Many small businesses are struggling with unsustainable debt and a staggering drop in revenue due to the COVID-19 pandemic. Although government loan programs have helped to ease the burden, it’s not surprising that some business owners are taking a closer look at debt relief strategies like bankruptcy. Bankruptcy is a legal process generally used by individuals and businesses to either discharge debts or to make a plan to repay them. While it does provide some relief from creditors, bankruptcy should be fully discussed with a lawyer before filing.
Here, we discuss the types of bankruptcies available to business owners, what to consider when choosing one type over another, and recent legislation, including the CARES Act, that has made filing for Chapter 11 bankruptcy easier and more accessible for businesses.
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Do you need to file for bankruptcy?
Because bankruptcy is an involved process and there are consequences for doing so, it makes sense to ask, “Are there other options, besides bankruptcy, to get debt relief and hopefully survive the pandemic?” The Small Business Administration (SBA) has already started debt relief measures for business owners with SBA loans. If you have a 7(a), 504, or Microloan through the SBA, the SBA will automatically pay six months of principal, interest, and fees. Other loans and tax relief measures to help small businesses stay afloat are available from the federal government and many state governments. Private lenders may also be willing to negotiate the terms of your loan. Relief is available and may make it possible for you to avoid bankruptcy altogether.
What are the different options available for small businesses considering bankruptcy?
There are three common types of bankruptcies available for small businesses or small business owners.
- Chapter 13 – This bankruptcy type is usually reserved for individuals but can be used by businesses organized as sole proprietorships. It’s a plan used by small businesses that seek to reorganize instead of liquidate the business assets. In a Chapter 13 bankruptcy, you submit a repayment plan with a Bankruptcy Court showing how you will repay your debts.
- Chapter 7 – If the business has no viable future, then Chapter 7 is a logical choice. In Chapter 7 bankruptcies, your remaining assets are liquidated in order to pay down your debts. It can be used for businesses organized as sole proprietorships, corporations, or partnerships.
- Chapter 11 – If your business has a chance at viability, Chapter 11 bankruptcy may be the right option. Typically used by partnerships and corporations, Chapter 11 reorganizes the business as it continues to operate with oversight from a court-appointed trustee. It allows the business to end contracts and leases, recover assets, discharge some debts and reorganize others.
How does a business choose which bankruptcy option is best for its needs?
When your business is considering bankruptcy options, it needs to account for various factors. Each bankruptcy type has different provisions, guidelines, and requirements. Businesses should consider:
- Debt Size – How much you owe factors into the kind of bankruptcy filing you can do. For example, in a Chapter 13 bankruptcy, unsecured debt must be less than $394,725 and secured debt less than $1.18 million.
- Ultimate Goal – What does your business plan to achieve following a bankruptcy filing? If you’re looking to shut down the business permanently, then a Chapter 7 bankruptcy is probably the right choice. If you’re looking to restructure the business, then Chapter 11 or Chapter 13 bankruptcies may be good options.
- Business Entity – How your business is organized plays a role in the bankruptcy type you can follow. Sole proprietorships, partnerships and corporations are allowed to file some bankruptcy types but may be restricted from filing others.
How has the CARES Act increased access to Chapter 11 bankruptcy for small businesses?
The Coronavirus Aid, Relief and Economic Security (CARES) Act provides much needed financial relief for small businesses. While more people are likely familiar with the Paycheck Protection Program (PPP) and small business loan programs, the CARES Act also made changes to the Chapter 11 bankruptcy guidelines, making it easier for businesses to qualify.
The Small Business Reorganization Act of 2019 (SBRA) set the eligibility threshold at $2,725,625 of aggregate debt for businesses that file for Chapter 11 relief. Under the CARES Act, the SBRA was amended. These changes, detailed under Subchapter V, increased the threshold to $7.5 million, making more businesses eligible to access the benefits of the SBRA. Eligibility guidelines exclude loans by business insiders and shareholders.
These changes are in effect until March 26, 2021, unless extensions or amendments to the CARES Act are approved by then.
How does a business currently qualify for Chapter 11 bankruptcy?
Under Subchapter V of the Bankruptcy Code, filings by a “small business debtor” are viewed as a “small business case.” A small business debtor must meet two essential requirements:
- They must be a person or entity engaged in business or other activities of a commercial nature.
- They must owe no more than $7,500,000 in total claims (loans from shareholders and insiders, like the business owner’s family members, don’t count towards the debt limit).
There are no other requirements for qualifying for Chapter 11 bankruptcy at this time.
How has the Small Business Reorganization Act of 2019 (SBRA) streamlined the Chapter 11 bankruptcy process for businesses?
There are several notable changes made by the CARES Act to Subchapter V of the SBRA that streamline the process and aid struggling businesses hit by the effects of the pandemic. These changes include the following:
- Debtors with unsecured and secured non-contingent liabilities that, in total, do not exceed $7.5 million, are eligible for Subchapter V relief.
