Just as individual consumers do, businesses sometimes find themselves in the uncomfortable position of being unable to pay their debts in a timely manner. In many cases, the solution to this dilemma is to declare bankruptcy, a legal proceeding in a federal court that releases the business from the obligation of paying all or some of its debts. Filing bankruptcy is not a perfect solution, however. Although it is often said that bankruptcy gives a business a fresh start, it can negatively affect the business's credit rating and make it hard to obtain credit in the future. Without good credit, it may be impossible to continue in business. On the other hand, in some types of bankruptcies the bankrupt business actually ceases to exist when the proceedings terminate.
Businesses have options in terms of which type of bankruptcy to pursue. These options are set forth in separate chapters of the Bankruptcy Code, and they are commonly referred to by their chapter numbers. Chapter 7 bankruptcies, for instance, are called liquidation bankruptcies. Chapter 7 is often employed by individual debtors, but it can also be used by businesses that want to liquidate their assets and be relieved of their debts. In Chapter 11 bankruptcies, which are most often filed by businesses rather than individuals, the debtor is allowed to stay in business during the bankruptcy proceedings.
The Chapter 7 proceedings begin when the debtor files a petition with the bankruptcy court. The filing of the petition triggers the automatic stay, which is bankruptcy terminology for the termination of all debt-collection activity. All collection actions against the debtor or its property must then cease. In a Chapter 7 bankruptcy, the court appoints a trustee who oversees the case and liquidates the assets of the business in order to pay its debts. In many cases, however, the debtor's assets are exempt or already subject to valid liens, so there will be no assets to liquidate. If there are assets to sell, the trustee will collect the sale proceeds into a fund from which the debts will be paid to the extent possible. When all of the proceeds are distributed, any remaining unpaid debts in essence no longer exist, and the debtor has no further obligation to pay them. Some debts, however, are non-dischargeable, such as taxes, damages resulting from the debtor's willful or malicious acts, debts incurred by giving false financial information, and some debts incurred just prior to filing for bankruptcy.
A Chapter 11 proceeding is initiated by filing a petition, but in these cases a trustee is not automatically appointed. The bankruptcy judge may decide to appoint a trustee in Chapter 11 cases, but usually decides against it. As in Chapter 7 cases, the filing of the petition stops creditors from trying to collect their debts. The debtor then has time to file a plan of reorganization, which sets forth the details of how it intends to remain in business while continuing to make payments to its creditors. All creditors whose contracts with the debtor are modified by the plan or who will not be paid the full amount owed to them have the right to vote on the plan. The plan must also be approved by the court. In some cases, the court approves the plan even though some of the creditors do not, in which event the court can force dissenting creditors to accept it. If a plan is not approved, however, the company can be forced into liquidation. The petitioner's choice of Chapter 7 or 11 is not necessarily permanent, and once proceedings have begun a case may be converted to a different chapter. Once converted, however, the case may not be converted back again.
Most commercial bankruptcy cases are initiated voluntarily, but they can also arise involuntarily when creditors band together and attempt to force the debtor business into bankruptcy. A minimum number of creditors and amount of debt are required for an involuntary bankruptcy. Creditors face stiff financial penalties if they initiate an involuntary bankruptcy for invalid reasons and the court sides with the debtor.
Bankruptcy can be an expensive process and has serious long-term effects on a commercial establishment. The damage to the business's credit and the public perception can have negative repercussions on future profitability. There are alternatives to bankruptcy, such as working informally with creditors to come up with a plan for repayment. A lawyer experienced in bankruptcy law can help a business decide which method may best meet its needs and can facilitate a debt-repayment plan with the business's best interests in mind.
Form: Sample Letter To Creditors
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Sample Letter to Creditors
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This publication and the information included in it are not intended to serve as a substitute for consultation with an attorney. Specific legal issues, concerns and conditions always require the advice of appropriate legal professionals.