Chapter 11 Bankruptcy for Small Businesses

Chapter 11 bankruptcy is rarely a good option for small businesses. Here's why.

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Chapter 11 bankruptcy has been in the news a lot lately. Plenty of businesses, from banks to car manufacturers, department stores, and airlines have been using Chapter 11 to try to reorganize their operations and get out from under their debts. However, because Chapter 11 is expensive—think $50,000 to $100,000 or more in legal fees—and extraordinarily complex, it’s rarely appropriate for any but the largest small businesses.

For more free legal information on bankruptcy for business owners, see Small Business Bankruptcy. You'll find plenty of information on Chapter 7 and Chapter 13 options that are usually better suited for small business owners struggling with debt.

How Chapter 11 Works

In Chapter 11, a company uses a set of procedural rules in the bankruptcy code to come up with a plan under which it will be able to continue its operations. Any business entering Chapter 11 must be represented by an attorney, who prepares a complicated set of disclosures and meets and negotiates with various creditor groups (secured, unsecured, equity holders, licensees, lessees, bond holders, and so on). All of the major creditor groups (which are organized into “committees”) must agree to the Chapter 11 plan proposed by the debtor business through its attorney, or the judge can approve the plan in spite of any creditor objections if the plan generally meets the best interests of the creditors overall. Once the plan is approved, it governs the business’s future relationships with its creditors, including any decisions the business might make that could adversely affect those relationships.

Many Chapter 11 bankruptcies fail—and attorney fees are often responsible. The business filing for bankruptcy is responsible for paying both its own attorney and the attorneys who represent the various creditor groups. Attorneys seldom charge less than a $10,000 retainer just to get things started, and the expenses for creditor attorneys can be astronomical; lengthy meetings and negotiations are necessary in a Chapter 11 bankruptcy, and the attorney fee meter is always ticking. As a result, a business that limps into Chapter 11 bankruptcy often feeds its meager remaining operating capital to attorneys, accountants, appraisers, and other professionals to come up with a plan the court will confirm. Unless the business can obtain a loan to finance its bankruptcy (called “debtor-in-possession” financing), once the business’s money is gone, the case is typically converted to Chapter 7 business bankruptcy where the business is liquidated and the proceeds distributed under various bankruptcy priority rules.

Chapter 11 Compared to Chapter 7

Chapter 11 is rarely the right choice for a small business. You should consider it only if your business has enough income—and the ability to swing debtor-in-possession financing—to both stay in business and pay tens or even hundreds of thousands of dollars in legal fees to successfully emerge from the bankruptcy intact. If you are interested in Chapter 11 bankruptcy, speak to an attorney who is experienced in Chapter 11 filings. If you receive advice that a Chapter 11 is your best option, either for your business or for you personally, make sure you understand exactly where the money will come from to pay the various players—including the one trying to talk you into Chapter 11. 

Excerpted from Bankruptcy for Small Business Owners: How to File for Chapter 7, by Attorney Stephen Elias and Bethany K. Laurence, J.D.

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