ABA Family Legal Guide

Forming and Operating a Small Business

Business Problems

Bankruptcy

Is there a specific type of bankruptcy for businesses?

Yes. Chapter 11 is open to all forms of business entities, including sole proprietorships. A Chapter 11 bankruptcy is used to reorganize a business. Chapter 11 allows a business to continue operating while it repays creditors through a plan approved by the bankruptcy court. It gives breathing room to businesses that are having financial problems, but that can generate a steady income and meet payroll. The goal is to give the business a chance to get back on its financial feet.

Under Chapter 11, management usually is allowed to continue to run the business on a day-to-day basis, though a trustee might take over if fraud or gross mismanagement were established. The bankruptcy court, however, must approve significant business decisions. The time it takes to get approval could mean the debtor will lose business.

At least one committee will be appointed to represent the interests of the creditors. The committee will work with the company to develop a plan of reorganization to get the business out of debt. This plan must be accepted by the creditors and approved by the court. If the creditors reject the plan, the court still may approve it if the court finds it to be fair.

The irony of Chapter 11 is that it pulls management in different directions. The need to comply with requirements imposed by the bankruptcy court and the law demands a lot of the debtor's attention just when the debtor needs to spend more time focusing on the business's financial health.

The assets of the business (debtor) will be used to pay at least some of the costs associated with a Chapter 11 restructuring. For example, the expenses of the committee of creditors may come out of the assets. However, each creditor will pay for the services of the professionals (lawyers, accountants, etc.) working for them.

This type of bankruptcy is costly and time consuming. The courts (and lawyers) are extensively involved. Some Chapter 11 bankruptcies end up being converted to Chapter 7 bankruptcies if the business can't meet its obligations under its plan.