These are unprecedented times. The government shut-downs and social distance and masking protocols have hurt many entrepreneurs with small businesses, forcing them to restrict operations or close temporarily. As a result, many people are out of work or underemployed.
Of course, there is hope that a 100% reopening of the economy will be safely accomplished eventually, but in the meantime, small businesses are relying on government assistance to survive, and how long will that assistance be available? How long can a business possibly survive on government aid?
A hard look at the economic slowdown suggests that small business bankruptcies are headed for record numbers in the coming months and years. Small businesses looking to cease operations and liquidate assets can file a Chapter 7 bankruptcy case and be finished. But if you could continue business operations if only you had the opportunity to renegotiate your debt, you can get your small business back on track and move on with a Chapter 11 bankruptcy filing.
How Do I Know Chapter 11 is Right for My Business?
If you are remotely considering the possibility of filing business bankruptcy under Chapter 11, you must plan ahead. Ask yourself these questions before making any decisions or taking any action:
- Can my business continue if it reorganizes its debt? If you think so, then review the provisions of Chapter 11 or the new Subchapter 5 Small Business Bankruptcy sections of the Bankruptcy Code. If deciphering a nuanced area of law is not something you have time for, as most business owners don’t, arrange to meet with an experienced business bankruptcy attorney to discuss your situation and your options.
- Is my business a sole proprietorship? If it is, you may be able to reorganize your business debt under an individual Chapter 13 filing, which will have substantially fewer costs. You can also deal with your personal debt in Chapter 13. Contact a bankruptcy attorney to find out if Chapter 13 might work for you and your business.
- How much business debt have I personally guaranteed? Know that a Chapter 11 filing will not discharge your personal responsibility to pay a debt you guaranteed.
- Are my financial records in order? If not, get help straightening them out, because once you file Chapter 11, you must make your financial records available to the Trustee who will review them. If your books are slipshod or simply unavailable, it is very likely your case will be dismissed.
How Chapter 11 Works
Your business can continue operating after you file a Chapter 11 bankruptcy case. As the owner of the business, you are called the “debtor in possession.” Only if business owners are grossly incompetent or attempting to defraud the bankruptcy court will a court-appointed Trustee step in and take control of the debtor in possession.
That being said, you cannot make certain decisions without the court’s approval. These include:
- Sale of business assets, other than inventory;
- Starting or terminating a rental agreement;
- Stopping business operations;
- Expanding business operations;
- Retaining and paying attorneys and other professionals, such as accountants;
- Entering into new contracts with vendors or unions;
- Taking out a loan that will be issued once the Chapter 11 closes.
As part of your Chapter 11 filing or shortly after filing, you will propose a plan of reorganization. This plan must be in the best interests of your creditors and will be subject to their approval or objection if warranted. If you fail to timely file a reorganization plan, your creditors will likely file one for you.
The plan can include downsizing to reduce expenses, renegotiating debts, and liquidating some or all business assets to satisfy the debt. If your reorganization plan is feasible – meaning possible for your business to execute and still operate – and fair to your creditors, the bankruptcy court will approve it and you as debtor-in-possession may begin to execute the plan.
Special Considerations for Small Business Debtors
In February 2020, the Small Business Reorganization Act of 2019 (“the Act”) became law. The Act added a new subchapter to Chapter 11 of the Bankruptcy Code designed to make the Chapter 11 procedure more streamlined for small businesses.
Under the Act, small businesses are defined as “entities with less than about $2.7 million in debts,” and the type of debt matters. Additionally, the Act grants qualifying small businesses shorter deadlines for completion of the case, more flexibility in negotiating with creditors, and access to an experienced Trustee who can help the debtor in possession work with creditors to achieve a plan of reorganization that is both feasible and fair.
The CARES Act and Small Business Debtors
The Coronavirus Aid, Relief, and Economic Security Act (“The CARES ACT”) was signed into law by the president on March 27, 2020. The CARES Act raised the small business debt limit to $7,500,000, among other things, so that more businesses qualify for small business treatment by the bankruptcy court.
The CARES Act also provided for grants and low-interest loans through the Small Business Administration. Some loans are forgivable if used to fund qualifying expenses.
What if after reading this, I realize that my business is at the end?
If there is no chance of continuing business operations, you can use Chapter 7 bankruptcy to tie up the business’ loose ends. Through the 4-6 month Chapter 7 process, the Trustee will liquidate the assets of the business to pay creditors. However, you should be aware of the following ramifications:
- A business Chapter 7 filing does not discharge a personal guarantee for business debt. Having outstanding personal guarantees may force you to file a personal Chapter 7 case in addition to your business Chapter 7 case.
- A business Chapter 7 filing will not discharge employment taxes or sales taxes. You as the owner may be personally responsible for paying those.
- Have you paid any creditors or distributed any product or assets which may deprive your other creditors of their full share? TheChapter 7 Trustee will not hesitate to “clawback” those payments or distributions for the benefit of all of the business’ creditors. The Trustee also has the power to sue the owner of the business to recover monies that have been disproportionately siphoned off from the business for personal expenses.
Whichever course you decide to take, if you see bankruptcy in your future, be sure to consult with an experienced business bankruptcy lawyer so that your filing is successful and there are no unintended consequences from your filing. Good luck!
About the Author: Veronica Baxter is a legal assistant and blogger living and working in the great city of Philadelphia. She frequently works with Stephen V. Bottiglieri, Esq., a bankruptcy lawyer in Woodbury, NJ.
