Chapter 11 Overview
Chapter 11 allows a business to propose a plan of repayment for part or all debts owed to its creditors over an extended period of time. In the alternative, the plan may propose liquidation whereby the business sells all of its assets to repay creditors. In Chapter 11, creditors must vote and approve the plan, and the court must approve the plan. The primary benefit of a Chapter 11 for a business is that the business may continue to operate during the course of the Chapter 11 pending approval of the Chapter 11 Plan. In addition, the debtor in a Chapter 11 bankruptcy serves as its own trustee or “debtor-in-possession” or “DIP.” The debtor as DIP has all the duties of a conventional trustee, i.e. preserving bankruptcy assets, obtaining financing to continue operations, gaining approval of business leases (see below), etc. The debtor must propose, and has the exclusive right to so propose, a Chapter 11 Plan within the first six months of entering bankruptcy. Thereafter, both the creditors and court must approve the Chapter 11 plan.
Federal and State Taxes
Employment taxes are normally withheld from an employee’s payroll and paid accordingly to the IRS or state. The problem is when the business fails to turn over sums to the IRS or state for one or more quarters. Unlike income taxes, payroll taxes are held “in trust” for the IRS. Therefore, the IRS is aggressive in collecting delinquent employment taxes. Employment taxes may not be discharged in bankruptcy. However, a business owing Federal and State Employment Taxes may propose a Chapter 11 plan for the repayment of those past due employment taxes in full. If the government has a tax lien for unpaid employment taxes (the usual case), the lien will extend to the business’ operating cash. This is called “cash collateral.” The business will necessarily have to gain the government’s consent to continue in business using cash from the business on which the lien exists or the business will have to obtain a court order to operate using cash from the business. Upon entering bankruptcy (on the first day), the business must obtain a temporary order in this situation allowing use of cash on which exists a government lien for unpaid employment taxes. Thereafter, either the court will grant further use of cash on a permanent basis or the government will consent to the same.
One of a business owner’s most important asset will be the lease in which the business operates. Unexpired business leases for a term (usually for at least a year) must be “assumed” in the Chapter 11 within the first 120 days of filing the bankruptcy in order to keep the lease. If the business does not assume the unexpired lease by that time, then the lease is deemed rejected and must be surrendered. A business owner must show the court that it can timely perform all obligations under the lease before the court will allow assumption.
Special Requirements for Chapter 11. If a business is organized as a corporation or partnership, it must file for Chapter 11 bankruptcy in order to rehabilitate itself. A business may also file for Chapter 7 if it does not wish to continue and merely wants to submit assets for liquidation.