Business bankruptcy usually involves Chapter 7 or Chapter 11 bankruptcy. Both types of bankruptcy can include “debt settlements” and “creditor negotiations” to reduce or pay off debts.
Chapter 7 Bankruptcy
If it files for Chapter 7 bankruptcy, the business will cease operations. Its assets will be wound up, and the proceeds of the sale will be used to pay creditors. Outcomes of Chapter 7 bankruptcy: 1) Debt reduction 2) The company closes. The court will set deadlines for paying off debts and winding up the business.
Chapter 11 Bankruptcy
If a Chapter 11 bankruptcy is filed, the company is allowed to reorganize and remain in business under a court-arranged debt repayment plan. Management will continue with the day-to-day operations of the company, but all major business decisions must be approved by the bankruptcy court.
In Chapter 11 bankruptcy, the court oversees business restructuring and settlement of debts. The purpose of this is to restore the financial health and commercial vitality of the company. If Chapter 11 bankruptcy fails to achieve this goal, the court or creditors can compel the business to file for Chapter 7 bankruptcy.
Alternatives to Bankruptcy – Liquidation (Workout)
Sometimes a business can liquidate to reorganize itself and avoid bankruptcy court. During the liquidation process, experts help a business analyze its operations, cash flow, liabilities, and contractual obligations. Experts then negotiate with creditors to reduce the debt and extend the time to pay it off.
Bankruptcy Considerations
When a business is contemplating bankruptcy, there are some things to be aware of.
First, the business form is very important. Corporations, limited liability companies, and partnerships are legal entities separate from the shareholders or partners. Companies have the right to file for Chapter 7 or Chapter 11 bankruptcy on their own. However, under a partnership, the trustee can sue the general partner if the partnership becomes insolvent. Therefore, a partner may be sued in court by a well-funded settlor representing all creditors.
A sole proprietorship is just an extension of the owner. Businesses cannot file for bankruptcy on their own. Since the business assets and liabilities are also the assets and liabilities of the business owner, the owner must file for bankruptcy. The owner can file for Chapter 7, Chapter 11 or Chapter 13 bankruptcy (if the debt limit is reached).
Second, the reason why the enterprise is facing the problem is also the key, and the enterprise should know the reason and the possible solution. This is because restructuring (Chapter 11 bankruptcy) does not create new markets, increase revenue, or get the best people to run the business. It can only free up some cash by rescheduling old debt or rejecting some unadvantaged contracts. It does provide business owners with breathing room to consider selling the business. Excess funds can be used to pay taxes or salaries. Later, the Chapter 11 bankruptcy can be transformed into a Chapter 7 bankruptcy, or a good relationship with the creditor can be established, and the Chapter 11 bankruptcy can be withdrawn.
Still, Chapter 11 bankruptcy can be time-consuming and laborious for owners/shareholders and managers, who must follow the bankruptcy process, work with attorneys, and negotiate with creditors. These will increase costs. So, most Chapter 11 reorganizations fail.
Bankruptcy Bargain is also an option. Essentially, debtors fully disclose their financial situation to creditors and the courts in order to obtain an “automatic stay” and other bankruptcy protections. Not only that, but the debtor needs to assume fiduciary responsibility to the creditor during the bankruptcy process.
Third, whether to establish a new enterprise after bankruptcy is also a consideration. For businesses that require little capital, few assets, or are simply an extension of the owner’s technology, a Chapter 11 reorganization may not be necessary. The owner is better off filing for Chapter 7 bankruptcy to wind up the business and start a new business from scratch.
Bankruptcy laws are complex and require professional advice.
Lei Jiang Law Firm provides bankruptcy and other commercial and corporate legal services. Please contact us for more detailed information and specific analysis.