Frequently Asked Questions About Bankruptcy
_
Bankruptcy is a very complicated interplay of several laws and should not be undertaken without adequate representation. Do not use document preparers or attorneys who do not practice bankruptcy law full time. Most bankruptcy lawyers offer free or very low cost initial consultations.
Is your business is in trouble? How do you determine if bankruptcy is necessary or even helpful in your situation?
What kinds of bankruptcies are there?
What's "bankruptcy" and how does it affect business?
What's the main effect of filing a bankruptcy petition?
Is the business a corporation, a partnership, or a proprietorship?
Should the business be reorganized or liquidated?
When is Chapter 7 the best choice for the company/shareholders/owners?
When is Chapter 11 the best choice for the company/shareholders/owners?
Does management have the resources and desire to engage in the reorganization process?
Possible pitfalls for management.
Is the business one that the owners could start up again after a liquidation of the current business?
Can a business be forced into bankruptcy?
Can a business give special treatment to certain creditors?
If the business can't pay its creditors, how do people afford bankruptcy lawyers?
What kinds of bankruptcies are there?
There are six kinds of bankruptcy cases. They're commonly known by the different chapters of the Federal Bankruptcy Code (The informal name for title 11 of the United States Code (11 U.S.C. §§ 101-1330), the federal bankruptcy law) that covers them.
What's "bankruptcy" and how does it affect business?
While technical definitions of bankruptcy can vary, the term refers to a situation where an individual or a business has more debts or liabilities than assets and usually can't meet their financial obligations as they become due.
Virtually anyone or any type of business entity can start a bankruptcy proceeding by filing a petition in Federal Bankruptcy Court. The person who files the petition is called the debtor. A link to the web site for the United States Bankruptcy Court for the Southern District of New York is here, and a link to the United States Bankruptcy Court for the Eastern District of New York is here. A link to all United States Courts is here.
The filing of a bankruptcy petition affects all of the debtor’s creditors.
There are many different categories of creditors, including:
Bankruptcy generally covers only pre-petition debts, or those that existed at the time the petition was filed. Inevitably, every business is going to run into situations where customers or vendors file bankruptcy.
What's the main effect of filing a bankruptcy petition?
The filing of a bankruptcy petition is a lot like filing a lawsuit in the sense that the act of filing simply starts a legal proceeding without any guarantees of the outcome. The debtor must go through a statutory process, with creditors and other third parties given the opportunity to challenge and object to the discharge or restructuring of the debts owed to them.
Unlike any other type of legal proceeding, though, the filing of a bankruptcy petition immediately gives rise to an automatic stay. It stops creditors from taking any further action to try to collect their debts unless or until the bankruptcy court gives them permission to do so. The stay is meant to give debtors temporary relief from their financial problems, giving them the opportunity to figure out how to deal with them.
There are exceptions to the automatic stay for certain creditors, and for others, the Bankruptcy Court can lift the automatic stay if the creditor requests it. However, the automatic stay prevents most debt collections.
One common way is to file a petition or motion with the court, asking for relief from the automatic stay. In the case of a secured creditor, a court will look to see if the creditor is adequately protected. For example, a creditor with a lien on real property may still be adequately protected if there's enough equity and/or the debtor starts making "post-petition" payments again after the filing of the bankruptcy. If there isn't adequate protection, a creditor may be given permission to proceed with foreclosure or other remedies.
Is the business a corporation, a partnership, or a proprietorship?
Corporations and partnerships are legal entities separate from their shareholders or partners. They can file Chapter 7 or Chapter 11 bankruptcy in their own right. Proprietorships are just an extension of the owner: they can't file bankruptcy alone: the proprietor must file bankruptcy, since the assets and the liabilities of the business are really just one form of assets of the proprietor.
The individual owner may file Chapter 7, Chapter 11 or Chapter 13 (if the debt limits are met). In a partnership's Chapter 7 case, the trustee can sue the general partners of the partnership if the partnership's assets are insufficient to pay all claims for the amount by which the partnership assets fall short of partnership debts. As a result, partners may be facing a suit by a trustee suing for the benefit of all creditors of the partnership.
Should the business be reorganized?
