Updated: Oct 22, 2021
The top 15 common factors that may indicate a chapter 11 bankruptcy filing can help your business stay operational despite debt and other issues:
# 1: Sales Tax and/or Withholding Tax Owed
In chapter 11, a business can repay all tax obligations including penalties and interest over a five-year payment plan at a low interest rate and sometimes according to a schedule that may adjust with the seasonality of business income. In contrast, state taxing authorities usually only allow tax repayment plans of six months (sometimes longer), resulting in far higher minimum monthly payments than the business can usually achieve in chapter 11. Also, sometimes in chapter 11 penalties and interest on penalties can be reduced. Click here to read more about Sales Tax Obligations and Chapter 11 Business Reorganizations.
#2: Tax Levies Pending
Filing chapter 11 bankruptcy will automatically stop tax levies from commencing or continuing. Instead, tax obligations can be repaid over a five-year payment plan (see above).
#3: Pending Tax Audit or other Tax Dispute including an “Indirect Mark-up” Sales Tax Audit
While chapter 11 will not always prevent a tax audit from concluding in an assessment, the forum for disputing the tax audit may be switched from tax court to bankruptcy court and, importantly, filing of bankruptcy opens the door for a settlement outside of continued tax litigation. Additionally, taxes owed can be repaid over a five-year chapter 11 plan versus the usually much shorter repayment periods demanded outside of bankruptcy.
#4: Posting of Liquor License for Unpaid Tax
Filing chapter 11 will automatically stay most pending actions to enforce an unpaid liability, including an action to post a liquor license for unpaid sales tax. If a license has already been posted, it may take an order of the bankruptcy court to reinstate the liquor license once the chapter 11 has been filed.
#5: Commercial Eviction Action Pending
Depending on the status of an eviction proceeding under state law, chapter 11 bankruptcy may automatically stay a pending eviction proceeding for unpaid rent or other causes. In Minnesota, this means that filing chapter 11 will prevent the eviction proceeding from moving forward from the moment in time that bankruptcy is filed so long as the county court has not yet entered a judgment for eviction. If a judgment for eviction has been entered, the debtor lessee may still have options to cure the arrears and remain in good standing under the lease so long as the lease has not otherwise terminated as of the date the bankruptcy is filed. Click here to read more about Chapter 11 and Commercial Lease Eviction and the Timelines and Requirements regarding Commercial Leases in Chapter 11.
#6: Unpaid Rent / Other Lease Obligations Owed
Even if an eviction proceeding has not yet commenced, chapter 11 allows breathing room and time to catch up on unpaid rent while the bankrupt tenant formulates a plan to either stay in the property and assume the lease, or vacate the property while rejecting the lease (see more below).
#7: Burdensome Rent Obligations and/or Inability to Modify Commercial Lease
In chapter 11, the tenant “lessee” must either assume (i.e., keep) or reject its current commercial property lease no later than 210 days after the bankruptcy is first filed. If a lease is assumed, all pre-petition rent and other lease obligations due through the date of filing bankruptcy must be paid on or before the date that the lease is assumed. Chapter 11 also provides an opportunity to renegotiate lease obligations—including monthly rent or duration of lease, etc.—in exchange for the tenant’s renewed obligation to continue to lease the property. If a lease is rejected, the pre-petition arrears and any rejection damages owed under the lease are treated as a general unsecured debt which is usually paid only a fraction of what is owed under a chapter 11 plan. Additionally, chapter 11 allows several months for a bankrupt tenant to remain in the property while seeking a new location so long as the tenant remains current on rent payments from the time the bankruptcy is filed through the date it rejects the lease. In all cases, post-petition rent due after the date of filing bankruptcy must be paid on time and no later than 60 days after the bankruptcy is filed or the lessee is at risk for eviction even after the bankruptcy is filed.
#8: Secured Lender Financing is Overly Burdensome to Business
Chapter 11 provides a business with the opportunity to renegotiate the terms of secured financing agreements or to reject the agreements altogether and surrender the property.
#9: Repossession of Critical Equipment
Just as with other lease obligations, burdensome lease terms may be renegotiated once chapter 11 is filed and any deficiency or default terms under the lease may be treated as general unsecured debt to be paid a fraction of what is owed.
#10: Inability to Fund Monthly Debt Service or other Financial Obligations
Chapter 11 plans typically provide for only partial payment on some debts over the course of time—including credit cards, judgments and other unsecured obligations—while other “priority” debts such as taxes and employee wages are repaid in full over an extended period of time.
#11: Employee Wage Lawsuit / Class Action
Chapter 11 will automatically stay pending lawsuits and may also have the effect of transferring the forum of the dispute from state court to bankruptcy court. If negotiations have stalled in the state court action, filing bankruptcy will provide for more time and a new platform to negotiate a resolution as an alternative to a trial. If a claim has reached the point of a judgment or award, this amount owed is treated as general unsecured debt which typically only receives a fractional payment under a confirmed chapter 11 plan of reorganization.
# 12: Other Claims or Lawsuits Pending (particularly if not covered by insurance)
The filing of chapter 11 bankruptcy has the immediate effect of staying all pending litigation against a debtor business. In practice, many plaintiffs will view a chapter 11 filing as effectively diminishing the potential return investment on continuing to litigate their claims since a confirmed plan of reorganization usually provides for only a fractional payment of the claim. Accordingly, many lawsuits are no longer financially worthwhile once bankruptcy is filed and will be dismissed or dropped upon filing of bankruptcy.
#13: Collection on Judgments / Bank Levies
Chapter 11 immediately stops all collection activity including bank levies. In some cases, it may be possible to have funds levied pre-petition returned to the debtor business if the business acts quickly to file chapter 11 no later than 90 days after the levy was served on the bank.
#14: Vendor Disputes
As with other debts, a chapter 11 plan will treat most vendor claims as general unsecured debts that receive a fractional repayment only. However, vendors do have certain reclamation rights for certain goods delivered within the 20 days prior to bankruptcy.
#15: Utility Shutoff
Filing chapter 11 allows utility debts to be treated as general unsecured debts and for the utility account to start again at zero as of the date the bankruptcy is filed and without threat of shutoff for non-payment. Usually utility providers will demand that a deposit be made as “adequate protection” for future payment, usually in the amount equivalent to two or three months of regular service.
Located in Edina, Minnesota, Wartchow Law Office is a Chapter 11 law firm providing Chapter 11 consultations to review the business lease and other liabilities affecting a Chapter 11 bankruptcy proceeding.