Understanding the Consequences (Both Positive and Negative) of Chapter 11 Bankruptcy

Deciding whether to reorganize a company’s debts under Chapter 11 requires careful consideration of several factors. While filing under Chapter 11 can have several positive consequences, there are potential negative consequences as well. Many of these potential negative consequences can be avoided with the help of an experienced Miami bankruptcy lawyer, but some are inherent in the process. As a result, informed decision-making is critical.

Here are some of the key consequences (and potential consequences) of pursuing reorganization under Chapter 11.

Immediate Relief Under the Automatic Stay

Companies that file for bankruptcy under Chapter 11 receive immediate relief under the automatic stay. The automatic stay prevents creditors from pursuing collection during the bankruptcy process. This can free up the capital that companies need to remain in operation, and it can provide companies time to negotiate with their creditors and find a path forward that works for both parties.

However, the automatic stay can also trigger litigation in some cases. Creditors can seek relief under the automatic stay on various grounds—and many will not hesitate to do so if this appears to be their least-costly option over the long term. Of course, defending against a motion for relief adds to the costs of the bankruptcy process for debtors, so the possibility of facing one (or more) of these motions is a factor that requires careful consideration during the pre-filing process.

Continuing to Do Business as a “Debtor in Possession”

Companies that file for bankruptcy under Chapter 11 are classified as “debtors in possession,” which means that they remain in possession of their assets throughout their bankruptcy proceedings. Since companies that file under Chapter 11 remain in possession of their assets, they can—and generally must—continue operating. In fact, the goal of reorganizing under Chapter 11 (instead of liquidating under Chapter 7) is to regain the financial stability needed to pursue both long-term stability and long-term growth.

However, operating as a debtor in possession comes with limitations. Major decisions outside of the normal course of business will generally be subject to the court’s or trustee’s approval, and creditors will be monitoring the company’s decisions with a watchful eye (Chapter 11 debtors are also subject to various recordkeeping requirements during the process). When pursuing reorganization under Chapter 11, companies must be able to demonstrate a path toward profitability as well. These all present additional costs, challenges, and potential risks that may be avoidable with various bankruptcy alternatives.

Eliminating Certain Debts During the Reorganization Process

While the crux of a Chapter 11 bankruptcy proceeding is reorganizing the company’s debts so that it can operate sustainably in the future, companies can often seek to eliminate certain debts during the reorganization process as well. Even when this involves paying a portion of a debt in exchange for a release from further liability, this can be extremely beneficial in the long term.

But, eliminating debts during the reorganization process can also have negative consequences. Creditors that are forced to write off a substantial portion of their debt may be unwilling to work with the company again in the future. Seeking to eliminate debts through the Chapter 11 bankruptcy process can also be more time-consuming, more adversarial and more costly than renegotiating outside of a formal bankruptcy proceeding. If there are better alternatives available, then the positive consequences of filing under Chapter 11 may not outweigh the negatives.

A Formal Process with a Clear End Goal

In contrast to bankruptcy alternatives such as informal debt restructuring and an assignment for the benefit of creditors (ABC), a Chapter 11 reorganization is a formal process with a clear end goal—and with clear steps for achieving this goal in a relatively efficient manner. As long as Chapter 11 debtors avoid costly mistakes, they will generally be able to reorganize their debts and move on. While there are no guarantees, this relative certainty—especially in small business bankruptcies under Subchapter V—can make filing under Chapter 11 preferable to pursuing other options in many cases.

At the same time, the formality of the Chapter 11 process can have its drawbacks. For example, many scheduling aspects of the process are beyond the debtor’s control. Going through the Chapter 11 reorganization process can publicly expose companies’ financial struggles as well. Additionally, since creditors have clear options for protecting their financial interests during the reorganization process (i.e., filing motions for relief from the automatic stay and asserting defenses to discharge on various grounds), creditors will often feel compelled to pursue these options to ensure that they are protecting themselves—and their shareholders—by all means available.

Reorganizing the Company’s Debts and Continuing to Operate Long-Term

Unlike a liquidation bankruptcy under Chapter 7, the purpose of a reorganization bankruptcy under Chapter 11 is to position the debtor for long-term success. The reason for pursuing a Chapter 11 bankruptcy is to allow the debtor to continue operating going forward. This alone can be reason enough to file under Chapter 11—even taking all of the potential negative consequences into account. If reorganizing a company’s debts provides a path toward profitability, this may not only be a company’s best option, but it may also be the only viable option the company has available.

At the same time, however, reorganizing a company’s debts comes with an obligation to continue paying those debts over time. Failing to do so can lead to collection actions and litigation—and potentially the need to file a “Chapter 22”. If maintaining solvency post-bankruptcy does not appear to be viable, then filing under Chapter 11 may not be worth it.

Speak with a Miami Bankruptcy Lawyer at Edelboim Lieberman

At Edelboim Lieberman, we have extensive experience guiding companies of all sizes through the Chapter 11 bankruptcy process. We also help our clients evaluate the alternatives that are available. If you would like to speak with an experienced Miami bankruptcy lawyer at our firm in confidence, please call 305-768-9909 or tell us how we can reach you online today.