To answer this question, you have to know what has caused the problems the business now faces and what are the prospects for change: Reorganization is not magic. However:
On the other hand:
Does management have the resources and desire to engage in the reorganization process?
Chapter 11 reorganization requires significant time on the part of the owners and managers to comply with the requirements of the bankruptcy system. Compliance with those requirements is usually expensive because of professional fees and court expenses.
Most reorganizations fail, usually for lack of the ability to stick to a budget, or to control the events and costs that forced the company into a bankruptcy. Often, the business owner has no real idea how much time and effort goes into a successful chapter 11.The value of the bankruptcy for the company and its owners/shareholders is that, in exchange for the protection of the automatic stay and other bankruptcy protections, the business provides full disclosure of its financial condition to creditors and the court, both at the beginning of the case and on a monthly basis in a form of a income and expense statement, and operates as a fiduciary for its creditors while the bankruptcy is ongoing.
Possible pitfalls for management.
Business owners and officers need to know when business isn't going well. Management should consider the following issues as part of their planning:
Is the business one that the owners could start up again after a liquidation?
Businesses that require little capital, have few assets, or are really just extensions of the owner's skills and personality are ones that it may not pay to reorganize. The owners may be better off liquidating the business, in or out of bankruptcy, and starting over in a fresh entity. This can be a complex issue and requires good professional advice to do correctly.
When is Chapter 7 the best choice for the company/shareholders/owners?
A Chapter 7 bankruptcy for a business is usually not a good choice. For an individual that has considerable personal liability for business debts, chapter 7 may be the best choice.
When is Chapter 11 the best choice for the company/shareholders/owners?
Deciding to file a Chapter 11 reorganization is not an easy decision. Each business owner should first exhaust all other options. It's a good idea to get financial and legal advice before taking any action. Chapter 11 can actually be an effective tool to save a business. In a Chapter 11 case, for example, you can sometimes restructure or consolidate debts and come out of the bankruptcy with a fresh start and a clean balance sheet. Most publicly-held companies file under Chapter 11 rather than Chapter 7 because current management can continue to run the business and control the bankruptcy process. Chapter 11 is a way to rehabilitate the business. Sometimes the plan returns the business to profitability; other times it ends up liquidating. In most instances, creditors would rather that a business not file for bankruptcy since they may then get nothing. But creditors are usually of the mindset that none of them is going to accept a compromise on a debt unless they all do. The threat of filing bankruptcy is sometimes just the leverage a business needs to hold creditors at bay until the business turns around.
Can a business be forced into bankruptcy?
Yes. If enough is at stake, creditors can start an involuntary bankruptcy action against a business. This doesn't happen too often, but it does happen when creditors are concerned that a business is squandering or misappropriating assets that should otherwise go to pay the debts owed to the creditors.
Can a business give special treatment to certain creditors?
As a general rule, no. In any bankruptcy, the fair treatment of all creditors is a main goal. Practically any transfer of business property or assets during the 90 days before bankruptcy is filed may be avoided or set aside by the bankruptcy trustee. That includes making payments to creditors. Also, transfers (e.g., payments, gifts, forgiveness of debt) to insiders (relatives, general partners and directors or officers of the business, for instance) made up to one year before filing can be avoided. And, the laws in your state may give the trustee even more time to avoid some transfers. It's important to talk to your attorney about all transfers, payments, etc. made by the business to make sure it's the right time to file for bankruptcy.
If businesses can't pay their creditors, how do people afford bankruptcy lawyers?
Bankruptcy lawyers usually insist on being paid up front. When people know that filing bankruptcy is inevitable, they can plan ahead to pay their lawyer. This usually involves paying the lawyer with money that may have gone to the company's creditors. The logic is that, if someone is going to file bankruptcy anyway, it's better to reallocate the resources to pay for good legal representation rather than continue to pay on debts that may be discharged or restructured in the bankruptcy. Keep in mind, too, bankruptcy lawyers usually aren't considered "creditors" of the bankruptcy-debtors they represent, so paying them upfront doesn't raise the problem of favoring one creditor over another.
As you can see from all the links on this page, bankruptcy lawyers use lots of specific words. A glossary of words you should know is here.
