First Steps in a Chapter 11

Do’s and Don’t’s that are keys to success or failure. A guide for business owners.

By Steven R. Neuner, New Jersey Attorney at Law, Certified by the American Board of Certification as a Business Bankruptcy Specialist

June 23, 2011

In previous articles, I outlined the steps business owners need to take to stay out of financial trouble, Nevertheless, in these difficult times, trouble can find you despite your best efforts. In this article we examine what you will face and what you cannot do immediately upon Chapter 11 to save your business. This in turn points out some of the planning and steps you need to take before you file under Chapter 11.

Chapter 11 of the Bankruptcy Code provides a means for individuals or business entities to continue in business either temporarily or permanently under court supervision and protection to try and save the business, or preserve some of the value of the business instead of simply shutting down and liquidating its asset. As we will see, it has benefits but also costs and risks.

Like any other bankruptcy, a Chapter 11 filing creates an “automatic stay” that stops most creditors from pursuing collection of most claims. At the same time, it imposes legal restrictions on what the person or business filing bankruptcy [called “the debtor”] can do. Here are the most critical “no-no’s” that will get you in trouble. After filing bankruptcy, a debtor cannot:

  1. You cannot continue using “cash collateral” without consent of the lender or a court order. Generally cash collateral is cash, money in the bank or incoming receipts (accounts receivable). Since this money is the lifeblood of most businesses, getting this approval is critical. Most lending institutions will demand a lien on such “cash collateral”. If you do not have the lender’s consent to use their cash collateral, you will have to file a motion (one of the “first day” motions commonly filed) for permission to do so. Generally, such permission is for a limited period, e.g. 30 days. You will need to be prepared to show how much cash you need to spend to keep the business going for that period, and also show that you have a reasonable prospect of breaking even or better now or in the near future. While courts are generally indulgent with debtors at first, if you do not have this worked out, you are off to a bad start.
  2. You cannot hire or continue to pay attorneys or accountants, brokers or auctioneers, or other “professionals” after the bankruptcy, without court approval. Applying to retain these people is an important first step. If they are owed money, or if the debtor paid down or paid off past due balances in the previous 90 days before the bankruptcy filing, they may not be “disinterested” and may not qualify for court approval. If you delay in applying for such approval, or if it is denied, these professionals will likely not get paid. Even then, a fee application will be required for the court to approve payments to these professionals.
    [NOTE: A secondary issue for you is having the cash or making other arrangements, all of which must be disclosed, for up front “retainers” for attorneys and accountants. This is an up front expenditure you must be prepared to make. Hiring qualified and experienced people for these tasks is critical to success. These professionals are not going to go into a Chapter 11 case without a substantial up front payment, because they will have a lot of work to do. The initial payment will not usually cover all the costs and fees to conclude a Chapter 11 case. In some cases, the court may approval periodic monthly payments after the bankruptcy filing]
  3. You cannot operate without all required insurance. You must have all required liability, fire or other casualty loss, normal business insurance, coverage for all autos or vehicles operated by the business, and worker’s compensation coverage in place. The Office of the United States Trustee (part of the Department of Justice) will promptly schedule a preliminary meeting with you and your attorney at which time you should have proof of all such coverage in place.
  4. You cannot fall behind on current taxes, sales taxes, payroll or payroll taxes. Doing this will get you into trouble quickly. Further, failing to pay sales taxes and failing to pay over monies deducted from employees’ pay exposes each owner, manager or other “responsible person” to personal liability.
  5. You cannot pay most creditors (including employees) past due money owed them as of the date the bankruptcy is filed, without court approval. Upon a bankruptcy filing, vendors or creditors the debtor owed money to become creditors in the bankruptcy. For the most part, payment to them on these “prepetition” debts is prohibited without court approval. Secured creditors, creditors with secured claims (e.g. mortgages on real estate or car loans) will have to be dealt with in some manner. The important point is that careful planning and legal advice is important to know who you can pay and when. Indeed one of the common first day motions is one seeking approval to pay employee salaries earned in the pay period before the bankruptcy filing, and to pay certain “critical vendors” whose continued cooperation is essential to future success.
  6. You should not operate without proper bank accounts, and good record-keeping. As soon as a Chapter 11 case is filed, all existing bank accounts are supposed to be closed and new “Debtor in Possession” accounts opened. Courts will consider and usually grant, as one of the “first day” motions, an application to continue using existing accounts. But just as importantly, you must have up to the minute accurate financial reporting. You will be expected to file detailed “Monthly Operating Reports” showing all financial activity. And in an operating Chapter 11 business, financial disaster can come quickly if you are not on the ball. Having daily access to accurate information about unpaid bills, past due receivables, money on hand and other financial information is going to be a key to success.

This is only a partial list. There are many important steps and critical deadlines to be met in Chapter 11. As soon as you file, a Chapter 11 case, you must be prepared “out of the box” to meet these and other requirements. But the point is that before filing a Chapter 11 bankruptcy, careful planning is essential. After filing there is a lot of work right away. As we will discuss in later articles, you need to go in with a well thought out plan and an exit strategy or the result could be to make a bad situation worse.

And of course, this article is no substitute for individual advice from a qualified attorney.

About the author

Steven R. Neuner Esq is a Certified Business Bankruptcy Specialist (American Bankruptcy Board of Certification). He regularly represents creditors, trustees, and debtors. A bankruptcy trustee in New Jersey since 1987, he has handled numerous preference suits, both as plaintiff’s attorney and as defense counsel. His practice takes him throughout New Jersey and Eastern Pennsylvania. He can be reached at (856) 596-2828 or sneuner@nv-njlaw.com. For more information, visit his website at www.nv-njlaw.com.



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