Can Filing For Bankruptcy Protection Save My Small Business?

Let’s answer the top-line question right out of the gate: yes, filing for bankruptcy protection can most certainly save your business. The benefits of the bankruptcy laws do not exist solely for big companies. In fact, they can apply with equal effectiveness to save your small business when it runs into financial difficulty. Here is how.

A Quick Sketch of Business Bankruptcies

Bankruptcy is a judicial process by which a debtor seeks legal protection from financial obligations to creditors. For businesses, a bankruptcy generally takes one of two forms, referred to by the chapter of the United States Bankruptcy Code that governs them:

• Chapter 7 business bankruptcies accomplish a partial repayment and (effectively) a cancellation of debts through the supervised liquidation of a business’s assets;
• Chapter 11 business bankruptcies accomplish the judicially-supervised reorganization of a business’s debts so that the business can continue to operate.

People unfamiliar with bankruptcy law sometimes harbor the misconception that bankruptcy means the death of a business. In fact, the Bankruptcy Code exists principally to give individual and business debtors alike a “fresh start.” Far from killing a business, going through a Chapter 11 bankruptcy, in particular, accomplishes something much closer to a “rebirth.” The reorganized company emerges from bankruptcy free of crushing debt burdens, able to continue operating on terms that give it at least a reasonable shot at long-term success.

The Chapter 11 Bankruptcy Process

Seeking Chapter 11 bankruptcy protection as a small business begins with filing what is known as a “petition” in the United States Bankruptcy Court located in the jurisdiction where the business resides. That filing alone triggers one of the most powerful protections the law offers for a business: an “automatic stay” (or “freeze”) that prevents the business’s creditors from taking action to collect on debts. This freeze gives the business the time and breathing room it needs to reorganize its debts in a fair and reasonable manner, according to the process dictated by the Bankruptcy Code.

In conjunction with filing its petition, the business must also file “schedules” that essentially disclose the details of its financial condition, and in particular, to whom it owes money and in what amounts. These are the business’s creditors, and they, too, have rights under the Bankruptcy Code. Specifically, they get to form a “committee” – if they so choose – that has a say in the terms on which the debtor can reorganize.

Filing a bankruptcy petition also transforms a Chapter 11 business debtor, in a sense, into a special legal entity called a “debtor-in-possession.” The business continues to operate, but subject to special duties to its (now-“frozen”) creditors dictated by the Bankruptcy Code. Those duties limit the debtor’s ability to take some actions without permission, such as borrowing money or selling assets, and obligates the debtor to take others, such as preparing and filing monthly financial reports of its operations, assuming or rejecting “executory” contracts, and responding to claims by specific creditors.

The ultimate aim of a Chapter 11 business bankruptcy is court and creditor approval (called “confirmation”) of a “plan of reorganization” that addresses the business’s obligations  of each of its “classes” of financial stakeholders, including creditors and equity holders. The plan typically proposes to adjust terms and conditions of the business’s debts, management, and (sometimes) ownership in a manner that allows for the business to emerge from bankruptcy as a viable enterprise. A plan may, for example, propose to extend debt repayment dates, allocate certain business proceeds to the repayment of debts, or adjust equity ownership interests. For a court to “confirm” a plan of reorganization, at least one class of creditors with an “impaired” claim (that is, whose rights as creditors get affected under the proposed plan of reorganization) must accept the plan, as reflected in a vote of approval by holders of at least 1/2 of the number of allowed claims in that class, who also hold at least 2/3 of the amount of allowed claims in that class.

Upon confirmation, the business “emerges” from Chapter 11 bankruptcy, no longer a debtor in possession, but a business with a “fresh start”, free of its old debts and subject instead to the terms of the confirmed plan.

Small Business Chapter 11 Bankruptcies

The Bankruptcy Code specifically addresses cases involving bankruptcies of small businesses. Under the Code, a small business debtor is one with total “non-contingent liquidated secured and unsecured debts” of $2,566,050 or less, which either has no creditor committee or for which the creditor committee is not active. Small businesses that qualify for this treatment must follow specific procedures, and submit to close supervision by a “trustee” appointed by the Bankruptcy Court, to demonstrate they have a solid business plan for reorganizing and that they have a realistic shot at confirming a plan of reorganization. In return, they get an exclusive 180-day period to propose that plan of reorganization. (Ordinary Chapter 11 debtors get only 120 days of “exclusivity” before other stakeholders can propose their own plans that are usually far less-favorable to the business than what its existing management proposes.)

Legal Advice for Small Businesses That Need Bankruptcy Protection

Small business owners know when they need help. It is one thing to operate on a shoestring. It is another to realize you cannot possibly support your current debt load and financial obligations to vendors and other “trade creditors” as things stand. Owners who reach that moment of realization should, immediately, seek the advice of an experienced business bankruptcy attorney.

The steps small business owners take pre-bankruptcy can have a significant effect on the outcome of a Chapter 11 case. If you want your business to survive the bankruptcy process, which it absolutely can in most cases with the right planning and approach to a Chapter 11 filing, then get the legal advice you need as soon as possible. Contact an experienced, seasoned business bankruptcy practitioner who can begin plotting a course through the Bankruptcy Code for your business, so that it emerges free of its unsupportable financial burdens and viable for the long-term.