Bankruptcy is a very complicated interplay of several laws and should not be undertaken without adequate representation. Do not use document preparers or attorneys who do not practice bankruptcy law full time. Most bankruptcy lawyers offer free or very low cost initial consultations.
Is your business is in trouble? How do you determine if bankruptcy is necessary or even helpful in your situation?
What kinds of bankruptcies are there?
What's "bankruptcy" and how does it affect business?
What's the main effect of filing a bankruptcy petition?
Is the business a corporation, a partnership, or a proprietorship?
Should the business be reorganized or liquidated?
When is Chapter 7 the best choice for the company/shareholders/owners?
When is Chapter 11 the best choice for the company/shareholders/owners?
Does management have the resources and desire to engage in the reorganization process?
Possible pitfalls for management.
Is the business one that the owners could start up again after a liquidation of the current business?
Can a business be forced into bankruptcy?
Can a business give special treatment to certain creditors?
If the business can't pay its creditors, how do people afford bankruptcy lawyers?
What kinds of bankruptcies are there?
There are six kinds of bankruptcy cases. They're commonly known by the different chapters of the Federal Bankruptcy Code (The informal name for title 11 of the United States Code (11 U.S.C. §§ 101-1330), the federal bankruptcy law) that covers them.
- Chapter 7. Chapter
7 is the most common type of bankruptcy proceeding. Individuals,
married couples, corporations and partnerships can use Chapter 7. In most of
these cases, all or most of your debts are discharged
or extinguished. A bankruptcy case trustee
is appointed to the case and controls all of your assets, and may sell anything
that isn't exempt
to pay your debts. Each State has its own list of exempt property.
- Chapter 9. Chapter 9 is used for municipalities and other
government organizations. States are not
eligible for Chapter 9.
- Chapter 11. Chapter
11 is a reorganization proceeding, usually used by corporations, partnerships or individuals that do not qualify for Chapter 13. In Chapter 11, a business tries to reorganize its outstanding
debts and continue business operations. The debtor (called the debtor-in-possession in Chapter 11),
prepares a reorganization plan. The reorganization plan tells creditors which debts will be paid off, how
much and when. It must be approved by the court and the creditors. Generally,
the plan must provide for paying creditors not less than they would have been
entitled to be paid in a Chapter
7 liquidation case. Through Chapter 11, a business can reduce or
eliminate debt and try to make itself profitable again, paying creditors out of
future income. However, it isn't easy to salvage a business through Chapter 11,
and many cases end up converting to a Chapter 7.
- Chapter 12. This is a reorganization bankruptcy for family
farmers. It's modeled after Chapter
13. Farmer-debtors keep their properties and pay creditors out of
future income.
- Chapter 13. Chapter
13 is a reorganization only for individuals with regular
income. There are strict income
qualifications that may prohibit an individual from filing Chapter 13. In a Chapter 13 case, debtors keep all or most of
their belongings in exchange for making regular payments to their creditors over
a period of time, usually 3 or 5 years. Repayments are made according to a repayment plan
made out by the debtor. The plan must approved by the court and the creditors.
- Chapter 15. Chapter 15 cases are designed to provide a means for
dealing with the debts of trans-national businesses.
What's "bankruptcy" and how does it affect business?
While technical definitions of bankruptcy can vary, the term refers to a situation where an individual or a business has more debts or liabilities than assets and usually can't meet their financial obligations as they become due.
Virtually anyone or any type of business entity can start a bankruptcy proceeding by filing a petition in Federal Bankruptcy Court. The person who files the petition is called the debtor. A link to the web site for the United States Bankruptcy Court for the Southern District of New York is here, and a link to the United States Bankruptcy Court for the Eastern District of New York is here. A link to all United States Courts is here.
The filing of a bankruptcy petition affects all of the debtor’s creditors.
There are many different categories of creditors, including:
- Secured creditors - usually those with a
lien on a debtor's property
- Unsecured creditors - usually vendors, credit card companies and anyone
else who doesn't have a security interest in any of the debtor's property
- Judgment creditors - usually those creditors
who have sued and obtained a judgment against the debtor before the bankruptcy
was filed
- Priority creditors - they have higher priority over other creditors because of special rules or proceedings within the bankruptcy
- Administrative creditors -
usually creditors such as accountants or lawyers with claims that are given
priority because of their having assisted in the bankruptcy in some manner
- Post-petition creditors - those who extended credit to the debtor after the bankruptcy has been filed.
