Matthew A. Staggs, Esq,
Real Estate Law, Business & Corporate Law
Although many economic experts predicted that the economy may deteriorate in 2020, none of these experts could have foreseen the unprecedented impact that the coronavirus pandemic has had on the economy. In a matter of weeks, the coronavirus pandemic has caused the record breaking economy to grind to a sudden halt with many businesses having to close their operations. The uncertainty surrounding the coronavirus pandemic has created a bleak economic outlook for the foreseeable future and many business owners are currently facing difficult financial decisions regarding the future of their businesses. Accordingly, this Article will attempt to assist struggling business owners by providing a broad understanding of the potential advantages and disadvantages of a chapter 11 business bankruptcy.
Chapter 11 Bankruptcy Overview
To better understand the potential advantages and disadvantages of a business filing for chapter 11 bankruptcy, a business owner must understand the basics of a chapter 11 bankruptcy. Chapter 11 of the Bankruptcy Code is designed to enable struggling businesses to restructure their debt while at the same time maximizing recoveries for creditors. A chapter 11 bankruptcy allows the vast majority of businesses to continue their operations while operating as a “debtor-in-possession” with no trustee appointed and with limited bankruptcy court overview. As such, the chapter 11 debtor has control over many business decisions during the bankruptcy proceeding. During the bankruptcy proceeding, the business and its restructuring professionals will create a plan of reorganization to restructure the business’ obligations and pay its creditors over a period of time.
Potential Advantages of Chapter 11 Bankruptcy
The most immediate advantage of a business filing for chapter 11 bankruptcy is that an “automatic stay” is in effect immediately after the business files for bankruptcy. Among other things, the automatic stay prohibits all creditors of the business from commencing or continuing any collection activity (e.g., lawsuits, repossessions, foreclosures, etc.) against the business subject to certain exceptions.
Another advantage of a business filing for chapter 11 bankruptcy is that the business is eligible for debtor-in-possession financing. Debtor-in-possession financing allows the business to obtain financing to enable the business to continue its operations while the business creates and proposes a plan of reorganization. Depending on the circumstances, the debtor-in-possession financing can be obtained on an unsecured or secured basis including secured by a lien senior to the business’ existing unsecured or secured debt (thereby creating an incentive for lenders to finance the chapter 11 debtor).
An often overlooked advantage of a business filing for chapter 11 bankruptcy is that filing for chapter 11 bankruptcy allows the business owner to sell his or her business free and clear of all claims, liens, and any other potential liability. As such, potential buyers are incentivized to purchase a chapter 11 debtor’s business because the bankruptcy court’s order approving the sale of the business usually contains language providing that the buyer is taking ownership of the business free and clear of all claims, liens, and any other potential liability. As a result, a buyer usually in a chapter 11 context may be willing to pay significantly more to acquire the chapter 11 debtor’s business (or assets) as compared to a sale of the business outside of bankruptcy.
Potential Disadvantages of Chapter 11 Bankruptcy
One of the primary disadvantages of a business filing for chapter 11 bankruptcy is that the chapter 11 bankruptcy process is often long, complex, and costly, and therefore, chapter 11 bankruptcy is often too burdensome for a business facing difficult financial decisions. The period of time that it takes for a bankruptcy court to approve a plan of reorganization after a business files for chapter 11 bankruptcy can range from a few months to a few years, during which time the chapter 11 debtor’s business is responsible for all filing, administrative, and professional fees related to its chapter 11 bankruptcy.
Another disadvantage of a business filing for chapter 11 bankruptcy is that once a business files for chapter 11 bankruptcy, the business loses control over business decisions that are considered outside the “ordinary course of business”. Some common examples of business decisions that may be considered outside the “ordinary course of business” include the sale of assets, a potential settlement with a creditor, obtaining credit, and the hiring of professionals (e.g., attorneys, accountants, and consultants). Before making a business decision that is considered outside the “ordinary course of business”, the chapter 11 debtor’s business must obtain permission from the bankruptcy court.
A frequent misconception of business owners who file for chapter 11 bankruptcy for their businesses is that the chapter 11 bankruptcy will automatically discharge the business owner’s personal guarantees related to the business’ debts. Although the business owner’s personal guarantees can potentially be reduced or completely eliminated through negotiations during the bankruptcy proceedings, chapter 11 bankruptcy does not discharge the business owner’s personal guarantees. The business owner’s personal guarantees are usually discharged only if the business owner personally files for bankruptcy.
Conclusion
The coronavirus pandemic has had an unprecedented impact on the economy, which has resulted in business owners facing difficult financial decisions regarding the future of their businesses. Although this Article provides business owners with a broad understanding of the potential advantages and disadvantages of a chapter 11 business bankruptcy, readers of this Article should be aware that many businesses under a chapter 11 bankruptcy ultimately do not reorganize and emerge from the bankruptcy as an ongoing entity. Instead, many chapter 11 bankruptcies result in either the liquidation of the business’ assets or the sale of the business.
Although Blalock Walters, P.A. does not specifically handle chapter 11 bankruptcy matters, Blalock Walters, P.A. does handle other creditor-related matters and can recommend an appropriate bankruptcy attorney for chapter 11 bankruptcy matters. For additional information or questions regarding a business filing for chapter 11 bankruptcy, please contact business law and real estate law attorney Matthew Staggs at mstaggs@blalockwalters.com.
[1] The information provided in this Article does not, and is not intended to, constitute legal advice; instead, this Article is provided for general information purposes only. Readers of this Article should contact Blalock Walters, P.A. to obtain legal advice with respect to any particular matter.
