Is Chapter 11 Bankruptcy Bad?

Is Chapter 11 bankruptcy bad? Imagine the local family-owned restaurant in your community, once bustling with regulars and laughter, now strained by an economic downturn, a hike in ingredient prices, and a drop in foot traffic due to a road closure. Or consider an entrepreneur who has poured their life savings into a promising tech start-up, only to see returns fall short because of market saturation and fierce competition.

In these challenging situations, instead of shutting down or filing for personal bankruptcy, these individuals or entities might consider an alternative solution – Chapter 11 bankruptcy. This option could be a lifeline, allowing them to remain operational while restructuring their debts, all under the court’s supervision. It provides a route to potentially regain financial stability without having to close their doors for good. Indeed, it’s the embodiment of the saying, “when the going gets tough, the tough get going.”

How Chapter 11 Bankruptcy Works

The basis for Chapter 11 in the U.S. Bankruptcy Code was so named. Companies that file for Chapter 11 do so to gain time to restructure debts and obtain a fresh start. The terms are contingent on the debtor fulfilling its obligations under the plan.

Chapter 11 proceedings provide court assistance to companies to restructure their debts and obligations, enabling the business to stay open and continue operations as normal. Many large US corporations such as General Motors and United Airlines have filed for Chapter 11 bankruptcy protection as a strategy for staying solvent.

Chapter 11 filings typically include corporations, partnerships, and Limited Liability Companies (LLCs).

In certain situations, a business amid a Chapter 11 filing can continue to operate. In such cases, the “debtor-in-possession” runs the business as usual. Meanwhile, in instances of fraud, dishonesty, or gross incompetence, a court-appointed trustee takes over the business to ensure its smooth operation throughout the bankruptcy proceedings.

Certain decisions cannot be made by the business without court permission. For instance, the sale of assets other than inventory. Another example would be the initiation or termination of a rental contract or the suspension or expansion of a business operation. The court also has control over decisions related to the hiring and payment of attorneys, contracts with vendors, and trade unions. The debtor also cannot secure a loan that will commence after the completion of the bankruptcy.

The business or individual that files for bankruptcy in Chapter 11 has the initial opportunity to present a reorganization plan. Some of these plans involve reducing business expenses and renegotiating debts. In certain cases, the plan may entail liquidating assets to repay creditors. The courts will approve the chosen path if it is fair and feasible.

Chapter 11 and Small Businesses

The Small Business Reorganization Act of 2019 came into effect on February 19, 2020. It introduced a subchapter to Chapter 11 aimed at simplifying the bankruptcy process for small businesses. According to the U.S. Department of Justice, “small businesses are defined as entities that have less than $2.7 million in debt and also meet other criteria.”

The Justice Department states that the act “imposes shorter timelines for completing the bankruptcy process and allows greater flexibility when negotiating restructuring plans and dealing with creditors. It also provides for the appointment of a private trustee to collaborate with small business debtors and their creditors, thereby facilitating the creation of a consensus plan for reorganization.”

Most companies will explore alternative options before resorting to Chapter 11, as it represents the most intricate and costly form of bankruptcy.

Example of a Chapter 11 Case

Gymboree Group Inc. announced in January 2019 that they had filed for Chapter 11 bankruptcy and planned on closing all Gymboree Outlet and Crazy 8 stores across Canada and the United States.

Gymboree announced in a press release that they had obtained a commitment from SSIG and Goldman Sachs Specialty Lending Holdings Inc for debtor-in-possession financing (30 million in new money loans), as well as “roll up” of all obligations under their “prepetition Term Credit Agreement”.

In March 2019, Gap announced its acquisition of Janie and Jack. Gymboree returned to Children’s Place stores in early 2020 as a “shop-in-a-shop” concept, alongside an online store.

Gymboree Group Inc. filed for Chapter 11 bankruptcy twice in the last two years. The company initially filed for bankruptcy in 2017, after successfully reorganizing and reducing its debts.

The Different U.S. Bankruptcy Code Chapters

The U.S. Bankruptcy Code, with its intricate guidelines and regulations, serves as a roadmap for individuals and entities navigating the turbulent waters of bankruptcy. It’s composed of six key chapters, each catering to specific types of bankruptcy.

Chapter 7, often termed as ‘liquidation bankruptcy’, is where the debtor’s non-exempt assets are sold off to pay creditors. Chapter 9 is dedicated to the financial restructuring of municipalities, such as cities or towns. Commonly known as ‘reorganization bankruptcy’, Chapter 11 is used mainly by businesses seeking to rearrange their debts while continuing their operations. Meanwhile, Chapter 12 is a special provision for family farmers and fishermen.

