Reorganizing Your Business With Chapter 11 Bankruptcy
Updated: Jul 15
By Tsu-Li Liew
In the past two weeks, we explored how small businesses can benefit from filing either a Chapter 7 or Chapter 13 bankruptcy if they find themselves in financial distress. However, both of those bankruptcy chapters have restrictions in place that may prevent a small business owner from filing for either one.
In 2019, Congress passed the Small Business Reorganization Act (SBRA) that took effect in February 2020. The SBRA introduces a new subsection to Chapter 11 bankruptcy, called Subchapter V, making changes to filing requirements that make it easier for small business owners to file for a Chapter 11 bankruptcy. This opens up more opportunities for small businesses to file for bankruptcy, even if they have been incorporated as a partnership, a limited-liability company or a corporation.
Unlike a Chapter 13 bankruptcy filing, both individuals and incorporated businesses alike can file for a Chapter 11 bankruptcy. While a Chapter 7 bankruptcy filing allows both individuals and businesses to file as well, they would first have to pass a means test in order to qualify. A Chapter 13 bankruptcy filing has a limit on how much debt a business owner can have, which will be adjusted every three years. Middlebrooks Shapiro provides more information on a Chapter 13 debt limit. Subchapter V also has more requirements than a regular Chapter 11 bankruptcy filing. While a regular Chapter 11 bankruptcy filing does not have a debt limit, under Subchapter V, a small business owner’s total debt has to be below $2,725,625. Not only is there a debt limit, at least half of the debts must come from business activity and not an owner’s personal debt.
However, similar to the other bankruptcy chapters, a small business owner would have to receive credit counseling from an approved credit counseling agency within six months of filing for bankruptcy. There are only two exceptions: 1) an emergency situation, or 2) a lack of approved credit counseling agencies in the area. Individuals are also barred from filing for a Chapter 11 bankruptcy if they filed for any bankruptcy chapter in the previous six months, but had their case dismissed due to failure to appear in court or comply with court orders, or if they voluntarily dismissed the case.
Once a small business owner fulfills all the necessary requirements, they can file a bankruptcy petition with the court that serves the area they live in. An individual can voluntarily file for bankruptcy, but there are some cases where creditors of the business will file for bankruptcy instead, forcing an involuntary bankruptcy. Cooley provides more information on involuntary bankruptcies. In addition to the petition, a small business owner will have to file: (1) schedule of assets and liabilities, (2) a schedule of current income and expenditures, (3) a schedule of executory contracts and unexpired leases, and (4) a statement of financial affairs. A business owner filing in their individual capacity should also file with the court their certificate of credit counseling. If a debt repayment plan was developed during credit counseling, an owner should file a copy of the plan as well. Under Subchapter V, a small business owner needs to file a balance sheet, statement of operations, cash flow statements, and federal tax returns.
The filing fee for Chapter 11 bankruptcy is $1,167 and a $550 for a miscellaneous administrative fee, which are considerably more than the fees for a Chapter 7 or Chapter 13 bankruptcy. However, individuals may pay the fee in up to four installments with court approval, and they have four months to pay the last installment. A small business owner may also file for an extension of two months.
Once the petition has been filed, the court will appoint a trustee to the case. This trustee will have a smaller role than the trustee in Chapter 7 or Chapter 13 and acts more like an advisor who facilitates the development of a reorganization plan, appear at hearings and keeps track of the small business owner making timely payments. One important distinction is that the small business owner will have to pay the trustee, and the payment will depend on the owner’s quarterly distributions, which can range from $325 to $30,000. It is important that a business owner does not forget to pay their trustee, as the trustee can file a motion with the court to change the bankruptcy chapter to a Chapter 7 or dismiss the case altogether.
In regular Chapter 11 cases, the trustee will appoint a creditor’s committee to consult with the small business owner about the repayment plan. However, in a Subchapter V case, the trustee might not find enough creditors to serve on the committee, which means that the creditor’s committee will not be as active or not active at all in the case. Since the creditor’s committee will take a smaller role in a Subchapter V case, the small business owner can finalize a repayment plan without the votes and acceptance of the committee. It is important that the plan does not unfairly discriminate against any of the creditors and in order to be fair, the creditors should get back as much as they would in a Chapter 7 bankruptcy.
A regular Chapter 11 bankruptcy may take more than a few years to complete. In comparison, a Subchapter V case moves very quickly as some of the regular Chapter 11 requirements will be dropped and can resolve within three to five years, much like a Chapter 13 bankruptcy. The court will hold a status conference within 60 days after the filing of the petition. Fourteen days before that conference, the business owner will have to report the efforts they are taking to come up with a repayment plan. A repayment plan should be filed with the court within 90 days of filing the bankruptcy petition. The big difference between a regular Chapter 11 filing and a Subchapter V filing is that only the small business owner can file a repayment plan. In a regular Chapter 11 filing, if the business owner does not file within a certain time period, their creditors can file a plan instead.