Bankruptcy generally covers only pre-petition debts, or those that existed at the time the petition was filed. Inevitably, every business is going to run into situations where customers or vendors file bankruptcy.
What's the main effect of filing a bankruptcy petition?
The filing of a bankruptcy petition is a lot like filing a lawsuit in the sense that the act of filing simply starts a legal proceeding without any guarantees of the outcome. The debtor must go through a statutory process, with creditors and other third parties given the opportunity to challenge and object to the discharge or restructuring of the debts owed to them.
Unlike any other type of legal proceeding, though, the filing of a bankruptcy petition immediately gives rise to an automatic stay. It stops creditors from taking any further action to try to collect their debts unless or until the bankruptcy court gives them permission to do so. The stay is meant to give debtors temporary relief from their financial problems, giving them the opportunity to figure out how to deal with them.
There are exceptions to the automatic stay for certain creditors, and for others, the Bankruptcy Court can lift the automatic stay if the creditor requests it. However, the automatic stay prevents most debt collections.
One common way is to file a petition or motion with the court, asking for relief from the automatic stay. In the case of a secured creditor, a court will look to see if the creditor is adequately protected. For example, a creditor with a lien on real property may still be adequately protected if there's enough equity and/or the debtor starts making "post-petition" payments again after the filing of the bankruptcy. If there isn't adequate protection, a creditor may be given permission to proceed with foreclosure or other remedies.
Is the business a corporation, a partnership, or a proprietorship?
Corporations and partnerships are legal entities separate from their shareholders or partners. They can file Chapter 7 or Chapter 11 bankruptcy in their own right. Proprietorships are just an extension of the owner: they can't file bankruptcy alone: the proprietor must file bankruptcy, since the assets and the liabilities of the business are really just one form of assets of the proprietor.
The individual owner may file Chapter 7, Chapter 11 or Chapter 13 (if the debt limits are met). In a partnership's Chapter 7 case, the trustee can sue the general partners of the partnership if the partnership's assets are insufficient to pay all claims for the amount by which the partnership assets fall short of partnership debts. As a result, partners may be facing a suit by a trustee suing for the benefit of all creditors of the partnership.
Should the business be reorganized?
To answer this question, you have to know what has caused the problems the business now faces and what are the prospects for change: Reorganization is not magic. However:
- Reorganization might free up cash
flow to permit current operations
- Reorganization might allow the
business to cancel non-performing leases or contracts (for example, an
expensive leased location or certain kinds of equipment purchases
- Reorganization might prevent the
loss of vital assets or cash to creditor collection actions (for example, a
building or other asset that is currently undervalued but that will increase in
value within a reasonable time)
- Reorganization might provide time
for the owners to sell the business as a going concern or sell the business
assets instead of at a foreclosure sale or a “fire sale.” The net sale proceeds could pay taxes or
unpaid salaries and provide ongoing jobs for the work force under new
ownership.
On the other hand:
- Reorganization can't create a market for the business
- Reorganization can’t increase gross revenue
- Reorganization can’t make up for a poor fit between the skills available and the skills required to run the business.
Does management have the resources and desire to engage in the reorganization process?
Chapter 11 reorganization requires significant time on the part of the owners and managers to comply with the requirements of the bankruptcy system. Compliance with those requirements is usually expensive because of professional fees and court expenses.
Most reorganizations fail, usually for lack of the ability to stick to a budget, or to control the events and costs that forced the company into a bankruptcy. Often, the business owner has no real idea how much time and effort goes into a successful chapter 11.The value of the bankruptcy for the company and its owners/shareholders is that, in exchange for the protection of the automatic stay and other bankruptcy protections, the business provides full disclosure of its financial condition to creditors and the court, both at the beginning of the case and on a monthly basis in a form of a income and expense statement, and operates as a fiduciary for its creditors while the bankruptcy is ongoing.
Possible pitfalls for management.
