Chapter 11 Bankruptcy: The Good, the Bad, and the Ugly for Small Business

by Dana Wilkinson, Attorney at Law

September 12, 2012

Chapter 11bankruptcies for big companies make big news.  There is the Chrysler Chapter 11, which is pretty much considered a success.  There is the GM case, which is a bit more equivocal.  And there are the perpetual airline Chapter 11s.

What you don’t hear a lot about are small business Chapter 11s. They may not eat up the same attorney and court time as the mega cases, but they are an important component of the bankruptcy system, andChapter 11can be an important tool for the survival (and hopefully success) of a small business.

Some of the challenges of Chapter 11 bankruptcies are the same for businesses large and small. For example, every Chapter 11 debtor that operates a business does so under a budget that will be supervised by the court, the US Trustee, and creditors.  Borrowing for working capital will be limited if it is available at all.  Thus, working capital may be scarce, and the business may not be as nimble as it might otherwise be.  The cost of Chapter 11 is significant for every business, although the magnitude of that cost differs significantly.

Other challenges are unique to the small business Chapter 11 debtor.  For example, Chapter 11 debtors are required to meet many administrative reporting requirements, relating to operations, taxes, insurance, and bank accounts.  A large company may be able to hire restructuring professionals to take on those tasks so that management can focus on restructuring.  A small business may not have that luxury, and may find that the administrative requirements monopolize management’s attention just when the focus should be on restructuring.

Despite the negatives, Chapter 11 can be beneficial in the right circumstances.  In my opinion, a Chapter 11 may be worthwhile if management can articulate a plan to restructure, or even to liquidate, going in.  If you file Chapter 11 and THEN start thinking about how to reorganize your business’s finances, you are wasting your time and especially your money.  You are also wasting your time and money (and incidentally violating court rules) if you fileChapter 11 just to delay creditors.  If your Chapter 11 “Plan” is the hope that a miracle will occur and something will turn up–you’ll find a buyer, or an investor, or a lender, or win the lottery–you shouldn’t be in Chapter 11 at all.

But, if you know what you would do if your creditors would agree, Chapter 11 may offer the chance to implement that plan.  A Chapter 11 plan can allow you to restructure debt, including tax debt.  You may he able to convert demand obligations to term loans. You may be able to compromise trade debt. You can even convert debt to equity.

But, a successful Chapter 11 almost always takes careful planning.  While I doubt there is ever a perfect time to file Chapter 11, you can never plan too much, or start too early.  The most difficult cases are almost always those that are filed on an emergency basis.  Sometimes there truly is an emergency–some unexpected development that no one anticipated.  More often, though, the emergency Chapter 11 is the result of management’s unreasonable expectation that persistent problems will somehow resolve themselves, or just plain denial.  Recently I’ve been involved in two “emergency” bankruptcies that were filed after years (literally) of litigation.  Optimism is great, and is probably a linchpin of the entrepreneurial spirit, but if there is even the slightest possibility that you will need  to reorganize in bankruptcy, you need to plan ahead.  You will need to find experienced Chapter 11 counsel, you will need to plan for financial and administrative burdens of Chapter 11, and you need at least the germ of an idea of how to restructure.  But, with some planning, good counsel, and a little luck, Chapter 11 can be an essential tool for survival of your small business.

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Däna (pronounced "Donna") Wilkinson, has been a bankruptcy lawyer in South Carolina for 20 years. She is certified as a bankruptcy specialist by the South Carolina Supreme Court.

Last modified: September 28, 2012