexibility to renegotiate terms with creditors and reorganize for long-term success.
Yes, individuals who are self-employed or run unincorporated businesses can use Chapter 13 to reorganize personal and business debts, setting up a repayment plan over three to five years.
Sources:
[1] Chapter 7 Bankruptcy – Liquidation Under the Bankruptcy Code | Internal Revenue Service. (n.d.). https://www.irs.gov/businesses/small-businesses-self-employed/chapter-7-bankruptcy-liquidation-under-the-bankruptcy-code
[2] Bankruptcy Filings Rise 13 Percent. (2023, October 26). United States Courts. https://www.uscourts.gov/news/2023/10/26/bankruptcy-filings-rise-13-percent
[3] Chapter 11 – Bankruptcy Basics. (n.d.). United States Courts. https://www.uscourts.gov/services-forms/bankruptcy/bankruptcy-basics/chapter-11-bankruptcy-basics
[4] Chapter 13 – Bankruptcy Basics. (n.d.-b). United States Courts. https://www.uscourts.gov/services-forms/bankruptcy/bankruptcy-basics/chapter-13-bankruptcy-basics
