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A Closer Look at Some of the Benefits (and Limitations) of a Chapter 11 Business Bankruptcy

Filing for bankruptcy under Chapter 11 allows companies to reorganize their debts so that they can sustainably manage their financial obligations on an ongoing basis. For struggling companies, filing under Chapter 11 can save them from going under, and it can also help ensure that their financial strain does not have a negative impact on their clients or customers.

But, filing for bankruptcy under Chapter 11 can afford a variety of other benefits as well. When evaluating their options, struggling companies must carefully consider all pertinent benefits (and their limitations) in order to arrive at an informed decision. With this in mind, this article provides an overview of some of the primary benefits available under Chapter 11:

Protection Under the “Automatic Stay”

One of the most immediate benefits of filing for business bankruptcy under Chapter 11 is the “automatic stay.” When a company files for bankruptcy, its filing triggers an immediate prohibition on collection actions related to the company’s pre-filing debts. Pending collection actions must cease, and the business’s creditors may not initiate foreclosure, litigation or collection efforts during the bankruptcy process.

While the automatic stay is a key benefit of filing for bankruptcy under Chapter 11, it has some limits. Section 362(b) of the U.S. Bankruptcy Code establishes 29 statutory exceptions, and various courts have established judicial exceptions to the automatic stay. Additionally, commercial creditors can seek relief from the automatic stay in some circumstances. Potential forms of relief include not only modifying the automatic stay to allow for collection action by an individual creditor but also annulment or termination of the automatic stay in its entirety.

Generally speaking, however, the automatic stay will provide adequate protection for most debtors, and most debtors will have grounds to dispute any creditors’ claims for relief. Still, the potential limitations of the automatic stay warrant consideration when deciding whether to file under Chapter 11.

Access to Debtor-in-Possession Financing

Once a company files for bankruptcy under Chapter 11, it gains the opportunity to secure debtor-in-possession financing. If the company needs additional capital in order to sustain its operations or invest in improvements, this financing could prove crucial. While debtors in bankruptcy generally need to avoid taking on additional debt, debtor-in-possession financing is a notable exception. Additionally, as creditors that extend this financing are entitled to priority over many of the company’s pre-bankruptcy creditors, debtor-in-possession financing can be an attractive option for lenders satisfied that the company will be able to meet its payment obligations over the long term.

However, debtor-in-possession loans are subject to court approval, and, as you might expect, existing creditors will often fight companies’ attempts to take on additional debt during the bankruptcy process. Of course, taking on additional debt presents its own financial risks as well. But, when seeking debtor-in-possession financing is a company’s best option, the ability to take advantage of this opportunity can be a major benefit of filing under Chapter 11.

Rejecting Leases and Other Executory Contracts

While the primary purpose of a Chapter 11 bankruptcy filing is to reorganize the company’s debts, companies also have the ability to reject certain leases and other executory contracts during the bankruptcy process. By rejecting a contract, the company becomes absolved of its continuing contractual obligations, and its counterparty becomes an unsecured creditor with respect to any amounts currently owed.

The ability to reject certain leases and other executory contracts is another major benefit of filing for bankruptcy under Chapter 11. But, here too, there are countervailing considerations to keep in mind. Other lessors, vendors and other third parties may be less interested in doing business with a company that has rejected contracts in bankruptcy previously, and if the company can restructure its obligations (rather than rejecting them), this could prove to be the more favorable approach in the long run.

Selling Encumbered Business Assets

The ability to dispose of distressed assets is another major benefit of filing for bankruptcy under Chapter 11. Through the bankruptcy process, companies can sell encumbered business assets free and clear of any liens or other third-party interests. Not only can this free up cash flow, but it can also serve as an impetus to streamline the company’s operations and focus on the essentials that are necessary for sustainability and steady long-term business growth.

This is one benefit of the Chapter 11 bankruptcy process to which there aren’t many downsides. Of course, creditors may complain, and finding buyers for distressed assets may extend the duration of the bankruptcy process. But, overall, these will often be small prices to pay for the outcome that is achieved.

No Bankruptcy Trustee

Unlike other types of business bankruptcies, seeking protection under Chapter 11 does not involve the appointment of a bankruptcy trustee. As a result, the company’s owners, executives and board members remain in charge, and they can continue operating without substantial oversight (though certain transactions will be subject to court approval). There are a few downsides to this benefit as well, and for many companies, this will be a key factor in their decision to file under Chapter 11.

Additional Benefits Under Subchapter 5

For companies that qualify as “small businesses,” additional benefits are available under Subchapter 5. The small business bankruptcy procedures under Subchapter 5 are available to companies that owe less than $7.5 million. The additional benefits available under Subchapter 5 include no obligation to file a disclosure statement, no opportunity for creditors to file competing reorganization plans, no unsecured creditors’ committee, and no need for creditor consent—among others.

Due to these additional benefits, a Subchapter 5 option will be an attractive option for many companies. While Subchapter 5 is relatively new, “small business” bankruptcy filings under this subchapter are becoming increasingly common, and we have been able to help many companies use Subchapter 5’s protections to their advantage.

Speak with a Business Bankruptcy Lawyer in Miami or Fort Lauderdale

If you need to know more about the business bankruptcy process or have specific questions about Chapter 11 or Subchapter 5, we invite you to get in touch. To speak with a business bankruptcy lawyer at our offices in Miami or Fort Lauderdale, please call 305-768-9909 or inquire online today.

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