How Chapter 11 Can Help Business Bankruptcy

You probably remember some giant corporations that were forced to declare bankruptcy, including United Airlines, the Texas Rangers, Marvel, Trump Entertainment Resorts and the Chicago Cubs. And each year, more than 22,000 American companies declare bankruptcy— and about one in four file for Chapter 11.

"Many small business owners can't afford to stay open, and it's very hard," says Cathy Moran, a bankruptcy attorney in Mountain View, Calif. But with a solid reorganization plan approved by your creditors, Chapter 11 may be the light at the end of the tunnel. Moran says fear, stubbornness and pride are the three emotions that most commonly interfere with a decision to file for bankruptcy. "Staying in debt means living with stress or dying of stress," she says. "Bankruptcy is not a moral failing; it's a legal solution to an economic problem."

Here are the pros and cons that you should weigh when making the decision whether to file a court petition for these legal protections:

Benefits

• Your business can continue operating while paying off debts.
• You can pay back at least part of your unsecured debts.
• You have the freedom to restructure secured debts to make lower payments and spread the debts over a longer period of time.
• Bankruptcy's automatic stay gives relief from harassing creditors contacting you at home or at your business.
• You have the benefit of "automatic stay," which stops foreclosures and debt collection until the case is resolved.

Of all of the benefits of Chapter 11, automatic stay is especially important, Moran says: "It has legal effect even if the creditor hasn't gotten official notice or a copy of the filing. It's no defense to say, 'I haven't gotten notice from the court.' This gives the debtor breathing space."

"The bankruptcy case brings all of the debtor's assets and all of the creditors into the same court, where the rights of all concerned can be balanced," Moran continues. "The automatic stay also protects creditors from being aced out of payment by other, more aggressive creditors."

Drawbacks

• There's a stigma to bankruptcy, unfair or not. Business owners may be reluctant to file Chapter 11 because they believe that declaring bankruptcy will affect their reputation.
• You'll suffer a loss of privacy. Debtors trying to reorganize under Chapter 11 must file detailed financial information with the bankruptcy court. These documents become public record with a court filing and are available to anyone.
• Expect a lot of paperwork. You'll have to maintain and report detailed financial records on a regular basis.
• You'll have to show your business is profitable. Profitability requirements. Debtors reorganizing under Chapter 11 must show profitable operation when their debts and obligations are reorganized. Although Chapter 11 reorganization can help the business reach profitability by reducing expenses, you'll need reason to believe that reorganization can make the business profitable again.
• You'll lose some control over business operations. You'll retain control over most operations known as "the ordinary course of business." But you'll need court approval to do other things like refinancing, selling or buying business property, leasing or breaking a lease, expanding operations, or signing and changing vendor agreements, licensing contracts and union contracts.
• There may be restrictions on compensation. The court may set pay limits for corporation insiders like company officers, directors and major shareholders.
• Your original shareholders could lose their position completely. When General Motors completed its reorganization under Chapter 11 in 2009, the value of its stock dropped to zero, and most of the old shareholders lost their investments. With smaller corporations, a well-planned Chapter 11 reorganization may preserve the control and investments of the old shareholders.
• During the confirmation process, creditors, shareholders and others may weigh in on court decisions, and the court may force you to pay for legal representation for unsecured creditors.

A Chapter 11 bankruptcy doesn't mean your business is closing its doors. Instead, a Chapter 11 lets you restructure your finances so that creditors and owners can get the maximum returns. In other words, you stay in control of your assets, work with the courts to come up with a plan to repay your debts and (if all goes well) make a strong comeback.

"For legal advice specific to your situation, see a bankruptcy lawyer," Moran says. "It's a complicated process and I wouldn't try to go it alone." Even the simplest Chapter 11 reorganization, she says, is roughly 10 times the cost of a Chapter 7 personal bankruptcy.

Attorneys can also advise you how to run your business without getting into debt. "Chapter 11 is often a knee-jerk reaction when things fall apart," she says. "The usual problem is there is no real plan, as in, what would you differently than you did before if you could reorganize?"

Here's a brief guide to how a Chapter 11 bankruptcy works:

You'll need to gather and organize all of your business paperwork. This includes documents proving what you owe, how much you owe, and to whom you owe it, as well as any payments you've made. Add to that any collection letters or any other documents related to your debts. Essentially, if something is relevant to your Chapter 11 bankruptcy, it's important that you prove it with written evidence, Moran says.

"Bear in mind that you must provide this information within 15 days of the date of filing, so be ready before you send in the official Chapter 11 bankruptcy filing," she says. "Your attorney will know these time limits and all the other details, which is why I strongly urge people to talk to a bankruptcy lawyer about their own situation."

The court will need a reorganization plan and a disclosure statement. Here are examples of each: a copy of the form for a reorganization plan under Chapter 11 and a Chapter 11 disclosure statement. For reference, here is a reorganization plan proposed by Winn-Dixie corporation; for a small business, the plan will be considerably less complex.

To approve, or "confirm" a Chapter 11 bankruptcy, a court will want to see the following in your plan:

• Persuasive evidence that the plan is feasible and likely to succeed
• A description of your business and its history
• A list of your creditors and claims, unexpired leases, contracts and how you plan to classify and treat each claim
• Events leading up to the bankruptcy
• Risk factors of the reorganization plan
• How the plan will be funded
• Tax implications of the plan
• Who will be directing the reorganization (officers or voting trustees)
• That you're proposing the plan in good faith, with your signature on a statement to that effect. This means you believe the plan to be accurate based on the facts of the case when you file the petition.
• That the plan is in the best interest of creditors. The court will determine if the plan goes as far as possible in repaying what creditors are owed.

A Chapter 11 plan is confirmed only upon the affirmative votes of the creditors, who are divided by the plan into different classes based on the amount of their individual claims.

Business owners who file for Chapter 11 sometimes manage to recover with their business intact. In most cases, however, the Chapter 11 bankruptcy is dismissed or converted to a Chapter 7 bankruptcy, which forces the debtor to sell off assets to pay creditors. Moran says conversion to Chapter 7 can occur for a number of reasons, though typically it's because the owner is unwilling or simply unable to follow through on the confirmed reorganization plan. However, with careful planning and help from your attorney, Chapter 11 may work for you.