Business Bankruptcies a Sign of the Times

March 16, 2011

By HunterMaclean Attorneys

Published in Business in Savannah

Bankruptcy has become a major reality in today’s business world due to the combination of a lengthy recession, high unemployment and a sluggish real estate market. Although filing for bankruptcy can help restructure or reduce business debt, the choice does not come without serious consequences.

Bankruptcy laws are designed to help individuals and business owners who can no longer pay their creditors get a “fresh start” by liquidating assets to pay their debts or by creating a repayment plan. Bankruptcy laws also provide for orderly distributions to business creditors through reorganization or liquidation.

A bankruptcy case normally begins when the debtor files a petition with the bankruptcy court. A petition may be filed by an individual or by a corporation, LLC or partnership. The debtor is also required to file statements listing assets, income, liabilities, and the names and addresses of all creditors and how much money each creditor owed. The filing of the petition automatically prevents, or “stays” any further debt collection actions against the debtor and the debtor’s property.

As long as the stay remains in effect, creditors cannot bring or continue lawsuits, enforce garnishments, foreclose on real estate, or make telephone calls demanding payment. There are certain exceptions to the stay. Creditors will receive notice of the filing and will be given a deadline to file proofs of claim.

Generally speaking, there are five basic types of bankruptcy cases under the U.S. Bankruptcy Code, which are referred to by the numerical chapters in the bankruptcy code which describe them. Most business bankruptcy cases are filed under Chapter 7 or Chapter 11.

Chapter 7 is a liquidation process under which a trustee takes over the assets of the debtor’s estate, converts them to cash and makes distributions to creditors according to a statutory priority scheme. This process is subject to the rights of secured creditors, and individual debtors can exempt certain limited types of property from creditors. Because there is often little or no nonexempt and unencumbered property in many Chapter 7 cases, the trustee may have limited funds to distribute. Thus, a creditor holding an unsecured claim in a Chapter 7 case will get a distribution from the bankruptcy estate only if there are assets in excess of secured and priority claims and costs of administration. Individuals filing Chapter 7 cases will receive a discharge that releases them from personal liability for most debts. Certain debts cannot be discharged, such as student loans, some taxes and debts that creditors prove were incurred through fraud.

Chapter 11 is used by commercial enterprises that want to continue operating a business and repay creditors simultaneously via a court-approved plan of reorganization. Chapter 11 is sometimes also utilized by individuals, usually with business debts, who do not qualify for Chapter 7 or 13. A Chapter 11 debtor usually has the exclusive right to file a plan of reorganization for the first 120 days after a case is filed. The filer must provide creditors with a disclosure statement containing information that enables creditors to review the plan, and to vote whether to accept or reject it. In some cases a creditors’ committee is appointed that will also evaluate and negotiate over the proposed plan. Ultimately, the court decides whether to confirm (approve) the plan of reorganization.

A Chapter 11 plan may take many forms, depending on the debtor’s reasons and goals for the filing. For example, the plan may compromise debts by repaying a portion of the obligations. It may also involve rejecting (terminating) unprofitable contracts and leases, restructuring or refinancing loans, or giving creditors equity interests in the restructured enterprise in exchange for their claims. Typically, the structure of the plan reflects the results of extensive negotiations with creditor constituencies.

Businesses may also sell some or all of their assets in a Chapter 11 proceeding. A sale under the auspices of a bankruptcy proceeding can be attractive to prospective purchasers, because the buyer will acquire the assets free and clear of most liens, claims and interests arising pre-bankruptcy. The Chapter 11 filing of Chrysler was an example of such a case.

While a business is operating under Chapter 11 bankruptcy protection, vendors who do business with the debtor post-filing are given the protected status of “administrative expense claims,” having a priority over pre-bankruptcy claims. The bankruptcy code gives vendors this favored treatment in order to encourage them to do business with debtors in bankruptcy. Chapter 11 debtors are expected to pay their post-bankruptcy bills in a timely fashion as a condition of being allowed to use the bankruptcy process to restructure their debt.

When should a business consider filing for bankruptcy? Many factors may precipitate the question, including adverse creditor actions such as foreclosure notices or judgments, liquidity issues, inability to service debts, or the need to downsize and eliminate unprofitable locations. Whatever the concern, the determination whether to file for bankruptcy is a decision that should be undertaken only after careful consideration of the costs, benefits and alternatives.

Bankruptcy gives the debtor certain rights and leverage against creditors, but also involves ceding some control over the process to the court, creditors and possibly a trustee. Business should consult with competent bankruptcy counsel, and competent financial advisors, before the crisis becomes so acute that time does not permit a careful assessment of the best course of action.

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