Addressing The “B” Word: Bankruptcy

All companies experience adversity throughout their lifespan. And how they navigate those inevitable landmines will determine the longevity of the organization, as well as the financial success of the business.

Some landmines a company might experience may include a downturn in the economy, the inability to collect on receivables, value of assets drastically plummeting, a crippling vendor contract or commercial lease, the inability to refinance a bad loan, and/or the mismanagement of the company.

While in certain situations out of court workouts can be accomplished to successfully resolve any landmines prior to filing corporate bankruptcy, in many instances, a workout, while desirable, is simply not feasible and business bankruptcy is inevitable.

Generally, if an out of court workout cannot be reached with the company’s creditors, there are two types of bankruptcy a business may file: chapter 7 and chapter 11.

Chapter 7 Bankruptcy

Chapter 7 is a liquidation of company assets with the goal that the company debts be discharged. Immediately upon filing a chapter 7 bankruptcy petition, the Bankruptcy Court will appoint a chapter 7 trustee to administer the company’s bankruptcy estate and operations as the company once knew them cease immediately.

The trustee then begins taking inventory of the company’s assets, such as the tangible property, equipment, real estate, bank accounts, and the intangible property such as patents, intellectual property, and accounts receivable. Generally, should the trustee not want to manage the business, the company’s employees will be terminated and the trustee most likely will begin the process of closing the business.

First, the trustee will collect the company’s accounts receivable, sell all tangible assets with value, and evaluate potential transfers which can be clawed back into the bankruptcy estate for the benefit of the company’s unsecured creditors. (Fraudulent, preferential and/or gap period payments which are known as the article 5 transfers.) The control of the business and the direction of the bankruptcy case are effectively over for its owners when a company files chapter 7.

The benefits some business owners may see in chapter 7 bankruptcy are a quicker process than chapter 11, less spent on court costs and professional fees, and landmines largely become the responsibility of the bankruptcy trustee.

Chapter 11 Bankruptcy

The other viable option for business owners considering bankruptcy is chapter 11 which is generally a reorganization of the company debts. Here, the company operates as a debtor-in-possession and no trustee is appointed in the bankruptcy.

Consequently, the company continues to operate – maintaining its employees, servicing its key accounts, and hopefully coming out of bankruptcy with a confirmed chapter 11 plan of reorganization.

A plan of reorganization allows the company to continue to operate while paying its creditors a smaller more manageable amount over the life of the plan. In order to secure a plan of reorganization in chapter 11, the debtor company must establish that its creditors will receive more than they would have in a chapter 7 liquidation bankruptcy case.

Moreover, chapter 11 allows a debtor company to re-value its assets should the secured debt exceed the fair market value of the company’s assets. While this does not come without a valuation fight from the secured creditor, the benefit for a debtor company is stripping the value of its assets down to its true fair market value. This results in a new amount for the secured debt associated with the asset, and the difference from the original debt amount to the new amount would be paid as an unsecured debt.

Another powerful tool of the bankruptcy process is the ability to reject unfavorable contracts that cripple the growth of the business or its long-term financial success. The most common example of a contract being rejected within bankruptcy is when a retailer expands much too fast and is required to scale back its operations and storefronts. Many well-known companies such as Pacific Gas and Electric Company, Delta Air Lines, Inc., Radio Shack and Brookstone have taken advantage of the bankruptcy process, and post-bankruptcy are now much more viable companies.

So Is It For You?

The “B Word” can be a tough pill to swallow. While bankruptcy may carry a negative connotation in the public eye, if you are a business owner facing this decision, remember, in many instances it is the only option that may lead to a positive outcome. Filing for bankruptcy can give a business a competitive advantage, and the opportunity for prosperous growth.

About The Author

John C. Woodman is a Business attorney at Sodoma Law, P.C. of Charlotte, North Carolina. His areas of practice include business litigation, creditor and debtor rights, and corporate law. Additional practice areas at Sodoma Law, P.C. include family law and estate planning.

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