Frequently Asked Questions

Fast Track Answers to Your Business Bankruptcy Questions

When should a business voluntarily file Chapter 7?: Chapter 7 bankruptcy of a business involves its liquidation and should be viewed as a last resort when all other reasonable and realistic alternatives to chapter 7 have been explored and exhausted. Alternatives to chapter 7 for a business may include obtaining new sources of debt financing or capital investment, sale of assets or sale of the business in whole or in part, an out‑of‑court workout with creditors, or a restructuring under chapter 11. If none of these alternatives are viable, management or the owners of a business may want to file a chapter 7 liquidation for a financially troubled business that is unable to pay its debts or has debts greater than assets (i.e., the business is insolvent). If a business is insolvent or in the zone of insolvency, there is a developing body of case law that holds that management no longer has a duty to the owners (i.e., shareholders or other equity holders) of the business, but rather to its creditors. By filing a chapter 7 bankruptcy, management can ensure that creditors’ claims are dealt with in a single unified proceeding and that the debtor’s assets are not stripped apart by different creditors pursuing their individual legal remedies, such as by judgment enforcement. The decision whether a chapter 7 is appropriate for a particular business must be made based on the facts applicable to that business.
What happens when a business files Chapter 7?: The filing of bankruptcy creates an automatic stay which is comprehensive and bars virtually all creditor collection activity, including commencement and continuation of lawsuits and enforcement of judgments against the debtor’s assets. When a business files chapter 7 bankruptcy an interim trustee is appointed by the U.S. Trustee’s Office to marshal and liquidate the debtor’s assets and distribute them to creditors. The interim trustee becomes the permanent trustee unless a different trustee is elected by creditors. The trustee has the ability to collect and pursue the receivables and claims (including legal claims and causes of action) of the debtor. In order to promote equality of treatment of similarly situated creditors, the Bankruptcy Code gives the trustee the ability to recover certain pre‑bankruptcy transfers of the debtor as preferential or fraudulent transfers.
When should a business voluntarily file Chapter 11?: Chapter 11 can permit management or owners of a business to restructure the debt of the business and reorganize the business. The filing of bankruptcy creates an automatic stay which is comprehensive and bars virtually all creditor collection activity, including commencement and continuation of lawsuits and enforcement of judgments against the debtor’s assets. In chapter 11 the business can seek to reorganize as a going concern, or to sell its assets in whole or in part. Chapter 11 is an attractive method for asset purchasers to acquire assets because through a sale in the bankruptcy court pursuant to section 363 of the Bankruptcy Code they can ensure that they are acquiring assets free and clear off all liens and claims (including tax claims). A chapter 11 bankruptcy also provides a mechanism for a business to reject burdensome leases and contracts (discussed further below). Chapter 11 should not be viewed as a panacea or first resort. A business must have a well-defined exit strategy in mind before filing a chapter 11 case due to the extreme costs associated with a reorganization effort. However, it can be a very useful way for a financially troubled business to restructure its debts in appropriate situations, or attempt to preserve the “going concern” value of its assets in a sale. The decision whether chapter 11 is appropriate for a particular business must be made based on the facts applicable to that business and it will not work for all companies.
How can a debtor reject burdensome leases and contracts in a chapter 11 bankruptcy?: One of the benefits of chapter 11 to a business debtor is that it has the choice to assume or reject its ongoing contracts and unexpired leases, and can reject financially burdensome ongoing contracts and unexpired leases. The claims of the other side to the contract or unexpired leases for rejection damages are treated as pre‑petition unsecured claims in the bankruptcy. The Bankruptcy Code also caps a landlord’s lease rejection damages claim (to one year’s rent or 15%, not exceeding 3 years, of the remaining term of the lease).
What happens when a business files Chapter 11?: Unlike chapter 7, when a business files for chapter 11, a trustee will usually not be appointed and the debtor will remain a “debtor-in-possession” (DIP) with the same management in place unless the bankruptcy court orders a trustee appointed for “cause” (including fraud, dishonesty, incompetence or gross mismanagement of the affairs of the debtor by its current management), or if the court determines that appointment of a trustee is in the best interest of creditors.
What is the U.S. Trustee and what is its role?: The U.S. Trustees Office is a branch of the Department of Justice tasked with overseeing the administration of bankruptcy cases. The U.S. Trustee plays an oversight role, particularly in chapter 11 cases. It does this primarily through reviewing operating reports the debtor-in-possession is required to file and tracking the progress of the case against benchmarks set in the early stage of the case.
