When a company no longer has the funds to pay creditors or keep down debt, they can file either a Chapter 7 or a Chapter 11. A Chapter 7 means that the business completely shuts down, sells all assets, pays off creditors and ceases to be.
A Chapter 11 gives a company a chance to restructure, by giving them opportunities to refinance with new lenders and putting an automatic stay on any litigation.
However, a Chapter 11 can become a Chapter 7 if the requirements aren’t met.
In order to remain a Chapter 11, the business must be able to come up with a reorganization plan that will be approved by a creditors committee or a bankruptcy judge. Let’s take a closer look at how you can do that:
Evaluate all outgoing expenses
In a Chapter 11 proceeding, companies can have so-called executory contracts cancelled, if it helps them to stay solvent. Executory contracts include labor union contracts, contracts with vendors and suppliers, and real estate leases. Breaking these contracts frees up a considerable amount of funds to divert toward reorganization and repayment.
Evaluate all assets
Since you have time to decide what assets you want to sell, take a hard look at all of them, including personnel, real estate, and other intangible assets. Trade in that expensive downtown office for something a little further out, and consider whether you really need personal secretaries for all executives.
A Chapter 11 plan has no room for unnecessary expenses. You need to win back the trust of your creditors, so make sure you do it responsibly.
Make sure you can keep paying your employees
When you file for Chapter 11, there are a number of supplementary motions that you can file. Make sure and take advantage of these, as these allow you to protect the following from the creditor’s ax: employee benefits, existing bank accounts, and cash collateral.
To keep your business running, you need to be able to assure employees and vendors that yes, you’ll still be able to pay them.
Creditors must approve the business plan for reorganizing debts and operations.
The stated aim of the Chapter 11 is to allow a business to get back on its feet. But the #1 priority is to repay debts. The ideal reorganization plan relieves a business from repaying at least part of its debt, so that it can reinvest in the business.
Any plan must be approved by a creditors committee, which typically consists of the 20 largest unsecured creditors who aren’t insiders. The debtor business usually has 120 days to propose a reorganization plan before the creditors committee can also weigh in, or insist that the Chapter 11 become a Chapter 7.
Even if creditors reject the plan, the business may still “cram down” the plan, as long as the treatment of creditors is “fair and equitable.” Here’s the definition of “fair and equitable”, according to the bankruptcy code:
"Fair and equitable" treatment of secured claims is defined as comprising of one of three options: 1) that the holders of the liens retain those liens and receive plan payments totaling "at least the allowed amount of such claim, of a value, as of the effective date of the plan;" 2) for the sale of the secured collateral with the creditors" liens attaching to the proceeds of the sale; or 3) for the realization of the creditors of the "indubitable equivalent" of their secured claims.
In a nutshell, a good bankruptcy plan has to repay the secured creditors, at the very least, or make arrangements to do so.
By creating a plan that your creditors can get behind, you maintain control of your business, which allows you to recover from bankruptcy. Treat the process with respect. There aren’t easy solutions, and hard decisions will have to be made to stay solvent.
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