3 bankruptcy options for small business owners
Depending on the circumstances, small businesses have three potential bankruptcy options:
Chapter 7 is a bankruptcy option for debtors that do not have the means to restructure their obligations and continue in business. In Chapter 7, a trustee is appointed, available assets are sold, and creditors are paid to the extent funds are available. Partnerships, limited liability companies, and corporations are all eligible to file bankruptcy under Chapter 7. Depending on their income, individuals who own and operate small businesses as sole proprietorships also may file bankruptcy under Chapter 7.
Chapter 13 can be a restructuring option for small businesses owned and operated by individuals (that is, sole proprietorships). Only individuals may file Chapter 13, so it is not an option for businesses operated through partnerships, limited liability companies, or corporations. Chapter 13 eligibility is also subject to debt limits. Currently, an individual cannot file Chapter 13 if he or she owes more than $394,725 in unsecured debt or $1,184,200 in secured debt.
The other bankruptcy option for small businesses is Chapter 11. Generally, small businesses shy away from Chapter 11, because the process can be expensive, risky, time-consuming, and complex. Chapter 11 is the only bankruptcy option, however, for a small business seeking to restructure and continue in operation if the business is owned by a partnership, limited liability company, or corporation. Chapter 11 is also the only bankruptcy option for individual business debtors who want to reorganize, but owe too much money to meet Chapter 13’s eligibility requirements.
Small business cases under chapter 11 of the bankruptcy code
The term “small business case” was added to the Bankruptcy Code as part of the Bankruptcy Abuse and Consumer Protection Act of 2005. The purpose of the small business amendments is to expedite small business chapter 11 reorganization cases and to implement greater administrative oversight and control over small business debtors.
A “small business debtor” is defined in Section 101(51)(D) of the Bankruptcy Code as a person (defined as an individual, partnership or corporation) engaged in commercial or business activities (including any affiliate of such person), other than a person whose primary activity is the business of owning or operating real property or activities incidental thereto, that has aggregate noncontingent liquidated secured and unsecured debts as of the date of the filing of the bankruptcy petition or date of the entry of an order for relief by the Bankruptcy Court in an amount not to exceed $2,566,050 (excluding debts owed to one or more affiliates or insiders).
Benefits of being a small business debtor include:
- There is no unsecured creditors’ committee. Typically, an unsecured creditors’ committee is appointed in a chapter 11 bankruptcy case to represent the interest of the debtor’s unsecured creditors. A creditors’ committee usually retains counsel and other professionals (with court approval) and the fees and expenses of such counsel and professionals are paid by the debtor’s bankruptcy estate. Such fees and expenses are avoided in a small business bankruptcy case.
- Plan disclosure and solicitation alternatives. Section 1125 of the Bankruptcy Code requires disclosure of adequate information before the proponent of a plan of reorganization may solicit acceptances of the plan. A written disclosure statement must be approved by the Bankruptcy Court, after notice and a hearing, and must be sent to the holders of claims and interests together with the plan. In a small business case, the Bankruptcy Court may determine that a separate disclosure statement is not required because the plan itself provides adequate information. Consequently, the Court may permit the hearing on the adequacy of the disclosure statement to be held at the same time as the hearing to confirm the plan. A combined confirmation and disclosure statement hearing saves the time and expense of having two separate hearings. In addition, the Bankruptcy Court may approve a disclosure statement submitted on a standard form approved by the Court.
- Longer exclusivity period to file a plan. In a typical chapter 11 case, the debtor has the exclusive right to file a plan during the first 120 days of the bankruptcy case. Under Section 1121(e) of the Bankruptcy Code, a small business debtor has the exclusive right to file a plan during the first 180 days of the bankruptcy case, unless the exclusivity period is extended after notice and a hearing.
There is also greater administrative oversight and control over small business debtors in a small business chapter 11 case. Small business debtors must be aware of the following:
- Additional reporting requirements. A small business debtor must attach to its initial bankruptcy petition its most recent balance sheet, statement of operations, cash-flow statement, and Federal income tax return. In addition, Section 308 of the Bankruptcy Code requires a small business debtor to file periodic and other reports containing the following information: (i) the debtor’s profitability; (ii) reasonable approximation of projected cash receipts and disbursements over a reasonable period; (iii) comparisons of actual cash receipts and disbursements with projections contained in prior reports; (iv) whether the debtor has timely filed tax returns, paid taxes, and paid administrative expenses when due; (v) information on the failure to comply with the requirements set forth above and how the debtor intends to remedy such failures; and (vi) information on such other matters as in the best interest of the debtor and creditors, and in the public interest in fair and efficient chapter 11 procedures. These reports must be filed monthly on official forms unless the Bankruptcy Court orders otherwise. Failure to comply with the reporting requirements is ground for dismissal of the bankruptcy case.
- Duty to timely file all schedules and statement of financial affairs. The Bankruptcy Court may grant an extension, after notice and a hearing, but such extension shall not extend such time period to a date later than 30 days after the date of the order for relief absent extraordinary and compelling circumstances.
- Duty to maintain customary insurance.
- Duty to pay all taxes entitled to an administrative expense priority other than those being contested in an appropriate proceeding.
- Plan requirements. A small business debtor must file its plan and a disclosure statement on or before the 300th day after the date of the order for relief. Absent an extension granted by the Bankruptcy Court, the plan must be confirmed within 45 days after it is filed with the Court.
The small business provisions of the Bankruptcy Code provide an expedited, less costly, process for small business debtors to reorganize and avoid liquidation. The additional reporting requirements and plan deadlines must be stringently adhered to. Thus, pre-planning for a small business bankruptcy is essential to complying with the roadmap set forth by Congress.