Bankruptcy

The following discussion is only applicable to corporations or other legal entities that are separate from their shareholders or partners (such as limited liability companies or partnerships). The following discussion does not apply to individuals or businesses conducted as sole proprietorships. Please contact an attorney for advice on filing bankruptcy in all cases.

What does it mean to file a bankruptcy petition?

Bankruptcy laws provide a breathing spell from creditor collection efforts during which the company can attempt to restructure or liquidate its business. Certain bankruptcy proceedings allow the company to stay in business and use revenue generated from operations for working capital and to make distributions to creditors. Bankruptcy laws also allow certain companies to receive a fresh start, that is, to be discharged of the financial obligations they have accumulated even if their debts have not been paid in full. Once a business files for bankruptcy it is referred to as a "debtor" and all property of the debtor (including causes of action against third parties) is put aside into an entity known as the debtor's "estate". A bankruptcy petition can be initiated voluntarily by a debtor or involuntarily against a debtor by its creditors, and is generally governed by the federal laws known as the "Bankruptcy Code".

Should my business file for bankruptcy?

Bankruptcy is not something that should be entered into lightly. Very often there are alternatives to bankruptcy that may produce a better result. Generally, bankruptcy allows a company to get rid of most of its debts, but it also requires the company to use almost all of its assets (bank accounts, cars, stock etc.) to pay off as many of its debts as possible. However, bankruptcy may result in the owners of the company losing their interests in the company. Bankruptcy is a serious decision and should only be made after careful consideration, preferably with the help of a lawyer. If you want to talk to an attorney about bankruptcy, contact the Legal Referral Service of the New York City and County Bar Associations at (212) 626-7373.

What are the various types of bankruptcy applicable to my business?

CHAPTER 7. Liquidation. If a filing is made pursuant to Chapter 7, the debtor's nonexempt assets are liquidated to pay creditors in order of priority (secured, expenses of administration and other priority unsecured debt, general unsecured debt and equity, in that order). A trustee is appointed, and management is no longer actively involved in operations. No ongoing operations are permitted unless necessary to preserve the value of the estate's assets.
CHAPTER 11. Reorganization. The debtor remains in business and seeks to reorganize its financial affairs through a plan of reorganization (although it is also possible for a debtor to liquidate in Chapter 11). Ordinarily, a trustee is not appointed and the debtor remains in possession of its estate (called "debtor in possession"). A creditors' committee is usually appointed as watchdog for interests of general unsecured creditors. Other committees (such as equity and subordinated debt) may be appointed. Committees may be represented by counsel (or other professionals, such as accountants) approved by the Court and will be paid from the debtor's estate.

Should I file under Chapter 7 or Chapter 11?

You should consult a bankruptcy attorney for professional advice. Generally, liquidation under Chapter 7 may be the best alternative when nothing vital will be lost if the company ceases to exist; in other words, if the business was not profitable and is unlikely ever to become profitable, does not have any assets that are essential to the business that can not be replaced or if the debtor does not have the time, money or energy to expend on a reorganization under Chapter 11. In addition, if a business is an extension of an owner's skills, has few assets and requires little working capital, it may be more advantageous to liquidate the current business and start a new business entity.

Reorganization under Chapter 11 may be used to a debtor's advantage if there is a viable business by providing temporary relief from creditor collection efforts, freeing up cash flow to fund operations and/or allowing the debtor to take advantage of provisions under the Bankruptcy Code that allow the debtor to reject burdensome leases and contracts. In addition, reorganization can provide added time for a debtor to sell its business at a better price.

How is a bankruptcy case commenced?

The filing of a petition in the bankruptcy court by ("voluntary" case) or against ("involuntary" case) the debtor commences a bankruptcy case.

In a voluntary case, the petition is granted automatically (an "order for relief" is entered); there is no statutory standard the debtor must meet except whether the debtor is qualified for the type (chapter) of bankruptcy involved. However, courts may dismiss a voluntary case if it is filed "in bad faith." "Bad faith" does not refer to any subjective malevolence; rather, it is a test for whether the existence of the case is consistent with the policies of the Bankruptcy Code.
In an involuntary case, a bankruptcy petition is filed by a party other than the debtor (such as a creditor) against the debtor. If the debtor does not stipulate to an order for relief, the petitioning creditors must show at a hearing that the debtor generally is not paying its debts as they come due or that substantially all of the debtor's assets recently have been transferred to a receiver or other custodian.