- Under the SBRA, the management of the company that has filed for Chapter 11 maintains control of the company barring unusual circumstances. This is done throughout the life of the case.
- The U.S. United Trustee Program will appoint a trustee to each Subchapter V case to act in a consulting capacity only. They do not conduct investigations of the debtor or the operations, nor do they engage in the operation of the business. Their only role is to aid the debtor in measures necessary to ensure that the outcome of reorganization is favorable. This may include negotiating with creditors or developing a plan for reorganization.
- There are no appointments for a creditors’ committee unless the court decides to order it, thus reducing costs.
- A status conference, held by the Bankruptcy Court, will be held within 60 days of a bankruptcy filing. This allows for the evaluation of unique circumstances so the court can determine the best course to take and tailor the proceedings as necessary.
- Only a debtor can file a reorganization plan. The plan must be filed no later than 90 days after they file for bankruptcy. This deadline may be extended if circumstances beyond the debtor’s control warrant it.
- The court can approve the reorganization plan even if the creditors reject it or have objections. This allows the business owners to maintain their interests without being required to first get consent from the creditors or pay them in full.
Provisions passed in the CARES Act, including reforms to the SBRA, make it easier for struggling businesses to access relief under the Bankruptcy Code. These reforms give businesses some breathing room to navigate the current economic crisis and come out stronger on the other side.
What is the current process for getting through a Chapter 11 bankruptcy?
The business first files a bankruptcy petition with the court. As a Subchapter V debtor, they must also file the following documents at the same time:
- Balance sheet.
- Statement of operations.
- Cash flow statements.
- Federal tax returns.
Once a bankruptcy petition is filed, the business is a “debtor-in-possession,” allowing it to keep property and continue operating. This status also usually activates a hold on collection attempts while repayment plans are negotiated with debtors.
A trustee is appointed to provide assistance to the business in reorganization efforts. They act in the capacity of an advisor or consultant only.
The court will hold a status conference within 60 days of filing. The debtor is required to submit written documentation, no later than 14 days before the status conference, describing the efforts, both past and future, that have been and will be made to arrive at a consensual plan. This plan of reorganization must be filed by the debtor within 90 days of the bankruptcy filing. The debtor is not required to file a disclosure statement, so creditors do not have to approve the plan, nor are they given an option to vote down the plan.
Under regular Chapter 11 requirements, if the debtor fails to file a plan within the defined time frame, creditors or other parties that have an interest in the company may file a plan. If creditors agree with the plan, it is then submitted to the bankruptcy judge for approval.
How long does it usually take to complete a Chapter 11 bankruptcy?
It typically takes anywhere from six months to two years to complete a Chapter 11 bankruptcy case. However, under Subchapter V, certain measures have been implemented that streamline the process, often cutting the time to months instead of years. Naturally, straightforward cases will move along faster while more complex cases may require more time.
Why would a business owner choose Chapter 11 over Chapter 13?
Only individuals, such as sole proprietors, are eligible to file for Chapter 13. Businesses that are not eligible for Chapter 13 must file under Chapter 11. The business owner will have to decide whether he or she wants to carry the bankruptcy under Chapter 13 or if they want the business to carry it under Chapter 11. There are several reasons that they may choose one over the other:
Fewer restrictions. Both Chapter 11 and Chapter 13 allow for the submission of a plan to restructure debt. Chapter 11 may be more attractive for business owners since it has fewer restrictions and is open to individuals, corporations, partnerships, joint ventures, and limited liability companies.
Easier to qualify and less stringent rules. In the current climate, Chapter 11 may be a more viable option due to amendments made by the CARES Act to SBRA, specifically Subchapter V. The changes there make the process easier from both a qualification and compliance standpoint. It also moves the process along at a much faster pace than either Chapter 13 or regular Chapter 11.
Higher debt limits. The debt limitations under Chapter 13 are much lower than for Chapter 11, making it easier to qualify for bankruptcy under Chapter 11. Chapter 13 plans are also limited to five years and the debtor must pay all disposable income towards the repayment plan.
Speak to a bankruptcy lawyer before moving forward
If you have reached the end of this article, then you hopefully have a better understanding of bankruptcy, the different types of bankruptcy, who qualifies, and what the process generally looks like. Armed with this knowledge, your next step may be to consult with a Rocket Lawyer On Call® attorney to help you decide whether a bankruptcy filing is right for you and your business. Rocket Lawyer has a free Bankruptcy Worksheet that will help you gather and organize your financial information in preparation for your On Call® attorney consultation. Together, these resources can help put you and your business on the road to economic recovery.
This article contains general legal information and does not contain legal advice. Rocket Lawyer is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.