Small businesses have several options for filing bankruptcy, with one of the most common being Chapter 11 reorganization. A recent legislative action, however, created a streamlined Chapter 11 process for some small businesses. Learn how the two Chapter 11 processes compare and how you may qualify for and file using the new small business version.
How Chapter 11 Bankruptcy Works
Federal bankruptcy courts run bankruptcy processes following the Bankruptcy Code (law). The Chapter 11 bankruptcy reorganization version provides a way for a business to continue to operate while clearing up its outstanding debts. The business can file a voluntary petition with the court, or a group of creditors may also petition the court to force involuntary bankruptcy on a company.
Any type of business can apply for Chapter 11 bankruptcy protection, including corporations, partnerships, LLCs, and sole proprietorships. Some Chapter 11 processes work differently depending on the business type.
When the petition is filed, the debtor becomes a “debtor in possession,” meaning that the debtor continues to control its business assets without a case trustee (a court-appointed administrator). In this situation, the debtor in possession acts in a fiduciary capacity, taking on most of the tasks a trustee would perform. But the debtor is still subject to a U.S. trustee (different from a case trustee).
The debtor then prepares and files a reorganization plan, which must be approved by the court. The plan must include a list of types of claims by creditors and the process for paying them. The court may require a creditors’ committee to participate in forming the plan and also consulting with the debtor and investigating the debtor during the process.
How the New Small Business Bankruptcy Process Works
The Small Business Reorganization Act of 2019, which went into effect on February 19, 2020, established a new subchapter V of Chapter 11 of the Bankruptcy Code for small business bankruptcy (SBB) cases.
The small business bankruptcy process creates shorter deadlines, gives debtors greater flexibility in negotiating with creditors, and provides for a private trustee to work with the small business debtor to help facilitate the process.
Elimination of the creditors’ committee (unless court-ordered) also helps resolve cases faster.
To qualify to apply for bankruptcy protection under the new Sub V provisions, the debtor must:
- Be engaged in commercial or business activities (but not in owning or operating real estate)
- Have specific types of debt of $2,556,050 or less
In addition, there must not be a creditors’ committee already in place.
Role of the Trustee
The role of the debtor in possession in the SBB process increases, but this person is subject to additional oversight during the process. This includes an initial interview with the U.S. trustee within 60 days after the petition filing to accomplish the following:
- Evaluate the debtor’s viability (ability to continue in business)
- Discuss the debtor’s business plan
- Explain the debtor’s obligations during the process
During the case process, the trustee helps the debtor in possession develop the reorganization plan and provides continuing oversight, including reviews of periodic reports from the debtor.
The debtor must pay the trustee for their services limited to 10% of “payments made under the plan.”
The Reorganization Plan and Disclosure
Within 90 days from the filing date, the debtor must submit a reorganization plan for the court’s approval, with help from the trustee. The court may confirm (approve) a plan even if no group of creditors accepts it.
The plan must provide that all projected disposable income for three to five years will be used to make payments to creditors, and it must be fair and equitable to all creditors.
The debtor must also give the court a disclosure statement with information to creditors so they can evaluate the plan. This statement isn’t as extensive as the one for a regular Chapter 11, and includes only:
- A brief history of the business operations
- A liquidation analysis that estimates proceeds that might be realized if the business were liquidated (all assets sold to pay creditors)
- Projections on the ability of the debtor to make payments as described in the plan
In addition, once the debtor’s plan is confirmed, the debtor receives a discharge from debts that were in place before the confirmation date.
Discharge of debts means that creditors can’t collect on these debts. Debts that aren’t discharged must be paid by the debtor.
How the Small Business Bankruptcy Ends
Like the regular Chapter 11 process, the small business bankruptcy ends when the reorganization plan has been finalized, all debts are either paid or discharged, and the bankruptcy court has issued its final decree.
Getting an Attorney for a Small Business Bankruptcy
You may be thinking that if you have a trustee, you don’t need an attorney for this process. But an attorney can advise you on whether to file and which type of bankruptcy to choose for your specific situation.
Bankruptcy is a complicated legal and financial process, and this article is intended to be an overview. Get help from a bankruptcy attorney as soon as you think you might need to file bankruptcy.
Also, note that the trustee is a facilitator, not a legal advisor. During the process, your attorney can look out for your interests and give you legal advice. The U.S Bankruptcy Court says, “...seeking the advice of a qualified attorney is strongly recommended because bankruptcy has long-term financial and legal outcomes.”
- The small business process normally goes more quickly than regular Chapter 11 cases.
- The debtor can continue to control the business while working on the reorganization plan.
- The paperwork burden is significantly reduced.
- Not having to deal with a creditors’ committee saves time and money.
- Help is available from the case trustee, who acts as a facilitator.
- In most cases, the business can continue, leaner and more efficient.