Chapter 13 provides an individual with a structured plan to repay all or part of their debts. Finally, Chapter 15 deals with cross-border bankruptcy cases, encompassing international legal complexities. The chapters most frequently employed are Chapters 7, 11, 13, and 15, given their broad applications to businesses, individuals, and international cases.

What Is the Difference Between Chapter 7 and Chapter 11?

While both Chapter 7 and Chapter 11 bankruptcy provide ways to manage overwhelming debt, they do so in markedly different ways. Chapter 7, or liquidation bankruptcy, involves a court-appointed trustee selling off a debtor’s non-exempt assets to repay creditors. This process often wipes out unsecured debt, like credit card debt, but will not absolve obligations like student loans or certain tax debts. Crucially, it allows the debtor to retain exempt property, such as basic household furnishings and personal items.

In contrast, Chapter 11, typically known as reorganization bankruptcy, allows a debtor – most often a business, but occasionally individuals – to restructure its debts and operations under the supervision of the court. The primary distinction here is that the debtor maintains control over their business operations and is not required to liquidate assets. Instead, they devise a plan to repay creditors over time while continuing to generate income.

Are There Advantages to Filing Chapter 11?

At first glance, Chapter 11 bankruptcy might seem like a daunting prospect, but it carries several significant benefits. One of the standout advantages is the opportunity for a business to continue its operations during the restructuring phase. This continuity is not just about maintaining market presence, but more importantly, it enables the entity to generate revenue, which can then be directed towards servicing its debts. The essence of Chapter 11 lies in this survival and recovery process – turning the wheels of the business while patching the leaks in its financial structure.

Moreover, Chapter 11 bankruptcy offers a protective shield against creditors. Once the process begins, a court order known as the automatic stay comes into effect. This prevents creditors from taking any collection actions against the debtor, allowing the business some breathing room to focus on its recovery plan. Additionally, many creditors view Chapter 11 in a positive light. Rather than facing a scenario where a debtor goes under and pays pennies on the dollar, creditors often prefer Chapter 11 as it usually results in a higher and quicker rate of repayment, thereby minimizing their losses.

What Are the Disadvantages of Filing Chapter 11?

Despite the potential benefits, the journey through Chapter 11 is not a walk in the park. It is universally recognized as one of the most intricate and costly forms of bankruptcy. The complexity stems from the detailed disclosures, negotiation processes with creditors, court approvals, and the execution of the reorganization plan. This can be a daunting process, requiring expert legal advice and guidance, and the related legal fees can quickly escalate, adding to the financial pressures already being experienced by the debtor.

Further complicating matters, the proposed reorganization plan must pass the scrutiny of the bankruptcy court. It’s not enough to simply lay out a plan; it has to be realistically viable. The court needs to be convinced that the debtor can fulfill their obligations under the plan over a specified timeframe. This requirement adds another layer of uncertainty, as the approval process can be unpredictable and complex. Businesses considering Chapter 11 must be prepared for a comprehensive and rigorous examination of their finances and future business projections, making the process not just a financial undertaking, but a test of resilience and adaptability.

The Bottom Line

Picture a ship caught in a storm – it’s battered and weary, but not yet sunk. That’s a business teetering on the edge of financial collapse. The Captain has a decision to make: abandon the ship or steer bravely through the storm. This is the crossroads where Chapter 11 comes into play, offering a chance to navigate through the rough seas of debt and return to smoother waters.

No doubt, the journey is challenging – it’s costly, time-consuming, and complex, like navigating through uncharted waters with only a dimly lit compass. It’s certainly not the first choice for any business. But when the alternatives have been explored and exhausted, it may be the lifeline needed to keep the ship afloat and eventually steer it back on course.

It’s crucial to remember, though, that the decision shouldn’t be rushed. A thorough, careful analysis of all options is a must. A skilled navigator knows the best course of action is rarely the easiest – and only after assessing all other routes can they determine if the arduous path of Chapter 11 is indeed their last, best hope for survival.

Take the Next Step with Bruner Wright

In the face of financial distress, taking the right step forward is crucial. The experienced team at Bruner Wright in Jacksonville, FL, is ready to guide you through the complexities of Chapter 11 bankruptcy. Don’t let uncertainty paralyze your decision-making.

Reach out to us today, and together, let’s chart a path towards financial stability and renewed growth for your business.