What Chapter 7 and 11 Bankruptcy Can and Cannot Do for Your Business

There are essentially two types of bankruptcies available for a business: Chapter 7 and Chapter 11. Chapter 7 is a straight liquidation. A trustee is immediately appointed randomly from a panel of individuals who have met the Bankruptcy Code qualifications to serve in that capacity. The trustee takes control of the debtor’s assets, sells them and distributes the proceeds to creditors. The trustee can operate the debtor’s business during the liquidation process. Trustees have full access to the debtor’s books and records. The benefit to a Chapter 7 is that there is an immediate finality.

Chapter 11 is typically a reorganization case. As in a Chapter 7, all assets become property of the “Estate,” but in a Chapter 11, there is no trustee and the debtor remains in possession of the assets. In fact, the debtor is referred to as the “debtor-in-possession” or “DIP.” Businesses typically continue to operate in a Chapter 11 with the goal of restructure debt or otherwise re-order their financial or corporate structure. Although generally referred to as a reorganization, a DIP can liquidate its assets in a Chapter 11 proceeding and may want to do so believing that the DIP can achieve a higher value than could a Chapter 7 trustee. This process may ultimately benefit an owner who also has personal obligations for the business debt.

What Bankruptcy Cannot Do

• Save money initially. Chapter 11 is an expensive process in terms of professional fees, disbursements to the United States Trustee’s Office, and uncompensated time for management to spend on bankruptcy matters.
• Allow the debtor to hide out. Chapter 11 is often referred to as a fish bowl. The financial reporting requirements are extensive and creditors are given carte blanche ability to explore the debtor’s books and records.
• Restructure a company that has no business. Bankruptcy cannot substitute for the lack of viability. There needs to be a core business to reorganize.
• Force creditors or customers to continue doing business with the company. Trade vendors, which supply on an open account, can require COD payments and are not required to extend credit terms. Customers without a contractual obligation to purchase from the debtor can simply quit the relationship.

What Bankruptcy Can Do

• Provide at least a short respite from paying creditors. The automatic stay brings all collection efforts and lawsuits to an immediate halt.
• Provide an opportunity to alter debt repayment terms.
• End troublesome contracts or leases. The debtor has a relatively unfettered ability to reject contracts or leases which it no longer believes are in its best interest.
• Allow a business owner to work with creditors for an overall solution and to preserve personal finances.

Carolyn J. Johnsen is Chair of Jennings, Strouss & Salmon’s Business Restructuring & Reorganization Section. Ms. Johnsen has extensive experience in every aspect of commercial reorganizations, representing both debtors and creditors. She can be reached at 602-262-5906 or cjjohnsen@jsslaw.com.