Chapter 11 Bankruptcy for Small Business Owners

Running a small business comes with countless challenges, and financial difficulties can sometimes feel overwhelming. When faced with unmanageable debts, small business owners may consider filing for bankruptcy. Chapter 11 bankruptcy is one option that allows businesses to restructure their debts while continuing operations. 

What is Chapter 11 Bankruptcy?

Chapter 11 bankruptcy is often referred to as a “reorganization bankruptcy.” It is a legal process that allows businesses to reorganize their debts and attempt to become financially stable. Unlike Chapter 7 bankruptcy, which involves liquidating assets to pay creditors, Chapter 11 allows the business to continue operating while implementing a repayment plan.

This type of bankruptcy is available to all businesses, regardless of size. However, it is most commonly associated with larger corporations due to its complexity and cost. That said, small business owners can also benefit from Chapter 11, especially if they believe their business has the potential to recover with some adjustments.

Who Can File for Chapter 11?

Any business entity can file for Chapter 11, including sole proprietorships, partnerships, limited liability companies (LLCs), and corporations. It is also available to individuals with significant debts and assets, although this is less common.

Small business owners often file for Chapter 11 if they believe their business is viable but needs time and a structured plan to resolve its financial issues. If a business owner believes they can turn their company around with reduced debt obligations, Chapter 11 may be the best path forward.

Key Features of Chapter 11 Bankruptcy

One of the defining features of Chapter 11 bankruptcy is the creation of a reorganization plan. This plan outlines how the business will repay its creditors over time. The goal is to create a strategy that satisfies creditors while allowing the business to remain operational.

Another key feature is the concept of the “automatic stay.” Once a business files for Chapter 11, an automatic stay is imposed, which temporarily halts all collection activities from creditors. This means creditors cannot seize assets, garnish wages, or take legal action against the business during this period.

Chapter 11 also involves significant court oversight. The bankruptcy court must approve major decisions, including the sale of assets, changes to business operations, and the reorganization plan itself. Creditors also have the opportunity to vote on the proposed plan.

Benefits of Chapter 11 for Small Business Owners

Chapter 11 offers several advantages for small business owners facing financial hardship. First and foremost, it provides the opportunity to restructure debts and improve cash flow. This can be especially beneficial for businesses with strong revenue potential but temporary financial setbacks.

Another benefit is the ability to keep the business running during the bankruptcy process. Unlike Chapter 7, which requires closing the business, Chapter 11 allows owners to maintain operations, preserving jobs and customer relationships.

Additionally, Chapter 11 can help small business owners renegotiate contracts and leases. For example, if a business is burdened by an expensive lease, the bankruptcy process may allow the owner to renegotiate terms or exit the lease altogether.

The Chapter 11 Process

The Chapter 11 process begins when the business owner files a petition with the bankruptcy court. This petition includes detailed information about the business’s assets, liabilities, income, and expenses. Once the petition is filed, the automatic stay goes into effect.

Next, the business owner must propose a reorganization plan. This plan should detail how the business will address its financial issues and repay its debts. It may involve measures such as reducing expenses, selling non-essential assets, or negotiating new terms with creditors.

The proposed plan is then reviewed by the bankruptcy court and creditors. Creditors have the opportunity to vote on the plan, and the court must approve it before it can be implemented. This process can take several months or even years, depending on the complexity of the case.

Once the plan is approved, the business owner must follow its terms to repay creditors. The court continues to oversee the case until the plan is completed and the business emerges from bankruptcy.

Small Business Cases

Recognizing that Chapter 11 can be cost-prohibitive for small businesses, Congress introduced the Small Business Reorganization Act (SBRA) of 2019. This act created Subchapter V of Chapter 11, which is specifically designed for small businesses.

Subchapter V simplifies the bankruptcy process and reduces costs for small business owners. It eliminates certain requirements, such as forming a creditors’ committee, and allows for faster approval of reorganization plans. Additionally, it provides more flexibility in developing a repayment plan.

To qualify for Subchapter V, a business must have total debts of $3,024,725 or less, with at least 50% of those debts related to business activities. This debt limit was temporarily increased to $7.5 million in response to the COVID-19 pandemic, but reverted to the lower amount on June 21, 2024.

Subchapter V has proven to be a popular and effective option for small businesses seeking to restructure and recover. It has accounted for a significant portion of Chapter 11 filings since its inception, with higher plan-confirmation rates and improved cost-effectiveness compared to traditional Chapter 11 cases.

Challenges of Chapter 11 Bankruptcy

While Chapter 11 offers many benefits, it is not without its challenges. The process can be expensive and time-consuming, requiring significant legal and financial expertise. Small business owners must work closely with attorneys, accountants, and other professionals to navigate the process successfully.

Additionally, court oversight can be burdensome. Every major decision must be approved by the court, which can slow down business operations. The reorganization plan must also satisfy creditors, which may require difficult compromises.

Finally, there is no guarantee of success. If the reorganization plan fails or the business cannot generate sufficient revenue to meet its obligations, the court may convert the case to Chapter 7, resulting in liquidation.

Is it the Right Choice?

Deciding whether to file for Chapter 11 is a major decision that depends on the specific circumstances of the business. Small business owners should consider factors such as the viability of their business, the level of debt, and their ability to develop a realistic repayment plan.

Consulting with a bankruptcy attorney is essential. An experienced attorney can assess the situation, explain the available options, and help determine whether Chapter 11 is the best path forward.

Key Takeaways

  • Chapter 11 Allows Debt Restructuring: Unlike Chapter 7, which involves liquidating assets, Chapter 11 enables small businesses to reorganize debts while continuing operations, preserving the business and jobs.

  • Automatic Stay Provides Immediate Relief: Filing for Chapter 11 triggers an automatic stay, halting creditor collection efforts and allowing the business time to develop a repayment plan.

  • Reorganization Plan Is Central: The process revolves around creating a court-approved plan to address financial challenges, satisfy creditors, and enable the business to regain stability.

  • Subchapter V Simplifies Chapter 11 for Small Businesses: Introduced by the Small Business Reorganization Act, Subchapter V streamlines the process, reduces costs, and offers flexibility for businesses with qualifying debt limits.

  • Renegotiation of Contracts and Leases: Chapter 11 provides opportunities to renegotiate burdensome leases or contracts, which can significantly improve cash flow and operational viability.

  • Court Oversight and Creditor Involvement Are Key: While court approval is required for major decisions, creditors also vote on the reorganization plan, making collaboration and negotiation essential.

  • Significant Costs and Challenges Exist: Chapter 11 can be expensive and time-consuming, requiring skilled legal and financial expertise to navigate successfully.

  • Success Hinges on Business Viability: Small business owners must realistically assess their company’s ability to recover and generate revenue under the terms of the reorganization plan. Consulting with a skilled bankruptcy attorney is critical to making an informed decision.