What is a creditors committee and what is its role?: A creditors committee is routinely appointed in chapter 11 cases by the U.S. Trustee and ordinarily consists of unsecured creditors who hold the seven largest unsecured claims against the debtor. The creditors committee consults with the debtor on administration of the case, investigates the debtor’s conduct and operation of the business, and participates in developing a reorganization plan. The creditors committee in a chapter 11 case may, with the approval of the Bankruptcy Court, hire attorneys, accountants, and other professionals (such as financial advisors).
What is the goal of Chapter 11?: The main goal of a chapter 11 case is for a plan of reorganization regarding the debtor to be approved by its creditors. The Plan can include, but is not limited to, bringing in new money investors, changing debt to equity in the business, selling off divisions or lines of business, closing unprofitable stores, or conducting an organized going-out-of-business sale. The Bankruptcy Code gives the debtor the exclusive right to file a plan for the first 120-days of the case (which can be extended not more than 20-months from the date the case was filed). A creditors committee, or even individual creditors, can file a plan of reorganization once the debtor’s exclusive filing period has lapsed (or been lifted by the Court). Debtors in chapter 11 must be represented by attorneys. Creditors’ committees typically also hire attorneys.
What is an assignment for the benefit of creditors?: An assignment for the benefit of creditors (ABC) is a business liquidation device available to an insolvent debtor as an alternative to formal bankruptcy proceedings. In many instances, an ABC can be the most advantageous and graceful exit strategy. This is especially true where the goals are (1) to transfer the assets of the troubled business to an acquiring entity free of the unsecured debt incurred by the transferor and (2) to wind down the company in a manner designed to minimize negative publicity and potential liability for directors and management. The option of making an ABC is available on a state‑by‑state basis.; The common law assignment by simple transfer in trust, in many cases, is a superior liquidation mechanism when compared to using the more cumbersome statutory procedures governing a formal Chapter 7 bankruptcy liquidation case or a liquidating Chapter 11 case. Compared to bankruptcy liquidation, assignments may involve less administrative expense and are a substantially faster and more flexible liquidation process. In addition, unlike a Chapter 7 liquidation, where generally an unknown trustee will be appointed to administer the liquidation process, in an ABC the assignor can select an assignee with appropriate experience and expertise to conduct the wind‑down of its business and liquidation of its assets. In prepackaged ABCs, where an immediate going concern sale will be implemented, the assignee will be involved prior to the ABC going effective. Further, in states that have adopted the common law ABC process, court procedures, requirements, and oversight are not involved. In contrast, in bankruptcy cases, the judicial process is invoked and brings with it additional uncertainty and complications, including players whose identity is unknown at the time the bankruptcy petition is filed, expense, and likely delay.
What is a receivership?: A receiver is neutral person who is not a party to the litigation who takes possession of and manages property or assets belonging to one or more of the litigants. A receiver is an agent for the court, not the litigants. Thus, the receiver holds or manages the property or the assets for the benefit of all who may have an interest in the receivership property. Generally, a receiver has the power to bring and defend legal actions, to take and keep possession of property, to receive rents, collect debts, to make transfers, and generally do anything with respect to the property that the Court may authorize. At the request of any creditor or stockholder of the corporation, the Court in the county where the corporation conducts business or has its principal place of business may appoint one or more persons to be the receiver of the corporation. The receiver may take charge of the corporation’s property, collect the debts and property due and belonging to the corporation, and to pay the outstanding debts of the corporation as necessary. The receiver may also divide any of the corporation’s income, money, and other property among the stockholders of the corporation.
What is an involuntary bankruptcy filing?: Involuntary bankruptcy can be a useful tool for creditors. Filing an involuntary bankruptcy petition against a debtor can help actualize the value of a debtors assets. The following are some basic requirements when considering filing an involuntary bankruptcy petition.Involuntary petitions may only be filed under chapters 7 and 11 of the Bankruptcy Code. A debtor in an involuntary bankruptcy case must qualify as a person. This generally excludes farmers and not‑for‑profits. Next, a petitioning creditor needs to consider the number and amount requirements for filing an involuntary petition. If the involuntary debtor has twelve (12) or more creditors, then there must be at least three (3) petitioning creditors with an aggregate, unsecured claim of at least $15,325. If the involuntary debtor has less than twelve (12) creditors, then only one (1) petitioning creditor with at least $15,325 in non‑contingent claims is required.; When counting creditors, employees, insiders, and transferees of voidable transfers are not counted. The number of creditors is computed on the date the involuntary petition is filed. Any post‑petition payment to creditors will not affect the number of creditors requirement.; Additionally, the debt at issue must be liquidated meaning settled or fixed. Debt that is contingent or subject to dispute does not count towards the amount requirement. Thus, tort claims are generally not a basis for an involuntary petition. Finally, there is a basic requirement that the debtor be insolvent, which is ordinarily proven by showing that the involuntary debtor is failing to pay his or her debts as they become due.