LEGAL GUIDE
Written by attorney Jeffrey Williams | Sep 28, 2013

CHAPTER 11 BANKRUPTCY FOR SMALL CORPORATIONS AND LLC’S

Chapter 11 bankruptcy is sometimes considered by owners of small corporations or LLC’s. Chapter 11 is primarily meant for reorganizing the financial affairs of large and small corporations, partnerships, and LLC’s, to enable the business to continue to operate and hopefully become profitable when it finds that its debts are more than its income. If the business could prosper if only it wasn’t servicingold, non-recurring debt; if it has recently fired or laid off non-productive people (or thieves!) who were secretly eating up profits; or if it could prosper if it could shed non-critical equipment or premises leases, Chapter 11 may be the answer.

If you have a Corporation or an LLC, there is no personal liability for any of the debts unless you signed a personal guarantee. (However, the Feds can go after you personally as an owner or officer of the corporation or LLC for any unpaid payroll withholding taxes, and the State can go after you personally for any unpaid sales taxes.) But if do not have a corporation or an LLC, and instead own a Sole Proprietorship or part of a simple partnership, you are personally liable for all of the business debts.

FACTORS TO CONSIDER

Both a Corporation (S- or C-) and an LLC are legally treated as “separate persons" in bankruptcy. Whether your small business entity should be bankrupted or not depends on several factors. Among the factors to be considered are:

-- Do you have the time, energy, and desire to continue the business?

-- Are there any significant assets (tools, inventory, vehicles, buildings, etc.)?

-- What is the net worth of the entity, when debts are subtracted from assets?

(You need an accurate current Balance Sheet to determine this.)

-- How much profit or loss did your company generate during

(1) the six calendar months prior to your bankruptcy filing and

(2) for the year-to-date when you file?

--Do you own all the stock or membership interest? If not, who else does,

and how much?

-- Are any Federal withholding (payroll) taxes due?

-- Are any State sales taxes due?

-- Are there any unpaid salaries due?

Corporations or LLC s can file either Chapter 7 bankruptcy or Chapter 11 bankruptcy, but not Chapter 13 bankruptcy. Although they cannot discharge their debts in a Chapter 7, they can under certain circumstances in a Chapter 11. But keep in mind that very few small corporations or LLC’s are good candidates for a Chapter 11.

ADVANTAGES OF CHAPTER 11

With Chapter 11 bankruptcy you can get out of any leases for offices or equipment you do not really need, and you can force secured creditors (such as mortgage holders of an office building or factory you are buying, or loans with which you bought vehicles your business needs) to re-write the loans down to the actual cash value of the items being paid for, possibly with other improvements in the terms such as a better interest rate.

The main purpose of Chapter 11 is to allow time to reorganize the business to make it successful (or, in the alternative, to allow for orderly, fair liquidation). If the business is not making money now, why not? Is there any evidence or reason this is likely to change? Will layoffs or trimming excess expenses enable the core business to succeed? Was the difficulty due to embezzlement or mismanagement by an employee or manager who is now gone from the company? If filing Chapter 11 will allow time and means to make the business profitable in the future, and stop losing money, andif the small business can meet all the other expenses and requirements, then the Chapter 11 might succeed. Filing just to stall creditors may only delay inevitable business failure. Small businesses should not rush into a Chapter 11 on an emergency basis, without careful planning; that may only be a waste of time and a lot of money. First make sure you have accurate, complete accounting, and up-to-date tax returns, so you and your CPA and a good bankruptcy lawyer can determine the true position of your company and the advisability of filing Chapter 11.

DISADVANTAGES OF CHAPTER 11

Chapter 11 is much more complicated and expensive than Chapter 7 or Chapter 13. Just the filing fee alone to start a new Chapter 11 proceeding is$1,213.00; and a typical cost for legal fees might easily be $10,000 or $20,000 the first year alone. The time period is variable; it could easily be longer than five years, if necessary. There are a lot of reports required for taxes, insurance, operations, and bank accounts.

The biggest problem with small-business Chapter 11 cases is that they fail very often (that is, they are dismissed by the Court, or forcibly converted to a Chapter 7 by the Court). In fact, it is the opinion of many good bankruptcy attorneys that most small-business Chapter 11 cases fail. The corporation or LLC may not be able to keep the company running without further losses, or may be unable to keep up with the reporting requirements and expenses of the Chapter 11, and consequently fail. The key to avoiding failure is limiting Chapter 11 filings to cases where a Chapter 11 is really called for and could work, combined with careful planning before filing. Even when Chapter 11 is appropriate, the cases most likely to fail are the ones filed on an emergency basis, with inadequate accounting or planning as to the company’s true prospects for success.

A WORD TO THE WISE

Warning: occasionally certain law firms like to steer their clients towards Chapter 11when a much cheaper Chapter 7 would have been much more logical. Why? Because under Chapter 11, the law firm stands to make tremendously higher fees, perhaps from four to thirty times as much! For a small company, just the legal fees alone can contribute to failure in a Chapter 11. Such firms sometimes advise their clients to file under Chapter 11 knowing that it is unlikely to succeed, and that the case will likely be dismissed or converted to a Chapter 7 by the court, after the law firm has made a lot of money from the client.

Fortunately, most reputable law firms would not do such a thing, but sometimes, this word to the wise may save you a lot of unnecessary expense and trouble. And a law firm is likely giving you good advice to file Chapter 11 if it is a case where Chapter 11 is the only practical way possible to keep a business going which has a good chance of success. Situations vary; be sure to see a qualified attorney for advice in your particular case.

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