December Newsletter – Chapter 7 v. Chapter 11: Liquidation or Reorganization?

It’s a choice no business owner wants to make. If you are a small business owner and you would like to file for bankruptcy, you have two options under Chapter 7 or Chapter 11 of the U.S. Bankruptcy Code. On top of business stress, your personal stress may be a large factor in choosing to file for bankruptcy under Chapter 7 or Chapter 11. You might have exhausted personal assets, maxed out credit cards, pending lawsuits, defaulted mortgages, bouncing checks, and overdue taxes, to name a few. If you are a business owner and identify with these issues, consider your options under the provisions of Chapter 7 and Chapter 11 of the Bankruptcy Code. In general, these sections of the Bankruptcy Code provide individuals and small businesses with the option to file for bankruptcy protection.

Before considering which Chapter will best benefit your business, prepare yourself with all the financial disclosures to the court. Being unprepared with the proper documentation can be the sole reason for a court to deny your business’s request to file. When you are ready to file, make sure you can provide the following: tax returns, balance sheets, a statement of profits and losses, a check register, documentation of transfers to business “insiders” and of personal guarantors, documentation of secured creditors and value of assets, and a list of unsecured creditors (names, addresses, amounts owed, etc.). When you are prepared, begin to look at your options.

Chapter 7 of the Bankruptcy Code is a provision that allows for the total liquidation of individual or business assets to pay unsecured loans. Do not confuse this provision with Chapter 13, which provides this option solely for individuals. Chapter 7 allows for individuals, partnerships, and corporations to file under its provision. Be prepared to file a detailed schedule of liabilities, income, assets, continuing financial dealings, and unexpired leases.

If your business is qualified to file under Chapter 7, the court will grant an automatic stay, a temporary injunction that will halt obligations to creditors. Before filing under this provision, understand what business assets will not be protected under a bankruptcy exemption. In general, the court will grant a bankruptcy exemption for some business property, in which the owner has equity, to protect it from creditors. The court will appoint a trustee to sell non-exempt business assets to settle debts that can be paid appropriately under the provision.

Chapter 11 calls for the reorganization of a business entity with a specific subsection for small businesses. Under Chapter 11, business owners provide a proposal for business reorganization along with a scheduled plan to pay back creditors over time. The business plans will then seek the approval of the court. Chapter 11 provides options for business owners and individuals; however, it has specific provisions for small businesses under subchapter V (5): “Small Business Debtor Reorganization” (SBRA).

Recently the SBRA section of Chapter 11 was paired with the Coronavirus Aid, Relief and Economic Security Act of 2020 (the “CARES Act”), making Chapter 11 an extremely enticing option for small business owners. The SBRA section of Chapter 11 was established in 2019 and recognized that small businesses needed different requirements for maximum debt and obligations to creditors to restructure as a small business adequately. Therefore, small businesses that fall under Chapter 11 are subject to exceptions to the general provisional requirements. In addition, the CARES Act allows for more small businesses to qualify for Chapter 11 relief by expanding the initial maximum debt requirement from $2.5 million to $7.5 million for one year. If your small business qualifies, consider restructuring your entity under Chapter 11.

Bankruptcy is not one fluid process. Incorporated in the proceedings are temporary and permanent options for individuals and businesses alike. Chapter 7 and Chapter 11 of the Bankruptcy Code have proven to be the most useful and successful provisions for small businesses and should be greatly considered as you prepare to approach the Bankruptcy court. The current economic posture is harsh; however, it is cause for new beneficial legislation that could positively affect your business. Stay informed and seek your best options.

The SJS Law Firm can help you resolve this issue. For a complimentary consultation, please contact us at (202) 505-5309.

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