Watching your finances spiral out of control and your business struggle to make ends meet is not easy for a small business owner to swallow. With Wall Street deteriorating some small business owners may find themselves forced into a corner with very few options. Chapter 11 bankruptcy is one option that helps them give their businesses one last-ditch effort. 

Unlike chapter 7 bankruptcy, which is reserved for businesses that are unable to meet their obligations, chapter 11 bankruptcy is designed for businesses that still have a chance at survival, if only they get a little more time to reorganize and get their affairs in order. If a business can reduce its debts or drastically lower its operating costs, then a return to viability is certainly possible.

A bankruptcy petition can be voluntary (filed by the company itself) or involuntary (filed by creditors that meet certain requirements). Whether voluntary or involuntary, once the petition is filed the company automatically assumes the identity of “debtor in possession,” which means that the company maintains possession and control of its assets and continues to operate the business throughout the reorganization process. After the petition is filed, a disclosure statement and a plan of reorganization need to be filed with the court. The disclosure statement basically contains information about assets, liabilities and anything else that will help creditors make an informed judgment about the reorganization plan. The reorganization plan needs to include a classification of claims with specifics about how each class will be treated under the plan. The disclosure agreement must be approved and the reorganization plan must be voted on by creditors. The court then holds a confirmation hearing to decide whether to confirm the plan.

Businesses of all sizes can file for chapter 11, but small businesses, defined as companies with secured and unsecured debt of less than $2 million, can elect to be treated differently. If a company does elect to be considered a small business, then it gets put on the “fast track.” Businesses on the fast track experience a rushed and somewhat less formal bankruptcy process. It’s not mandatory for them to have a creditors’ committee appointed for them, as is sometimes the case with other chapter 11 filings. They also don’t have to have a separate hearing to approve their disclosure statement. Small businesses can instead combine this hearing with the confirmation hearing. In addition, they have a shortened period of time (100 days) in which to file their reorganization plans. After the 100 days, parties with a vested interest can file their own plans. All plans must be filed within 160 days though.

Chapter 11 is among the most flexible of all the bankruptcy chapters, but it can also be pretty expensive. Above and beyond attorney’s fees, there are expenses for accountants and other professionals. In addition, the success rate for chapter 11 reorganizations is low. I’ve heard anywhere from 25 to 10 percent actually make it through the process. The most important thing for small business owners to remember when considering chapter 11 bankruptcy is that they have to have a great comeback plan, something that will get the business back on track quickly. If they don’t, then this attempt at a second chance will end up being very costly.

I also think it’s important to reiterate that filing for chapter 11 bankruptcy should be a last resort. It may help your business get through a rough patch, but in doing so it could hinder your chances of receiving credit in the future. Under the Fair Credit Reporting Act, chapter 11 bankruptcy gets reported on your credit rating for up to 10 years, and your credit rating is generally something you don’t want to mess with. So consider your options carefully before filing. 

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