Source: Cathy Moran, Bankruptcy Attorney, Silicon Valley and Steve Evans
That dream of owning your own business has turned sour. The popular neighborhood coffee shop you started was flourishing until a national coffee chain opened a block away. You’ve tried everything, even maxed out your business credit cards, but the cash flow can’t keep up with your cash obligations. It’s time to consider a Chapter 11 bankruptcy – a type of bankruptcy usually reserved for businesses.
This type of bankruptcy could save your business and lower your debts, though there are some disadvantages, too. This guide provides the information you’ll need to make an informed decision.
Is a Chapter 11 Bankruptcy Right for Me?
You probably remember some giant corporations that were forced to declare bankruptcy, including United Airlines, the Texas Rangers, Marvel, Trump Entertainment Resorts and the Chicago Cubs. And each year, nearly 25,000 American companies declare bankruptcy— and about one in four file for Chapter 11.
“Many small business owners can’t afford to stay open, and it’s very hard,” says Cathy Moran, a bankruptcy attorney in Mountain View, Calif. But with a solid reorganization plan approved by your creditors, Chapter 11 may be the light at the end of the tunnel. Moran says fear, stubbornness and pride are the three emotions that most commonly interfere with a decision to file for bankruptcy. “Staying in debt means living with stress or dying of stress,” she says. “Bankruptcy is not a moral failing; it’s a legal solution to an economic problem.”
Here are the pros and cons that you should weigh when making the decision whether to file a court petition for these legal protections:
- Your business can continue operating while paying off debts.
- You can pay back at least part of your unsecured debts.
- You have the freedom to restructure secured debts to make lower payments and spread the debts over a longer period of time.
- Bankruptcy’s automatic stay gives relief from harassing creditors contacting you at home or at your business.
- You have the benefit of “automatic stay,” which stops foreclosures and debt collection until the case is resolved.
- Of all of the benefits of Chapter 11, automatic stay is especially important, Moran says: “It has legal effect even if the creditor hasn’t gotten official notice or a copy of the filing. It’s no defense to say, ‘I haven’t gotten notice from the court.’ This gives the debtor breathing space.”
- “The bankruptcy case brings all of the debtor’s assets and all of the creditors into the same court, where the rights of all concerned can be balanced,” Moran continues. “The automatic stay also protects creditors from being forced out of payment by other, more aggressive creditors.”
- There’s a stigma to bankruptcy, unfair or not. Business owners may be reluctant to file Chapter 11 because they believe that declaring bankruptcy will affect their reputation.
- You’ll suffer a loss of privacy. Debtors trying to reorganize under Chapter 11 must file detailed financial information with the bankruptcy court. These documents become public record with a court filing and are available to anyone.
- Expect a lot of paperwork. You’ll have to maintain and report detailed financial records on a regular basis.
- You’ll have to show your business is profitable. Profitability requirements. Debtors reorganizing under Chapter 11 must show profitable operation when their debts and obligations are reorganized. Although Chapter 11 reorganization can help the business reach profitability by reducing expenses, you’ll need reason to believe that reorganization can make the business profitable again.
- You’ll lose some control over business operations. You’ll retain control over most operations known as “the ordinary course of business.” But you’ll need court approval to do other things like refinancing, selling or buying business property, leasing or breaking a lease, expanding operations, or signing and changing vendor agreements, licensing contracts and union contracts.
- There may be restrictions on compensation. The court may set pay limits for corporation insiders like company officers, directors and major shareholders.
- Your original shareholders could lose their position completely. When General Motors completed its reorganization under Chapter 11 in 2009, the value of its stock dropped to zero, and most of the old shareholders lost their investments. With smaller corporations, a well-planned Chapter 11 reorganization may preserve the control and investments of the old shareholders.
- During the confirmation process, creditors, shareholders and others may weigh in on court decisions, and the court may force you to pay for legal representation for unsecured creditors.
Chapter 11 Bankruptcy: How It Works
A Chapter 11 bankruptcy doesn’t mean your business is closing its doors. Instead, a Chapter 11 lets you restructure your finances so that creditors and owners can get the maximum returns. In other words, you stay in control of your assets, work with the courts to come up with a plan to repay your debts and (if all goes well) make a strong comeback.
“For legal advice specific to your situation, see a bankruptcy lawyer,” Moran says. “It’s a complicated process and I wouldn’t try to go it alone.” Even the simplest Chapter 11 reorganization, she says, is roughly 10 times the cost of a Chapter 7 personal bankruptcy.
Attorneys can also advise you how to run your business without getting into debt. “Chapter 11 is often a knee-jerk reaction when things fall apart,” she says. “The usual problem is there is no real plan, as in, what would you differently than you did before if you could reorganize?”
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