Are There Any Drawbacks to Filing a Business Bankruptcy Under Chapter 11?

While reorganizing a business’ debts under Chapter 11 affords significant benefits in the right circumstances, company executives who are considering business bankruptcy filings need to assess the drawbacks as well. Although the benefits of filing will often outweigh the drawbacks, this is not always the case, and executives need to make the right decisions based on their companies’ unique risks and needs.

So, what are the drawbacks of filing a business bankruptcy under Chapter 11? Some of the issues company executives will need to consider before deciding to file include:

Public Disclosure (and the Potential for Negative Publicity)

When a company files for bankruptcy under Chapter 11, much of the information contained in its filing becomes public record. While many business bankruptcies fly under the radar, having your company’s Chapter 11 filing and financial records made public presents risks for various adverse consequences.

For example, in the event of litigation, creditors or other parties may be able to use the information disclosed in your company’s Chapter 11 filing to their advantage. If your company is currently in litigation, a Chapter 11 filing could provide leverage for its counterparty to target a disadvantageous settlement as well. Additionally, if media outlets report on your company’s Chapter 11 filing, the connotations of filing for bankruptcy could result in a loss of goodwill regardless of the specific reason for your company’s filing.

Additional Recordkeeping and Reporting Obligations

While all companies should maintain comprehensive and accurate financial records, filing for bankruptcy under Chapter 11 can trigger additional recordkeeping and reporting obligations. For those that do not have a history of maintaining adequate books and records, this can present a significant challenge.

But, even for companies that follow good recordkeeping practices, seeking to reorganize their debts under Chapter 11 could still result in additional recordkeeping-related costs. Chapter 11 filers must maintain all records required by the bankruptcy court in the manner the bankruptcy court prescribes, and they must report their revenue and expenses to the court throughout the bankruptcy process.

Restrictions on Certain Financial Transactions

Filing for bankruptcy under Chapter 11 can also trigger prohibitions and restrictions on certain financial transactions. For example, Chapter 11 debtors may be limited in their ability to make payments to owners, officers and directors. Certain other financial transactions may also require court approval. Bankruptcy courts impose varying restrictions in differing circumstances.

As a related issue, when pursuing relief under Chapter 11 (or any other provision of the U.S. Bankruptcy Code), company executives must be careful not to authorize any preferential transfers. These payments to certain creditors (to the disadvantage of others) are subject to being unwound during the bankruptcy process, and they can lead to denial of discharge in some cases.

Restrictions on Borrowing

Businesses that file for bankruptcy under Chapter 11 may need to obtain court approval prior to borrowing additional funds. This may or may not be an issue in any particular case. If a company needs additional funding, this is an issue that the company’s executives should address with outside counsel before filing for bankruptcy. Experienced bankruptcy counsel will be able to assist with making informed decisions that help the company remain viable while protecting its interests in relation to the Chapter 11 bankruptcy process.

Monitoring by the Bankruptcy Trustee

As the U.S. Courts explain, “[t]he U.S. trustee plays a major role in monitoring the progress of a chapter 11 case and supervising its administration.” This “major role” includes engaging in tasks and activities such as:

• “[M]onitoring the debtor in possession’s operation of the business and the submission of operating reports and fees;” and,
• “[I]mpos[ing] certain requirements on the debtor in possession concerning matters such as reporting its monthly income and operating expenses, establishing new bank accounts, and paying current employee withholding and other taxes.”

Contrary to popular belief, the bankruptcy trustee’s role is not to take over the operation of the business (except in extraordinary cases). Rather, the trustee’s role is more in the vein of oversight. Even so, operating under a bankruptcy trustee’s oversight presents certain challenges and entails certain risks, and these are factors that require consideration during the pre-filing stage as well.

Costs

While reorganizing a company’s debts under Chapter 11 will often be in the company’s long-term best interests, pursuing a Chapter 11 bankruptcy entails various short-term costs. Along with the costs of meeting the bankruptcy court’s recordkeeping and reporting requirements as discussed above, these include filing fees, legal fees and the costs of paying for the bankruptcy trustee’s oversight. As the U.S. Courts also explain, in a Chapter 11 bankruptcy case “the debtor in possession must pay a quarterly fee to the U.S. trustee for each quarter of a year until the case is converted or dismissed. . . . The amount of the fee, which may range from $325 to $30,000, depends on the amount of the debtor’s disbursements during each quarter.”

The Risk of Bankruptcy-Related Litigation

Filing for bankruptcy under Chapter 11 also inherently presents a risk for bankruptcy-related litigation. When creditors face collecting less than the full amount they are owed, they will often engage legal counsel to help them collect as much as possible (and understandably so). If the trustee challenges any of the company’s transactions or other activities during the bankruptcy process, this can lead to litigation as well. Depending on the nature of the litigation, it could add costs and delays to the process, result in a denial of discharge, or even lead to a post-bankruptcy revocation of discharge under Chapter 11.

Discuss Your Company’s Options with a Chapter 11 Bankruptcy Lawyer in Florida

The Chapter 11 bankruptcy lawyers at Edelboim Lieberman rely on decades of experience to help company executives make informed decisions before, during and after the bankruptcy process. If you have questions about whether reorganizing under Chapter 11 is the best option for your company, we invite you to get in touch. Please call 305-768-9909 or contact us online to arrange a confidential consultation today.