Will Geer, a partner with Rountree Leitman Klein & Geer, LLC discusses the questions a business should ask itself when determining whether to file for Chapter 11 bankruptcy.
As a business owner, I can tell you that operating your own ship is one of the most exciting and frightening things you’ll ever do, but the rewards are immeasurable (well, almost immeasurable). Almost every business will experience some lull in income a month or two out of the year; however, sometimes that stagnation turns into a regular monthly occurrence that results in creditors knocking down your door demanding to be paid. It feels as if you are Atlas carrying the planet’s troubles on your shoulders, even if it is limited to your own world. In this situation, an appropriate solution may be to file Chapter 11 bankruptcy for your business to restructure the debts of the business to give you and your company a bit of breathing room. Before considering Chapter 11 as a viable option, you will want to ask yourself these 5 questions:
1. Is the management ready and willing to cooperate?
Filing bankruptcy should not be taken lightly and adhering to the requirements of the code, including the quarterly Trustee payments, monthly operating reports, advanced disclosure requirements, and numerous hearings will take a significant amount of time and energy from your already hectic schedule. If management is not ready and willing to take on these new responsibilities, shutting the doors or filing Chapter 7 to allow for an orderly liquidation may be the route to take. Chapter 11 is also an expensive undertaking, so make sure there is actually something to reorganize before paying thousands of dollars in attorneys’ fees.
2. Is your product or service marketable?
In Chapter 11, cash flow is everything, and something filing Chapter 11 cannot do is increase the marketability of your business. It can, however, help increase your immediate cash flow concerns by preventing creditor collection efforts and lowering secured creditor payments. Certain tax obligations may also be treated in the Chapter 11 Plan of Reorganization. But one thing a Chapter 11 filing will not do is create a marketable product or service where one does not exist, so if the market is entirely tapped or your product is simply not expected to sell in the future, it may be times to shut the doors. If you do wind up filing, the lack of cash flow will draw objections on the feasibility of your Chapter 11 Plan. In short, if you cannot make enough money to fund a viable plan of reorganization, your case will be unsuccessful and likely dismissed.
3. Does my lender have an interest in “cash collateral”?
What is “cash collateral”, you may ask. In short, cash collateral is, among other things, cash, negotiable instruments, rents, inventory, and accounts receivables of a business in which a lender claims a security interest. For instance, in Georgia, when a lender loans a borrower money to fund the purchase of real property, the lender will take a security interest in the real property as evidenced by a Deed to Secure Debt. This security instrument will often contain a clause providing that all rents and income arising from the use of the real property will secure the debt obligation of the borrower. Just because your lender has an interest in cash collateral does not mean that filing Chapter 11 is impossible. In fact, one of the first motions that a Debtor’s attorney will file in this situation is a Motion to Use Cash Collateral to allow a business to continue to operate throughout the bankruptcy. However, be aware that attorneys’ fees, including the initial retainer, will often have to be paid from funds not categorized as cash collateral. Otherwise, the creditor and debtor must work out some type of “carve-out” to pay your attorney. Often, the executive officers of the corporate debtor will fund the debtor’s attorneys’ fees for this reason.
4. Does my business only have one creditor?
This situation often presents itself in the case of a single piece of real property in which all the Debtor’s income is derived from the operation of that property. In this case, there may be only one secured creditor. If you have a company with only one creditor, filing Chapter 11 bankruptcy is probably not the best option. Doing so will only prevent foreclosure for a few months at best, as the secured creditor will file a Motion to Dismiss for “bad-faith” filing based on your inability to effectuate a viable plan. In Chapter 11, creditors are given the option to vote on the acceptance of your plan. Under certain circumstances, you may force the creditors to accept the terms of the plan; however, one of the conditions of forcing such acceptance is to have the affirmative vote of at least one impaired class of creditors. If you only have one secured creditor in one class, you will not be able to satisfy this requirement. “But wait”, you cry, “I have a few unsecured creditors that can vote to accept the plan!” This may be your saving grace; however, in most of these cases, the secured creditor’s lien is worth more than the value of the property. As a result, the secured creditor’s claim will be bifurcated into a secured claim and unsecured claim. The unsecured deficiency claim will be lumped into the general unsecured claims class with the aforementioned unsecured creditors, and because this deficiency claim will typically be MUCH larger than the aggregate of the other claims, it will control that class and result in a vote against your Plan.
5. Do we have a Plan?
I’m not necessarily talking about a finalized plan of reorganization, but you should definitely have an idea, with the help of experience counsel, of your end-game goal. Chapter 11 requires hours and hours of planning and communication prior to filing the petition, and prior to that petition being filed, the debtor and its attorney should have some idea of the results to be obtained whether it be to restructure short-term trade debt into a long-term liability or to force secured creditors to accept more favorable terms and consequently lower your secured payments. Going into the case without adequate preparation is simply a waste of time and money for both you and your company’s attorney.
One of the most important features of the original CARES Act — the federal government’s response to the COVID-19 economic crisis — was the creation of the Paycheck Protection Program (PPP), which allows small businesses to obtain emergency loans to stay in operation. But regulations issued by the Small Business Administration made PPP loans unavailable to small businesses that had filed for bankruptcy. Now, the CARES II Act has made it clear that these loans can be secured by debtors seeking protection under Subchapter V, a simplified form of Chapter 11 reorganization for small businesses.
CARES II, formally known as the Consolidated Appropriations Act of 2021, came after a deluge of Subchapter V filings that resulted in part from the CARES Act’s raising of the debt threshold for eligibility. Businesses with debts of up to $7.5 million can now qualify for Subchapter V — double the original threshold of $2.725 million. However, the unavailability of PPP loans has made it difficult for Subchapter V debtors to get the credit they need to meet overhead expenses while the reorganization proceeding goes on. CARES II has addressed that problem.
The new law amends the federal bankruptcy code to allow a Subchapter V debtor to apply to the bankruptcy court for a PPP loan to help cover payroll, rent and utilities. If the money is used for those purposes, the loan may be forgiven or, if not, may be treated as a “superpriority” administrative expense, which means it can be paid off ahead of other debts. The loan may also be repaid under the Subchapter V plan of organization approved by the bankruptcy court.
CARES II provides further rent relief to small businesses in Subchapter V. It adds an additional 60 days to the existing 60-day grace period within which a debtor must begin paying rent, as long as the debtor has experienced “a material financial hardship due, directly or indirectly,” to the effects of the pandemic. CARES II also allows post-petition rent arrearages to be paid over the course of the reorganization plan, rather than requiring them to be paid in a lump sum prior to plan approval.
Another change is to give Subchapter V debtors additional time to decide whether to assume or reject a lease. The period is now 210 days — up from 120 days — with a potential 90-day extension. This helps small businesses avoid having to make quick, possibly bad, decisions about whether to close stores during the uncertain economic environment caused by the COVID pandemic.
The experienced Georgia attorneys at Rountree Leitman & Klein LLC, in Atlanta guide small businesses through the Subchapter V bankruptcy process. Call us at 404-737-9623 or contact us online for a free consultation.
Rountree Leitman Klein & Geer, LLC's blog is a resource provided to clients, prospective clients, and colleagues that discusses issues related to Personal Bankruptcy, Business Bankruptcy, Collections, and Litigation.