Business owners and officers need to know when business isn't going well. Management should consider the following issues as part of their planning:
- How much of the business debt is secured? The division of debt between secured and unsecured has an enormous effect on the outcome of a reorganization.
- Are taxes paid and up to date, or have returns been filed, even if those taxes have not as yet been paid? Certain taxing authorities will be paid before creditors.
- Has management signed personal guaranties? If the business files bankruptcy, management will not be protected from a separate action by the holder of the guaranty. ·In addition, management may be personally liable for unpaid “trust fund taxes” (such as payroll taxes). When an employer deducts taxes and social security contributions from employee wages, the employer becomes a fiduciary for that money which belongs to the employee. "Loaning" the business the money due to the government from employees' paychecks makes the responsible corporate officers personally liable for the trust fund taxes not paid to the taxing authority. Sales taxes are trust fund taxes in some jurisdictions, as well. ·
- Has management repaid itself for loans to the the business? If so, those payments may be recoverable by the company as preferences or fraudulent conveyances.
Is the business one that the owners could start up again after a liquidation?
Businesses that require little capital, have few assets, or are really just extensions of the owner's skills and personality are ones that it may not pay to reorganize. The owners may be better off liquidating the business, in or out of bankruptcy, and starting over in a fresh entity. This can be a complex issue and requires good professional advice to do correctly.
When is Chapter 7 the best choice for the company/shareholders/owners?
A Chapter 7 bankruptcy for a business is usually not a good choice. For an individual that has considerable personal liability for business debts, chapter 7 may be the best choice.
When is Chapter 11 the best choice for the company/shareholders/owners?
Deciding to file a Chapter 11 reorganization is not an easy decision. Each business owner should first exhaust all other options. It's a good idea to get financial and legal advice before taking any action. Chapter 11 can actually be an effective tool to save a business. In a Chapter 11 case, for example, you can sometimes restructure or consolidate debts and come out of the bankruptcy with a fresh start and a clean balance sheet. Most publicly-held companies file under Chapter 11 rather than Chapter 7 because current management can continue to run the business and control the bankruptcy process. Chapter 11 is a way to rehabilitate the business. Sometimes the plan returns the business to profitability; other times it ends up liquidating. In most instances, creditors would rather that a business not file for bankruptcy since they may then get nothing. But creditors are usually of the mindset that none of them is going to accept a compromise on a debt unless they all do. The threat of filing bankruptcy is sometimes just the leverage a business needs to hold creditors at bay until the business turns around.
Can a business be forced into bankruptcy?
Yes. If enough is at stake, creditors can start an involuntary bankruptcy action against a business. This doesn't happen too often, but it does happen when creditors are concerned that a business is squandering or misappropriating assets that should otherwise go to pay the debts owed to the creditors.
Can a business give special treatment to certain creditors?
As a general rule, no. In any bankruptcy, the fair treatment of all creditors is a main goal. Practically any transfer of business property or assets during the 90 days before bankruptcy is filed may be avoided or set aside by the bankruptcy trustee. That includes making payments to creditors. Also, transfers (e.g., payments, gifts, forgiveness of debt) to insiders (relatives, general partners and directors or officers of the business, for instance) made up to one year before filing can be avoided. And, the laws in your state may give the trustee even more time to avoid some transfers. It's important to talk to your attorney about all transfers, payments, etc. made by the business to make sure it's the right time to file for bankruptcy.
If businesses can't pay their creditors, how do people afford bankruptcy lawyers?
Bankruptcy lawyers usually insist on being paid up front. When people know that filing bankruptcy is inevitable, they can plan ahead to pay their lawyer. This usually involves paying the lawyer with money that may have gone to the company's creditors. The logic is that, if someone is going to file bankruptcy anyway, it's better to reallocate the resources to pay for good legal representation rather than continue to pay on debts that may be discharged or restructured in the bankruptcy. Keep in mind, too, bankruptcy lawyers usually aren't considered "creditors" of the bankruptcy-debtors they represent, so paying them upfront doesn't raise the problem of favoring one creditor over another.
As you can see from all the links on this page, bankruptcy lawyers use lots of specific words. A glossary of words you should know is here.