Will property I own individually be affected by the bankruptcy of my business?

Generally, no. The property of the estate does not include property owned by another person or entity even though the debtor has a property interest that is derivative of, dependent on, or in some other way related to that other property interest. For example, a debtor partner's estate does not include property owned by the partnership; instead, the partner's estate includes only the partner's interest in the partnership. Furthermore, the estate takes the property in the condition that exists when the case is commenced. The commencement of the bankruptcy generally does not expand the debtor's property rights.

Can I continue to run my business while it is in a Chapter 11 bankruptcy reorganization?

In general, the debtor does not need the court's permission to use, sell or lease property in the ordinary course. The debtor normally does not need court approval to incur ordinary course trade credit. Court approval is needed for other borrowing or credit, or for transactions that are not in the ordinary course of the debtor's business. To induce a party to make loans after the commencement of the bankruptcy case, the debtor can offer various inducements (subject to court approval ) including "super priority" over other priority claimants and certain security interests. A debtor normally cannot force one of its existing lenders to continue making advances after the commencement of the bankruptcy case even if there has been no default.

What happens to my business' agreements when it files for bankruptcy?

A debtor often enters bankruptcy as a party to partially performed agreements. Completing performance of those agreements according to their terms involves the estate's incurring additional burdens and achieving additional benefits. The Bankruptcy Code creates a mechanism for the debtor to decide whether the burdens are worth the benefits. If they are, the debtor will "assume" the agreement (if the debtor can otherwise meet the Bankruptcy Code's standards for doing so); if not, the debtor will "reject" the agreement. Rejection is not rescission and does not relieve the debtor of the consequences of his failure to complete performance (damage claims). During the bankruptcy case, pending the decision on whether to assume or reject an agreement, the debtor generally must perform such agreement as if the bankruptcy had not been filed (except for defaults under the agreements existing prior to the bankruptcy).

How are employees' claims addressed in a bankruptcy reorganization case?

Claims for wages earned by an employee within 90 days of the filing of the bankruptcy petition or the date of cessation of the debtor's business, whichever occurs first, enjoy a priority over general unsecured claims but currently only to the extent of a total of $4,650 for each individual.

How are a landlord's claims addressed in a Chapter 11 case?

The debtor must pay rent to its landlord on a going forward basis. The debtor is required to assume or reject its leases within the time frame specified by the Bankruptcy Code. If the debtor assumes a lease with the approval of the Bankruptcy Court, the debtor must promptly cure its defaults and provide the landlord with adequate assurance of future performance. If the debtor rejects a lease, it must promptly vacate the premises. The landlord will then have a claim for damages, which must be addressed in the Chapter 11 plan.

What happens to legal actions against my business when it files for bankruptcy?

The commencement of a bankruptcy case by the filing of a petition also creates an "automatic stay" or injunction that essentially prohibits creditors from taking acts, whether judicial or private, to enforce their rights against the debtor or the property of the estate except through the Bankruptcy Court and procedures of the bankruptcy case. Actions that violate the stay may subject the perpetrator to damage claims by the debtor, including punitive damages. There are some exceptions to the stay's general protection, such as the perfection or preservation of a lien that under non-bankruptcy law relates back in priority to a date prior to the commencement of the bankruptcy case or a governmental agency's enforcement of police powers.

Can all debts be discharged under bankruptcy?

No. That is why it is important to consult with a bankruptcy attorney. Depending on the circumstances, bankruptcy may or may not be right for you.

Where can I go to get further information?

Links to the Federal Bankruptcy Code, the Federal Rules of Bankruptcy Procedure and numerous other valuable resources are available online at www.law.cornell.edu/topics/bankruptcy. If you are considering filing for bankruptcy, you should contact a lawyer.