Why Would I File a Liquidation Chapter 11? First of all, while Chapter 11s are usually filed by businesses, they can be filed by individuals. Certainly any liquidation, either under Chapter 11 or Chapter 7, should be done to protect the interests of individuals. If there are no people on the hook for debts, who cares if the business fails?
As a practical matter, small businesses almost always have personal guarantees from principals of the corporation. Sometimes there are assets of the business that can be sold to reduce or eliminate those claims against the principals. Withholding taxes are the ever popular example of this type of debt.
The difference between Chapter 7 and Chapter 11 liquidations is who will be responsible for liquidation. In a Chapter 7, the bankruptcy trustee will sell assets. In a Chapter 11, the authorized representative of the business as Debtor-in-Possession will sell the assets (barring sustained objections from those ravening creditors). Simply put, if you think you need to sell assets of your business in an orderly fashion and believe you can get a better price for them selling them yourself than a Chapter 7 trustee could AND doing so will eliminate debt you would otherwise owe, a liquidation Chapter 11 may work for you.
How Does Chapter 11 Work? First of all, Chapter 11s are extremely complex and you should discuss your situation with an attorney experienced in Chapter 11s. In Cincinnati and Northern Kentucky where I practice, there are relatively few Chapter 11s filed and most bankruptcy practitioners have no experience with them. The procedures and path to success are very different from Chapter 7 and 13.
First of all, the bulk of the petition is the same for all chapters of bankruptcy. Assets and debts must be listed accurately. The Statement of Financial Affairs must be completed. A budget will only be filed if the Debtor is an individual. There are some forms, like the listing of the top twenty unsecured creditors that are unique to Chapter 11. The U.S. Trustee will use that list to try to get a Creditor’s Committee formed. If one is formed, it will be a significant player in the process for approving your plan.
Assuming the Chapter 11 will be filed by a business, forms also will need to be filed designating the official representative of the business to head the administration of the case. Beyond the petition itself, Chapter 11 practice wouldn’t be complete without “first day motions”, filed with the case or as soon thereafter as possible to appoint a representative, hire an attorney and any other professionals and, most importantly, to free up cash collateral to allow the business to continue to run and make payroll.
While the goal is to file a plan, either of liquidation or reorganization, that does not need to be filed with the petition. Frequently, a bankruptcy is filed for immediate protection before anyone knows precisely how the business will pull itself out of its present crisis. That said, times are limited and you can expect your creditors to want to limit that time still more.
Upon filing, the organization becomes a Debtor-in-Possession and is tasked by bankruptcy law with conducting its business for the benefit of its unsecured creditors, a weird sort of conflict that inevitably creates tension. The Debtor also gets an Automatic Stay, which stops (almost) all collection against the Debtor, at least for a time. It is this stay of collection that allows the Debtor to breathe long enough (hopefully) to create a plan of reorganization.
How Does the Reorganization Happen? I tend to think of the components of a successful Chapter 11 as being about the past, present and future. The present is represented by the bankruptcy petition itself. There, for all the world to see, is the business’s prayer for relief with all the relevant information about the finances of the business. The future is the Plan of Reorganization, which is a detailed statement about how creditors will be paid back, why it will probably be both slower and less than they were hoping for and (most importantly) why it really is the best solution for everyone. The plan must be supported by reference to the past, represented by the Disclosure Statement, which explains clearly and in detail, why the Debtor couldn’t pay its obligations as they came due and (ideally) why it wasn’t their fault. Disclosure Statements are typically very detailed documents and usually longer than the plan itself.
The actual approval process is beyond the scope of this posting, but suffice it to say the procedure involves a lot of negotiation, argument and frequently multiple ballots and hearings before approval. A large majority of Chapter 11s fail without ever getting a confirmed plan. It isn’t easy.
What Can Go Wrong? Short of saying everything, the chief dangers to a Chapter 11 debtor are failing to free up cash collateral, which will shut down the business and having the automatic stay lifted, so that collection action begins again, usually involving foreclosing on the premises or equipment of the business. The next potential problems involve having a trustee appointed, who will wrest control away from the Debtor-in-Possession and usually liquidate the business. Alternatively, if it appears no plan can be confirmed or the Debtor-in-Possession is failing to perform its duties, creditors or the United States Trustee’s office can move to have the case dismissed or converted to a Chapter 7.
Should My Business File Chapter 11? Chapter 11 bankruptcies are extremely complex and I have only scratched the surface and explained some of the terminology. If you think it may be an option you wish to pursue, contact an experienced bankruptcy attorney to discuss your particular situation as soon as possible. Delay works to the advantage of your creditors. If you wait too long to make a decision, you will find your choices become more limited. Good luck.