When a business must file for bankruptcy, the process and rules that apply are a bit different from those of a personal bankruptcy filing. The following material addresses the types of bankruptcy and the process for filing each type.
Types of Bankruptcy
There are generally three types of chapters of bankruptcy relevant to businesses or business owners. These are Chapters, 7, 11, and 13. Chapter 7 bankruptcy is known as a liquidation bankruptcy. This means that the company identifies all outstanding debts or obligations and sells all of its assets to cover as much of those debts as possible. The debtors are paid based upon their rank or priority. If creditors with the same priority are not paid in full, all of those creditors will be paid an equal percentage of the outstanding debt. Chapter 7 is useful when the operations of the business have completely failed and the business seeks to close down.
Chapter 11 and 13 are known as reorganization bankruptcies. Chapter 13 applies to individuals. Chapter 11 applies to business entities. Chapter 13, however, is relevant for business owners who are personally liable for the debts and obligations of the business. In a bankruptcy reorganization, the business identifies all assets and determines what amount creditors would receive if the business assets were liquidated and the proceeds distributed to creditors. If the business is able to propose a plan under which the secured creditors (namely those who have collateral securing the debt) would receive more than they would in a liquidation bankruptcy, the business can pursue a reorganization bankruptcy. This means that the business can continue operating. The business will propose a plan for paying creditors some amount of disposable income over a specified period of time (often 7 – 10 years). As stated, secured creditors must be paid in full. If there is any disposable income after paying all of the secured debts, all unsecured creditors will receive payment on their debts based upon their priority. If any class of unsecured creditor is not paid in full, all creditors in that class of priority will receive payment in equal percentages. Of course, the amount of payment will vary depending upon the amount of debt being paid. Interestingly, at least one class of impaired creditor (creditors receiving less than full repayment of the debt over the life of the payment plan) must vote to approve the plan before the bankruptcy court will approve.
Process for Filing a Voluntary Business Bankruptcy
The process for voluntarily filing bankruptcy for an LLC or Corporation begins with authorizing the bankruptcy filing. The members of the LLC are the owners. Because this is a major occurrence for the corporation, the members must vote in accordance with state law or the company’s operating agreement to authorize the bankruptcy filing. Once the bankruptcy filing is approved, the company must hire a bankruptcy attorney. Because an LLC, like a Corporation, exists independently of its owners, the individual filing the bankruptcy must be represented. A bankruptcy filing is a legal proceeding; thus the representative must be an attorney. The remainder of the process depends upon whether the bankruptcy will be subject to Chapter 7 or 11.
The process for filing a Chapter 7 starts by filing the bankruptcy petition with the court and paying the filing fee. The petition must include (1) schedules of assets and liabilities; (2) a schedule of current income and expenditures; (3) a schedule of executory contracts and unexpired leases; and (4) a statement of financial affairs. The amount of the filing fee in 2018 is $1717. The matter is then turned over to Bankruptcy Trustee (Trustee) and the bankruptcy estate is created. The trustee represents the interests of creditors and administers the liquidation and sale of the company’s assets. The business must disclose all creditors and assets to the trustee. The trustee will provide notice of the filing. Creditors making a substantiated claim against the bankruptcy estate will be paid based upon their priority. As previously explained, a secured creditor is paid in full or the collateral securing the debt is surrendered to the creditor. All unsecured creditors will be paid based upon priority if any funds remain after paying all secured creditors. Once the entire estate is administered, the bankruptcy estate is closed. The owners of the company must take additional steps to dissolve the company with the state’s secretary of state’s office.
The process for filing a Chapter 11 starts by filing the bankruptcy petition with the court and paying the filing fee. The bankruptcy petition must include (1) schedules of assets and liabilities; (2) a schedule of current income and expenditures; (3) a schedule of executory contracts and unexpired leases; and (4) a statement of financial affairs. The amount for the filing is the same. Unlike the Chapter 7 Bankruptcy, there is no trustee appointed and the debtor remains in possession of the company and its assets. Once the petition is filed, the court will grant stays of collection efforts against the debtor. The company must form a creditor committee and begin putting together a payment plan. The creditor committee represents the interests of all creditors, as there is no trustee to do so. The plan must pay all secured creditors in full or release the collateral securing the debt to the creditors. At least one class of unsecured creditors being paid less than their full claim must approve the plan. Once the plan meets approval requirement, the company can file the plan with the court for approval. As part of this process, the debtor must provide an extensive disclosure statement to all creditors. This statement discloses all of the financial and operational dealings of the company. Once approved, the repayment period begins. Once the repayment schedule is completed, the company will seek dismissal of the bankruptcy case. The company emerges from the bankruptcy anew.
If the LLC is a small company, it may qualify for small business treatment under Chapter 11. A small business filing is a business that owes no more than $2,566,050 in total claims (not including debts to insiders such as family members of the business owners). This status allows for some administrative simplicity, such as:
- There is not creditors’ committee appointed.
- The company does not have to file the very burdensome disclosure statement. It must, however, file reports with the court, such as a balance sheet, cash flow statement, statement of operations, and federal tax return.
- The US Trustee’s office can exercise oversight over the filing.
- The bankruptcy plan must be proposed within 300 days of the bankruptcy filing, and the exclusive right to file the plan for 120 days.
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