Once a petition is filed, a business owner will receive an automatic stay, which prevents most creditors from collecting a debt from the owner, even if these claims were filed before the filing. An automatic stay gives the business owner some time to negotiate and resolve some of the problems of the business owner’s financial situation. This automatic stay does not apply to regular business activities. During the regular operation of the business, an owner still needs to pay expenses incurred by the business.
Another reason a Subchapter V filing takes less time is because a small business owner does not have to file a disclosure statement, which is usually designed to provide creditors with information to analyze and vote on the repayment plan. Creditors can dispute the amount of information, which can delay a vote. However, since a Subchapter V case does not require a disclosure statement from the business owner, it will significantly reduce the length of time of the case. The business owner will instead file: 1) a history of the business operations, 2) a liquidation analysis, and 3) projections showing the owner’s ability to make the payments. The creditors will have to determine whether their claims are accurately listed on the owner’s schedules and repayment plans.
Once the small business owner files the repayment plan with the court, the court will then have to confirm it. The business owner will need to pass two conditions. The court must find that 1) the business owner will be able to make all the plan’s payments and 2) that even if there is a good chance the business owner can make the payments, the plan contains protections for the creditors if the owner fails to make the payments. If there is a consensual plan, the owner’s debt may be discharged. Without a consensual plan, the debts will be discharged once the owner makes all the payments under the plan.
For more information about a Chapter 11 bankruptcy, the U.S. Courts website provides details about a regular Chapter 11 filing, while the National Law Review focuses on Subchapter V of the Small Business Reorganization Act.
Advantages and Disadvantages
Similar to the other bankruptcy chapters we have previously discussed, filing for a Chapter 11 bankruptcy under Subchapter V will have its advantages and its disadvantages for a business owner. One of the biggest advantages is that there are less restrictions to filing a petition for Chapter 11. A business owner will not be prevented from filing due to the amount of income they generate in comparison to the average, nor will it depend on how business was incorporated. However, Subchapter V does have more limitations than a regular Chapter 11 filing. At least half of the debt has to come from business activity and must be below $2.7 million to be eligible for a Subchapter V filing. Otherwise, a business owner will have to rely on a regular Chapter 11 filing, which can be very expensive and more time-consuming since there are more steps to take during the process.
Another advantage is that the trustee has a smaller role than a trustee in Chapter 7 or 13 bankruptcies. The trustee will not be in possession of any of the business owner’s assets or property and acts more like an advisor that will steer the owner into the right direction, making sure that they are following the repayment plan. The biggest downside to a Chapter 11 trustee is that the business owner will have to pay them for their role, and non-payment can result in a conversion or dismissal of the bankruptcy petition. A Chapter 11 Subchapter V bankruptcy gives an owner more freedom when repaying a business’s debts, as they are the only ones who can file a repayment plan and not have to worry about creditors filing their own plan to the court.
While there are many advantages to a Chapter 11 bankruptcy filing in comparison to the other chapters, there are some disadvantages that are important to note. One of them is the cost. Not only do the filing and administrative fees cost more than the Chapter 7 or 13 ones, a business owner will have to pay their trustee as well during the process. Another disadvantage is that a Subchapter V has some limitations regarding who can file for one. Even though both individuals and incorporated businesses can file under Subchapter V, the debts cannot be more than $2.7 million and the business must engage in commercial activity, although it cannot be a single-asset real estate operation.
The SBRA allows small business owners or businesses in debt to reorganize without liquidating their assets. Though a Chapter 11 bankruptcy filing is more expensive than the other chapters, it offers small business owners another avenue of saving their business without having to sell everything. Especially during the COVID-19 pandemic, it is important that small business owners explore every avenue they can to help their struggling business. The CARES Act raises the debt limit for a Chapter 11 Subchapter V bankruptcy filing to $7.5 million and this will apply to all cases filed within one year of the CARES Act’s passage. This gives greater flexibility to businesses who fall out of the $2.5 range but cannot afford a regular Chapter 11 bankruptcy.
Are you interested in launching or sustaining a pandemic proof small business? Spot issues, take action, stay safe, and thrive in a post Covid-19 world with Legalucy. Learn more at thelucyreport.com
Your interaction with Legalucy and mypandemicproofbusiness.com does not create an attorney client relationship. We provide information for your reference only. Such information should not and cannot be construed as legal advice. For more information, please contact email@example.com.