When Is Chapter 11 Bankruptcy a Good Option for a Small Business?

Sometimes Chapter 11 bankruptcy is a good option for small businesses struggling with debt. Learn when it can help.

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While Chapter 11 bankruptcy is often used by big corporations to solve their financial problems, it can also be used effectively by a small business in certain situations. Since Chapter 11 it is significantly more expensive than the other bankruptcy chapters, it is important to understand what it can and cannot do to help your small business.

What Is Chapter 11 Bankruptcy?

Chapter 11 is a reorganization bankruptcy that can be filed by individuals as well as corporations, partnerships, and limited liability companies. There are no debt limits and a trustee is generally not appointed to run your business or handle your cash (although a trustee can be appointed if you are mismanaging your business or not complying with the bankruptcy law).

While Chapter 11 is much more expensive than a Chapter 13 bankruptcy, it is also more flexible in how do you it and what you can accomplish through it. While there are reporting requirements that go into effect as soon as you file, Chapter 11 provides your business with “breathing room” in that you generally have several months before you need to file a plan of reorganization and begin paying into the plan. During this time, you continue to operate the business while it takes steps to fix its business problems. (Learn more about special provisions for small businesses in Chapter 11 bankruptcy.)

Common Problems That May Be Resolved by Using Chapter 11

Chapter 11 bankruptcy provides tools to small businesses that are not available or not as effective in other types of bankruptcy. Chapter 11 may be able to help if your business needs to:

  • reduce excessive secured debt (mortgages or liens that exceed the value of the property which is pledged as security for payment)
  • rid itself of unfavorable leases and contracts
  • obtain more time to pay tax debt or unsecured debt, or
  • obtain more time to market and sell unprofitable divisions, unnecessary equipment, or property that is no longer needed.

If your business is in danger of failing or if there are unavoidable problems in its foreseeable future, Chapter 11 may be a good option.

How to Know If Chapter 11 Can Help Your Business

The best way to predict the outcome for your business in Chapter 11 is to thoroughly analyze your business situation. Ideally, you should do this before you file for bankruptcy. You should:

  • identify the problems your business has
  • determine whether Chapter 11 can fix the problems, and
  • determine whether your business can continue to operate after the problems are fixed.

Determining whether your business can continue to operate successfully after the problems are fixed is vital. You can get rid of excessive secured debt and unprofitable leases but if your business can’t generate enough money to pay the reduced amount, or has no profitable locations, Chapter 11 will not help.

Examples of When Chapter 11 Makes Sense

Here are some examples of situations where Chapter 11 makes sense for a small business:

More time to pay unsecured debts. Road construction restricted access to your business causing your business volume to drop substantially. Now that the construction is complete, business has picked up and is better than ever, but the business fell behind on debts during the construction and can’t afford to pay them all at once. Creditors are threatening to sue and shut the business down. You can use Chapter 11 to keep the business operating while paying the creditors all or part of what is owed over time.

Unprofitable leases. A company with several locations with long-term leases has seen its business change over the years. Many of the locations are no longer profitable and the business is having trouble covering the rent and expenses associated with the unprofitable locations. Other locations are profitable. The business could continue successfully if it could get rid of the leases on the unprofitable locations, but breaking the leases outside of bankruptcy would increase the business debt to unbearable levels. Under Chapter 11, damages for breaking, or rejecting, the unprofitable leases is limited. The company can use Chapter 11 to rid itself of the leases and pay the limited rejection damages over time.

More time to pay tax debt. Due to business problems in the past, which have largely been resolved, a company has a large tax liability. The taxes are past due and the IRS is threatening to take collection action. The business can afford to make payments but has not been able to reach agreement with the IRS. Under Chapter 11, the business can pay its tax debt in installments over a period of up to five years from the date the bankruptcy is filed.

Unnecessary equipment and business units. A family owned company has shifted its business focus. The strategy worked to increase income but the company finds itself with a small manufacturing operation that is no longer needed and is a financial drag on the business. The equipment is in good condition, the workers are skilled, and selling the manufacturing operation as a whole will result in more money than will shutting it down and selling the equipment. However, creditors won’t give the business the time it needs to sell the manufacturing unit and get the money it needs to catch up on its bills. A Chapter 11 will stop the collection efforts and give the company time to market and sell the manufacturing unit.

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