Chapter 11 bankruptcy is designed to offer relief and protection to financially distressed companies by providing them with the opportunity for reorganization. However, in spite of these benefits, it is a serious step that is generally undertaken only after other efforts to get out of debt, such as restructuring workouts, have proven unsuccessful. When a business owner or CEO arrives at the point of contemplating a Chapter 11 filing, it is therefore important that they have already carefully considered the following issues:
What level of relief is needed?
The first step for any business owner or CEO who intends to file a Chapter 11 petition is to assess the current health and future prospects of their business. Is there sufficient cash flow to maintain current operations, or will it be necessary to downsize? Can operations be sustained if debt is restructured? What is the present state of corporate assets and liabilities? It can be valuable to bring in an outside professional, such as a restructuring officer or temporary chief financial officer, to help answer these questions and evaluate whether the business has a reasonable opportunity to be profitable in the future if its debts are reorganized. If the business has scant future prospects, no substantial assets, or debt so overwhelming as to make restructuring unfeasible, then Chapter 11 may not be the best option for the situation.
A realistic plan will be necessary
It is important for business owners to be realistic about the benefits of Chapter 11 bankruptcy and to be able to develop a reasonable reorganization plan. Reorganization can certainly help a business by freeing up cash through debt restructuring, extending maturity dates on pre-existing debts, or lowering interest rates. However, it will not automatically increase revenue or create a market. Therefore, by developing a reorganization plan, business owners can frankly assess what operational, management, or debt structure changes – such as price adjustments, location changes, or downsizing – will be necessary for ongoing operations and create a reasonable strategy for implementing them.
Financial records will be closely scrutinized
Business owners should be aware of the heightened financial scrutiny that a company is subject to during the bankruptcy process, including a more intense focus on a company’s financial records. If a company’s current records are scarce or inaccurate, it may be appropriate to instigate some pre-bankruptcy planning steps to prepare missing records and bring existing records up to date. This is an especially important consideration for small business owners, who are subject to additional rules and requirements under the Bankruptcy Code that are somewhat different from those that govern larger Chapter 11 cases and that involve filing a number of key financial records within days of launching a bankruptcy petition.
Decision-making powers will be affected
On the surface, Chapter 11 may seem like it allows companies to simply continue their operations as usual. This is true to a certain extent, but business owners should be aware that, even though they can continue to manage their businesses and control their assets under Chapter 11, there will be significant changes to their decision-making powers. Specifically, the bankruptcy court must approve any major decisions or transactions that affect the company, including renegotiating contracts and licensing agreements, shutting down certain stores or business operations, securing financial arrangements, retaining and paying lawyers or other professionals, and selling any assets outside the usual course of business.
Personal assets may be at risk
All business owners, regardless of the size of the company, should consider the impact that a Chapter 11 filing will have on their personal finances. While part of the rationale for incorporating a business involves limiting personal liability, a business owner may nevertheless have personally guaranteed some corporate debt. In this situation, creditors may seek and obtain judgements against the business owner personally and have the right to go after the owner’s home or other personal assets. The automatic stay that is immediately imposed when a Chapter 11 petition is filed will not apply here, as it only relates to creditor actions against the debtor corporation.
The outcome may be different than expected
One of the most important things a business owner should be prepared for in a Chapter 11 case is that the outcome may not be what was hoped for or expected. A great many Chapter 11 cases are ultimately converted to Chapter 7 cases in which corporate assets are liquidated upon approval by the court. Business owners should therefore be as certain as possible that Chapter 11 is the right fit for their company before investing the time, money, and energy that Chapter 11 proceedings require. They should also be aware that – even in these cases – a different outcome may still happen.