Five Common Chapter 11 Myths

The COVID-19 pandemic was very difficult for many businesses. One recent business bankruptcy filer, a shopping mall owner in Texas, said the “COVID-19 pandemic proved insurmountable.” Many other business owners around the country probably feel the same way. Stimulus money, PPP loans, and some other relief programs probably allowed many businesses to remain open. Now that these programs are ending, firms which never considered bankruptcy are taking a long look at Chapter 11.

Unfortunately, there are a lot of bankruptcy myths out there. Banks and other creditors have perpetuated these myths for many years. But despite what Wall Street says, financial relief is available. And, in many cases, the cost is minimal, especially when compared to the price of doing nothing.

Filing Bankruptcy Means Failure

This myth probably comes from Monopoly. In this board game, when real estate companies (i.e. the thimble, top hat, racecar, and so on) declare bankruptcy, they lose the game, and there is no hope of redemption. Additionally, these players lose all their assets, and there is no way to get them back.

A real-life Chapter 11 is much different. This federal debt relief program allows companies to restructure and reorganize. That process usually involves some court-supervised downsizing. However, no one wants the business to cease operations. That outcome is bad for owners, employees, creditors, and customers.

Chapter 11 does more than reshuffle the deck, In many ways, it replaces the old deck of cards with a new deck. For example, after General Motors emerged from bankruptcy, it was no longer General Motors. An entirely different company, NGMCO Inc., bought GM’s assets. Therefore, if potential civil liability is an issue, Chapter 11 might be a way to legally get rid of the plaintiffs’ lawyers who are circling overhead.

Chapter 11 Cases Are Always Complex, Long, and Drawn-Out

This myth is partially true. Chapter 11 bankruptcies are normally complex. Inexperienced lawyers should never handle your business bankruptcy.

But this myth is also mostly false. Many Chapter 11s are much shorter than Chapter 7 or Chapter 13 personal bankruptcy. The aforementioned GM bankruptcy, which was one of the largest ones ever filed, lasted less than six weeks. That’s actually a long time for a prepackaged Chapter 11. Many of these bankruptcies end in several days, or even several hours.

A prepackaged Chapter 11 basically means that the company’s lawyers negotiate with its creditors before the bankruptcy filing. So, when attorneys file legal paperwork, all ducks are in a row. Closing the bankruptcy is largely a matter of filing additional paperwork. The biggest possible roadblock is that if creditors know a bankruptcy is pending, they are often uncooperative.

Many small businesses qualify for a streamlined Chapter 5 bankruptcy. Largely since there is no creditors’ committee, at least in most cases, these matters offer the same relief as a Chapter 11 and are often not much more complex than a personal bankruptcy.

Bankruptcy Means You’re Out of Business

In a few cases, yes, that’s exactly what bankruptcy means. Sometimes, businesses are beyond saving. Winding down operations is in everyone’s best interests. But for the most part, business owners, as opposed to their creditors, have this choice.

However, in most cases, many customers do not even know the company is going through bankruptcy, unless they read about it online. Retail sales are unaffected. Court supervision is the only difference, and most courts don’t scrutinize retail transactions.

In fact, Chapter 11 often has the opposite effect on your business. Since interest rates are so low, attorneys can usually renegotiate contracts and obtain better repayment terms. So, if you were considering this move, now might be the time to pull the trigger.

There’s Only One Way to File

This myth is true in personal bankruptcy matters. These debtors must file certain documents and follow certain procedures. But this myth is completely untrue in Chapter 11 business bankruptcies.

At the most, a bankruptcy plan is a small part of a personal bankruptcy. But in Chapter 11, the plan is pretty much everything. And, since there are many sizes of businesses, there are many available plans. Usually, the plan is part of a prepackaged Chapter 11, as mentioned above.

Bankruptcy Ruins My Business’ Credit Score

Chapter 11 adversely affects your ability to borrow money. Anyone who says otherwise is either inexperienced or telling you what you want to hear. However, in most cases, the actual effect is minimal. By the time most businesses file bankruptcy, multiple late payments and other negative information have already effectively ruined the firm’s credit score. Chapter 11 simply takes it from bad to worse.

Additionally, Chapter 11 usually looks better to creditors than repossession and foreclosure. These entries usually mean the debt ignored the problem. If you file Chapter 11, at least you are doing something.

Furthermore, the adverse effect is not permanent, or even long lasting. General Motors posted record profits the year after it emerged from bankruptcy. At that point, almost all creditors wanted to loan the automaker money. There’s no guarantee that your bankruptcy story will have this happy of an ending. But it’s more than possible.

Lyle Solomon is a licensed attorney in California. He has been affiliated with the law firms in California, Nevada, and Arizona since 1991. As the principal attorney of Oak View Law Group, he gives advice and writes articles to help people solve their debt problems. You can connect with him on LinkedIn or tweet him @lyle_solomon.

Chapter 11 stock image by Vitalii Vodolazskyi/Shutterstock

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