🔒How to get a ‘fresh start’ through Chapter 11

Small businesses are critical to Maine’s economy, accounting for tens of thousands of jobs and a significant portion of the state’s private workforce.

Many small businesses have operated in Maine for decades, while many others are startups, brought to life in recent years by Maine’s ever-growing entrepreneurial community. And for those startups, most are finding success early on: according to one recent survey, Maine ranked first in the country for the percentage of startups that remained active after one year of opening.

But whether a technology startup or a long-running family business, not all Maine small businesses are experiencing uninterrupted financial success these days. Challenges continue to arise from many sources, such as burdensome debt structures, unexpected cost increases, losing a major client, or changing consumer preferences. In trying times — when companies must balance obligations to creditors, vendors, employees, and ownership — it is critical for leadership to holistically review the business’s operations and develop a realistic strategy toward long-term sustainability.

One sometimes-overlooked strategy that small businesses should keep in mind during difficult times is whether to file for Chapter 11 bankruptcy. In fact, the bankruptcy code offers special rules for reorganizing “small business” debtors (generally those with debt below $2,725,000). Those rules — which include simplified reporting requirements and a streamlined process for exiting bankruptcy — help alleviate some of the administrative and financial burdens of being in bankruptcy. And more help may arrive soon: Congress recently passed the Small Business Reorganization Act of 2019, which, if signed into law, will add a new subchapter to Chapter 11 relaxing several requirements for small businesses and allowing for a faster, less costly exit from bankruptcy.

No matter the company’s size, however, the bankruptcy code offers a variety of tools to achieve the fundamental goal of providing debtors with a fresh start, which can be done by reorganizing operations, settling disputes with creditors, and, ultimately, crafting a feasible exit plan that preserves the company’s future value. At the same time, Chapter 11 allows the business to remain operating under existing management, while also maintaining benefits and paying employees for their work both before and after the bankruptcy.

One of the key tools in the bankruptcy code for achieving a fresh start is that filing for bankruptcy stops litigation and collection efforts by creditors through the “automatic stay” that immediately goes into effect. This stay helps all debtors, but it can be especially helpful for a startup by offering it a chance to catch its breath during the reorganization process.

Take for example a startup whose most valuable asset is intellectual property and that has struggled to establish a manufacturing or distribution process it needs to generate revenue and service debt. The automatic stay can stop a foreclosure proceeding against that intellectual property and give the business time to obtain necessary capital and to perfect its operations while in bankruptcy, so it can exist as a thriving business for the future. At the same time, the debtor also has, for instance, the power under the bankruptcy code to reject unprofitable contracts, or to assume profitable contracts that the company wants to keep. This power can be particularly useful in a contract dispute with a customer or vendor, as it can provide leverage to the debtor not available outside bankruptcy. As another important power, the bankruptcy code also allows a business to restructure its debts, including modifying interest rates and amortizing debt payments, which is critical to freeing up post-bankruptcy cash flow that allows for continued operations.

Adam Prescott, an attorney at Bernstein Shur, focuses on business, restructuring and insolvency. He can be reached at aprescott@bernsteinshur.com.