Chapter 7 Filing
Chapter 7 is a last resort. It liquidates the business, distributing proceeds to creditors. The alternatives before it begin with new financing or an investment, and range through the sale of assets (or even the business), an out-of-court workout with lenders, and a Chapter 11 filing. So you need to try every realistic alternative before you take this step. “Insolvent” means that a business can’t pay its debts as they come due or that its debts exceed its assets. If the company is insolvent, as a practical matter management’s duty may run more to creditors than to the owners. Do you need to file at all? You’d be better off not filing if you can handle your debts outside court, but at some point the process can become impossible to control. You reach that point when the business can’t be saved, when the owners and officers are worried about their duty to creditors, and when one orderly proceeding makes more sense than having creditors enforce judgments one by one. Chapter 7 is the logical next step. A Chapter 7 filing gathers all claims in one place so individual creditors can’t rush in and grab what assets they can. Whether that is the right move depends on the facts of each business.
Once the business files for Chapter 7, there is an automatic stay. That halts nearly every collection, lawsuit and judgment enforcement action while the case is going on. It can be tough on creditors but that is the point of a Chapter 7: To make sure they all stand in one line, behind the trustee. The Chapter 7 trustee is named on an interim basis by the U.S. Trustee’s Office and becomes permanent unless creditors vote to elect their own trustee. That trustee’s job is to collect assets, sell the business or whatever of it there is, and pay out the proceeds to creditors. He or she can use the business’s rights to sue, often on receivables. The trustee can undo preferential or fraudulent transfers so all similar creditors are treated equally.
Chapter 11 Is About Keeping Them
Chapter 11 does the same basic things as Chapter 7–halt collection and lawsuits by creditors–but Chapter 7 is largely about distributing assets; Chapter 11 is about keeping them. Chapter 11 is a set of tools to restructure debt and reorganize. The business can keep operating as a going concern while management, creditors, employees, the court, and investors put together a plan to get the company back on its feet. Or the case can lead to a sale of the business or its assets as a going concern. Through a Section 363 sale, buyers can get assets free and clear of liens, taxes and other claims. That is a big plus, and it attracts bidders. The business can shed unprofitable leases, and force creditors to accept payment over time. It gives you time to work out some issues, but you also have to deal with the court, new lawyers, and creditors. Chapter 11 is not a cure-all and it is not a first step. It is very helpful in some cases, but you need to pick the ones where it’s right. Whether Chapter 11 fits your company and whether it can turn your company around are fact-specific questions.
A major draw of Chapter 11 is that it lets you shed contracts that are sucking you dry. If you want to pick and choose, chapter 11 lets you decide which contracts and leases you will keep or reject. Chapter 7 doesn’t let you do that–once you file, the trustee takes over. For example, you might need to keep a leased truck if your business delivers products, but not a leased copier. Even when you reject a contract or lease, the affected party–the truck or copier company, for instance–can claim damages. But it becomes an unsecured claim, lumped in with all the other unsecured creditors. And the law caps a landlord’s claim at one year’s rent or 15% of the remaining term, up to three years.
Chapter 7 has a new trustee in charge; in Chapter 11, the management usually stays on as the debtor in possession. Your day-to-day authority is huge, but you also have an official set of eyes looking over your shoulder. But if you committed fraud, there is evidence of gross mismanagement or incompetence, or it is otherwise in the best interest of creditors, the court can appoint a trustee to run the business.
The U.S. Trustee’s Office is a Justice Department agency that supervises bankruptcy cases. Its real focus is on Chapter 11. It reviews the operating reports you must file, along with benchmarks for the first few months of the case.
Chapter 11 has a creditors’ committee, usually made up of the seven largest unsecured creditors. The U.S. Trustee appoints it. Its job is to investigate your business’s conduct and its financial condition, give the creditors a say in the case, and to help shape the plan. It can hire lawyers, accountants, and other professionals to advise it, all with court approval.
The whole point of Chapter 11 is the reorganization plan, a detailed blueprint for who gets what and what happens to any liens or other claims. The key goal is confirmation–court approval of the plan. In Chapter 11, only the debtor can propose a plan in the first 120 days. This can be extended, up to 20 months after the filing. The committee or creditors can file theirs only after the exclusivity period runs out or the court lifts it. And any debtor in Chapter 11 must have a lawyer.
Alternatives Outside Bankruptcy Court
One alternative outside bankruptcy court is an assignment for the benefit of creditors under Article 2 of the New York Debtor and Creditor Law. It isn’t bankruptcy, but it is a lot like bankruptcy. The company transfers all its property to an assignee by written agreement, and the assignee liquidates and pays the creditors in the order the law lays out. The process is supervised by the New York Supreme Court. Yet assignments are rare in New York. In some states it is often used and well understood. But there is no automatic stay across the country. Still, it may be cheaper and faster than a Chapter 7 in some circumstances, letting more money and assets reach creditors.
A receiver is not part of the bankruptcy laws, but is an important tool nonetheless. A receiver is named for an insolvent company or person, typically to preserve assets or recover them for the benefit of everyone affected. The receiver is the adult in the room. New York lets a court appoint a temporary receiver even before there is a final judgment, if a plaintiff shows the property might be moved out of state, lost or destroyed. That is especially useful for creditors before there is a judgment. Or the receiver can step in to enforce a judgment. In New York, the Business Corporation Law lets the court appoint a receiver when dissolving a corporation. Other states have similar laws. Mortgage lenders often use receivers to collect the rent from mortgaged buildings.
Creditors, for their part, can force a business or individual into Chapter 7 or Chapter 11 involuntarily. Three or more creditors, or one if there are fewer than 12 creditors, can file a petition. The claims need to be noncontingent, totaling at least $16,750 (the figure set in 2019, adjusted every three years), not subject to bona fide dispute. The grounds are failure to pay debts as they come due, or a custodian, such as an assignee for the benefit of creditors, has been appointed to take control of nearly all the assets.
About Delancey Street
Delancey Street is a premier, and award winning, business debt settlement company that helps business owners nationwide. Our goal is simple: help you escape debt in a safe and legal manner. Based out of New York, we can help in 49 of 50 states. We tell you how it is; because your business and future is on the line.
