Many of my small business corporate clients are reluctant to file for Chapter 11 Bankruptcy because there a lot of misconceptions about the process. This is understandable as small business Chapter 11 bankruptcy is a niche area and there is not much good information about it being passed around. Additionally, this is an area of law that is very safely guarded by the Courts and most attorneys (even bankruptcy attorneys) are not allowed to represent their clients in chapter 11. The reason for this is that Chapter 11 cases are extremely complicated and require an understanding of a different set of rules than Chapter 7 and Chapter 13 cases. There are also a lot of extra requirements such as filing a disclosure statement, paying attention to the exclusivity period…etc. Given the fact that we are expecting a wave of new small business cases to be filed over the next few years it is a good idea to get a basic understanding of preparing for a small business Chapter 11 Bankruptcy filing.
Your Business Does Not have To Close
I am always shocked at the fact that a discussion with my clients about Chapter 11 usually begins with an assumption by them that they will have to close the doors the moment the case is filed. This could not be further from the truth and this is the key difference between Chapter 11 and Chapter 7 Bankruptcy. In a Chapter 7 small business bankruptcy case the business does close the moment the case is filed; in a Chapter 11 small business bankruptcy case the case is filed so that the business does not close. A Chapter 7 is a liquidation that requires business closure in most cases and a Chapter 11 is a reorganization that requires that the business remain open in order to get debt relief. The business remains open by virtue of the automatic stay being invoked immediately after a case number is issued. This allows time to figure out how to repay the secured creditors as well as the unsecured debt. The answer as to how the business does this will depend largely on the financial situation of each debtor. Luckily, the automatic stay is in effect while we figure this out.
Automatic Stay In Chapter 11
After the case is filed, you can breathe a little bit easier…but not for too long. The automatic stay is now in effect and secured and unsecured creditors are prohibited from taking any collections efforts. This means that any pending judicial sales of property or any judicial freezes of bank accounts cannot proceed. This also means that any monthly (or sometimes weekly or daily) payments scheduled for creditors must cease. The automatic stay protection is what allows your business to operate without having to worry about impending debt issues. The idea is that your business can coast for a few months without debt service and see how it does. This allows the Court and the creditors to evaluate whether your business has long term reorganization potential. This does not mean that there are not exceptions to the automatic stay protection; nor does it mean that it is completely immune from creditor attacks. Any issues with the automatic stay are usually known before filing and will be discussed as you put the petition together with one of our bankruptcy lawyers.
First Day Motions For Small Business Chapter 11 Cases
I began the prior section of this post by allowing you to breathe a little easier…but not for too much longer. There are a whole host of responsibilities that a small business chapter 11 debtor must take on but the most urgent is what we refer to as “first day motions.” For small business debtors there are usually only two such motions: a motion for use of cash collateral and a motion to pay pre-petition payroll.
Motion For Use Of Cash Collateral
This motion is filed to allow for something that you probably did not know exists. Most small businesses that end up filing for Chapter 11 usually take out a secured loan at one point or another. Almost all of these secured debts are secured by all of your business assets. This means that they are secured by your office furniture, your vehicles, and the money in your bank account. That’s right, the money in your bank account. This is not an issue that comes up outside of bankruptcy very often because it usually requires a lawsuit for a creditor to enforce it. The story changes when a bankruptcy case is filed because you proactively bring everyone to court by filing the case. It is crucial to understand that as soon as you do this the secured creditor’s lien on your business property is active. This means that you cannot spend your own money. In fact, the bankruptcy code goes so far as to define cash collateral. This is why we file a motion on the first possible day to allow for you to use the money in the bank account to operate your business. This is a very complex issue and we spend a considerable amount of time preparing for it prior to filing the case.
Motion To Pay Pre-Petition Payroll
The other common first day motion filed in a small business Chapter 11 case is a motion to make payroll. This motion is necessary if you want to keep your employees paid and working for you after the bankruptcy case is filed. The reason this motion is filed is that most small businesses that issue payroll every two weeks (or twice per month). The payroll that is being paid to the employees as well as the taxes being withheld are always being paid for the prior weeks worked. When filing a bankruptcy case you are prohibited from paying any creditors that you owed money to for any time before the case was filed. Yes, your employees are creditors. The Court considers this such an important issue to deal with that it will allow you to present this issue the day the case is filed. What you will do in to motion is ask for special permission to allow for payment of the employees as pre-petition creditors. As long as there is sufficient money in the bank to make the required payroll and your payment records are somewhat organized this motion is routinely granted. This motion is also something discussed at length prior to the case being filed.