What is a Chapter 11 bankruptcy?
Answer: It is one tool, but perhaps the most dramatic remedy, in the toolbox of restructuring attorneys. Chapter 11 is the business reorganization section of the U.S. Bankruptcy Code. Most corporations, LLCs and other business entities are eligible to file for bankruptcy protection in one of two places: the state where they were created or the site of their principal place of business/assets.
Why do companies file for bankruptcy?
Answer: Some of the most common reasons to file for bankruptcy include:
- Getting the benefit of the “automatic stay,” in the event of a bad litigation outcome or to prevent a creditor from taking dramatic steps against a company’s assets.
- Where a distressed company is trying to sell all or some of its assets as a going concern, the buyer might insist on a sale under Sec. 363 of the Bankruptcy Code, which “cleanses” the assets from ALL claims.
- Escaping “bad” deals, such as over-market leases or underwater long-terms supply contracts.
- Where a “good” company has a “bad” balance sheet and needs to restructure its debts, via debt-for-equity swaps or writing down debt to the value of the collateral.
How does it start and how much does it cost?
Answer: The current board and management team are presumed to be capable of getting the company through a Chapter 11 bankruptcy case. In the rare instance of fraud or gross mismanagement, a Chapter 11 trustee can be appointed, however. Filing a bankruptcy petition only requires Board of Directors (or equivalent) approval; however, in some more elaborate ownership structures, there are special super-majority, or even unanimity, requirements for voting by stakeholders that make it more difficult for the Board to take these actions. The cost of the Chapter 11 case is directly related to the size of the debtor company(ies), the complexity of its balance sheet and the length of time it needs to remain in bankruptcy. Legal fees alone will be $50,000-100,000 for a small company and many, many times that for a larger company.
Then, how do small companies afford it?
Answer: There’s no getting around the fact that Chapter 11 is a difficult, expensive and time-consuming process. However, as part of the recent CARES Act, Congress has increased the eligibility levels for the amount of debt that can be handled under the expedited small business reorganization act type of cases, up to $7.5 million.
Does filing Chapter 11 create liquidity for a company?
Answer: In a word, no. The debtor company must be able to operate at a break-even level of cash flow while the case is pending. Of course, if the lenders or other stakeholders are willing to absorb the short-term operating losses during the bankruptcy case, in order to obtain the best overall value, then even a money-losing business can succeed in a Chapter 11 case.
Once my company is in Chapter 11, how does it get out?
Answer: There are essentially two ways that a company can conclude a successful trip through bankruptcy court. The most common is the sale of all of the assets as a going concern under Bankruptcy Code §363. We expect this to be especially true in the days ahead. The other way is a “true” reorganization whereby, for example, bondholders might agree to a debt for equity swap that fixes the debtor company’s balance sheet.
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