Bankruptcy Article #25

James Molleur November, 2006

The purpose of this Article is to provide a basic understanding of Small Business Chapter 11 bankruptcy cases.

As with any other bankruptcy topic, the specific requirements for any particular business going through Chapter 11 can vary, but there are certain experiences that are universal for every business in Chapter 11. Small businesses in Chapter 11 have special burdens and benefits, all of which are designed to speed up the reorganization process, at hopefully less cost.

What is a Small Business Debtor?

A small business debtor is usually a corporation, although it can be an individual who operates a sole proprietorship (with more debt than is allowed under Chapter 13). A small business debtor is an individual, corporation, partnership, or limited liability entity engaged in a commercial or business activity with total secured and unsecured debt less than $2,000,000. To be considered a small business debtor, the U.S. Trustee must also not appoint an unsecured creditors committee to monitor the case

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What are the benefits for a Small Business Debtor?

One of the benefits for a small business debtor is that the Court may conditionally approve (without notice and hearing in Court) a disclosure statement, thereby allowing the debtor to solicit votes for a plan earlier than is available for usual Chapter 11 debtors. A small business debtor has 180 days to file its plan; during this time period, creditors may not file a competing plan. As part of the revisions to the Bankruptcy Code in October 2005, Congress encouraged the Bankruptcy Courts to develop standardized disclosure statements and plans to speed up the plan approval process. Another technique that might work well for small business debtors is to file a combined disclosure statement and plan. Although large Chapter 11 businesses have complicated finances, small business debtors may be able to simplify the financial reorganization sufficiently to permit this cost saving technique.

What are the burdens for a Small Business Debtor?

One important burden a small business debtor faces is timely confirmation of a filed Chapter 11 plan. Confirmation of the plan must occur with 45 days of filing, unless a timely extension is requested and the debtor demonstrates to the Court that the plan can be confirmed within a reasonable time. If the debtor cannot meet this timetable, the Court is required to dismiss the case.

A small business debtor must file a variety of documents with the Court at the time the voluntary petition is filed. The debtor must "append" to the petition the debtor's most recent financial documents, including a balance sheet, statement of operations, cash-flow statement, and federal income tax return. The senior management of the debtor must attend an initial interview with the U.S. Trustee's office, file all schedules within 30 days of filing the petition, and file all post petition reports with the U.S. Trustee's office. Tax returns and other government filings must be timely filed and post-petition taxes timely paid. The U.S. Trustee is also allowed to visit the business premises to inspect the business books and records at reasonable times, upon reasonable notice.

What about the U.S. Trustee reporting requirements?

Whenever any debtor files a Chapter 11 case, certain reporting requirements established by the U.S. Trustee's office must be met. First, the debtor must close any bank accounts, and open new accounts with "Chapter 11 Debtor in Possession" noted on the checks. The accounts must be opened with an Authorized Depository Institution, a list of which follows this article, for Region One (essentially the First Circuit). Upon a written request to the U.S. Trustee's office, some small business debtors may receive permission to establish new accounts at a bank other than those listed.

The U.S. Trustee has Operating Guidelines which detail the obligations of a Chapter 11 debtor. The guidelines set forth not only the establishment of new bank accounts, but also the prohibition upon paying pre-petition debts, the need for proof of various insurances, the timely filing of post-petition tax returns, the timely payment of post-petition taxes, the filing of monthly operating reports with the U.S. Trustee, and payment of quarterly fees to the U.S. Trustee's office. A copy of the U.S. Trustee Operating Guidelines follows this article.

The monthly business reports provide extensive detail of the business's cash flow, accounts payable, and accounts receivable for the previous month and permit the U.S. Trustee's office to make certain the business is not continuing to experience financial problems. The reports require perhaps more financial discipline by a business debtor than it was accustomed to before it filed Chapter 11. The reports are not just helpful to the U.S. Trustee - they also make the debtor certain the business is operated efficiently. A copy of the monthly business report form follows this article.

Conclusion

Small businesses can reorganize at a reasonable cost and relatively quickly if they are well prepared and have adequate financial controls when they file Chapter 11. While attorney retainers for large Chapter 11 businesses can exceed $25,000, small businesses should expect a retainer request between $6,000 - $9,000, plus the filing fee of $1,039. Small businesses should consider Chapter 11 as a viable option to keep creditors at bay while they reorganize their finances and create a new business plan which will result in saving the business.

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