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Business Bankruptcy as a Strategic Option: What You Need to Know

COVID-19, murder-hornets, and now wildfires… we have all had enough 2020! If you are a business owner, your business has likely taken a hit due to COVID19. Hopefully, you applied for and received a Paycheck Protection Program (PPP) loan and/or Economic Injury Disaster Loan (EIDL) for the full amount allowed by Congress. Many businesses that were blindsided by the pandemic have still not received any funding or were awarded far less than the anticipated amounts. As a result of this “take-it-or-leave-it proposition” that had no room for questions or negotiations, many businesses are now wondering how they will afford to cover rent and other operating expenses, and whether they can expect any additional financial relief.

Every business leader should now be in the process of planning a survival and recovery strategy, which may include using business bankruptcy as a strategic course of action. This involves both negotiating with your landlords and deciding whether a well-planned, strategic bankruptcy can reorganize your debts and relieve your business from burdensome contracts and leases that you may have signed before the pandemic became a consideration. While many people consider the filing of a bankruptcy case to be a failure, I’m determined to reframe your thinking to understand that this can be a well-thought-out pivot that clears your path to a fresh start right sizing your operations, expenses, and obligations to accommodate the new normal. The following are some FAQs about the business bankruptcy process:

Who makes decisions and manages my business during bankruptcy?

In almost every other country in the world, the filing of a bankruptcy displaces management and a trustee is appointed to oversee the financial affairs of the bankrupt company. In the United States, businesses may file voluntary petitions for relief under Chapter 11 of the Bankruptcy Code. This does not mean the end of your business; management stays in place and you can remain in control. Each month, you simply file an operating report revealing the key financial metrics and a summary of the receipts and disbursements made during the preceding month. Under the guidance of your trusted counsel, you’ll negotiate with your creditors and propose a plan for repayment while you are protected by the automatic stay against claims, demands, and lawsuits.

What is the automatic stay?

This is perhaps one of the most notable pros of filing for bankruptcy for an operating business in the United States, particularly if you’re facing the harassment of creditors. Upon the filing of a petition for bankruptcy, an automatic stay is imposed and legally protects you from claims, demands, lawsuits, judgments, collection activities, foreclosures, and repossessions. This allows you to stay focused on your operations and reorganization, eliminating the cost and expense of defending litigation claims. Your newfound freedom will give you the breathing room to reorganize and create a plan for your business with the help of your counsel. Timing is everything when it comes to filing for bankruptcy and seeking counsel early will put you on the best path to success.

OK, but how does a business bankruptcy keep creditors from calling me or suing me?

While you prepare the business recovery plan, regardless of whether it eventually involves a strategic bankruptcy, you can avoid calls from creditors by hiring a trusted legal advisor. Your phone staying silent equals peace of mind. After filing for business bankruptcy, all demands made to you or through your counsel must stop. Your creditors and contract counterparties will receive notice that you’ve filed for bankruptcy and will be prohibited from initiating communication without severe sanctions being imposed. While there are exceptions to the automatic stay, we can help you navigate any unexpected caveats along the way.

What happens to my contracts and leases?

Most contracts and leases contain provisions that state that the filing of a bankruptcy petition either invalidates the contract or constitutes a breach of the contract or lease. These provisions are invalid “ipso facto” provisions that are disregarded by the Bankruptcy Code. In addition, bankruptcy law allows most contracts to be assumed and assigned (effectively sold) to third-parties, notwithstanding anti-assignment provisions. In layman’s terms, this means that bankruptcy provides powerful new tools that allow your business to accept or reject any lease or contract, and enable you to transfer any contract to a third-party. Of course, there are exceptions, but in general, you will be able to assume or reject executory contracts or unexpired leases. “Executory” means that the contract is still in force and both signers are obligated to perform; “unexpired” means the contract/lease timeframe has not run out. It’s common to reject contracts and leases during a bankruptcy, especially when they are no longer advantageous due to supervening events like COVID19.

What happens to my debts?

Filing for a Chapter 11 bankruptcy, first and foremost, will temporarily protect your business from creditors who might attempt to liquidate the business. You obtain a breathing spell that allows you to save money that you would otherwise have to pay to secured lenders (i.e. mortgage lenders). You will eventually need to pay them a portion or the entire amount of what you owe, but the reduction in the amount due combined with a new timeline for payment will give you the opportunity to recover and regain profitability.

What do I need to know about the Small Business Reorganization Act of 2019?

The Small Business Reorganization Act of 2019 (“SBRA”) became effective in February 2020 and provides small businesses with a quicker, cheaper way to restructure their debt obligations. The SBRA simplifies the bankruptcy process, reduces legal fees and other restructuring costs, and minimizes the time and expense required to confirm a plan of reorganization.

While the SBRA was originally intended to only apply to small businesses with aggregate debts of less than $2,725,625, recent stimulus measures by Congress temporarily allow larger companies with aggregate debts of less than $7,500,000 to qualify for SBRA relief.

You still remain in control of your business under the SBRA, but a Chapter 11 trustee is appointed to oversee the reorganization of your business, eliminating the need and potential cost of a traditional creditors’ committee. Businesses also have an easier path toward a successful reorganization because several plan confirmation requirements are eliminated. Reorganizing under the SBRA can provide for the retention of your equity ownership even in the event that your plan does not pay all creditors in full (where a larger company bankruptcy would ordinarily require the proposition of a plan that satisfies the “absolute priority rule”).

We’ll help you understand if an SBRA Subchapter V is the right course of action for your business, and evaluate all of your options.

If I haven’t been sued yet, why should I consult with counsel?

When a company is unable to pay its debts, management has additional fiduciary obligations to conduct business affairs for the benefit of equity holders as well as creditors. While this may sound like a bunch of legal mumbo jumbo, the reality is that the decisions you make today will be heavily scrutinized in the future. The law also prohibits you from selling assets for less than a reasonably equivalent value or with any intent to remove the assets from potential administration to creditors. Investing in competent counsel can help you reduce the pain you are experiencing, and avoid future obstacles and expensive mistakes.

What does life look like on the other side of this?

A strategic bankruptcy filing may or may not be part of your business’ recovery and survival plan. As we’ve covered in previous blogs, bankruptcy is a tool designed to foster innovation. In the light of COVID-19, the pressure to make these big decisions can feel even more mammoth and overwhelming than under normal circumstances. You worked hard to build your business and none of us saw this economic hit on the horizon. Consulting with an attorney who specializes in bankruptcy and insolvency matters is the first step on the road to emerging from this crisis feeling confident that you made the most informed business decisions possible. We’re here to help you, or simply point you in the right direction.

Remember, your current financial circumstances don’t have to define you.

Michael H. Moody is a business and bankruptcy lawyer operating regionally from Tallahassee, Florida. After a two-year federal bankruptcy clerkship and a decade in big law, Michael formed Michael H. Moody Law, P.A. in 2019 to provide a higher level of quality and service to businesses throughout the Southeast. Since forming MHMLPA, Michael has successfully resolved a substantial shareholder derivative suit. In addition, MHMLPA recently obtained the approval of an emergency sale of substantially all assets in a multi-national Chapter 11 bankruptcy case due to COVID19.