What Partners and Shareholders Should Know about Personal Exposure When Putting Their Business in Chapter 11

In many small and medium-sized businesses, one or more of the partners or shareholders—also called equity security or equity interest holders—manage the day-to-day operations of the business. In this capacity, the partner is an acting principal of the business and, as such, often incurs personal liability for some—but rarely all—of the business debts by way of personally guaranteed security and loan agreements, personally guaranteed SBA notes or co-signed leases. A partner can also be held personally liable for some business debts usually owing to government and taxing authorities by way of statute, for example personal assessment for business taxes and even employee wages in some instances.

When a business files chapter 11, the question naturally arises what happens to the partner’s liability for business debts and what exposure does the partner face when his/her business files chapter 11. This articles attempts to address some of those concerns in the context of a privately held (i.e., not publicly traded) small or medium-sized business that files a chapter 11 reorganization proceeding. The term ‘partner’ is used interchangeably in this article with the concepts of equity ownership, whether that persona be a partner, principal or shareholder of the business depending on how it was formed or organized.

The Automatic Stay Protects the Business from Collection but Not Necessarily a Partner-Guarantor

Most people know that filing a bankruptcy proceeding invokes the sweeping protections of the “automatic stay”, which stays (i.e., legally stops) further collection efforts and pending lawsuits from proceeding. The automatic stay is one of the core principles of bankruptcy relief, as it affords the necessary time and relief from levies, repossession, evictions, expensive and burdensome lawsuits and other collection efforts in order for the business to come forward with a plan of reorganization. The automatic stay remains in place for the duration of any bankruptcy proceeding until such time the case is either dismissed or the plan of reorganization is confirmed or until the time that a party in interest, usually a creditor or landlord, successfully ‘lifts’ the automatic stay for cause granted by an order of the bankruptcy court. The grounds for relief from the automatic stay are not addressed in this article.

From a partner’s perspective, it is important to understand that there is no co-debtor automatic stay in chapter 11 proceedings. This means, for example, that a pre-bankruptcy lawsuit pending against both a business and its partner as co-defendants will be automatically stayed once the business files chapter 11. However the plaintiffs may still proceed against just the partner if they dismiss the lawsuit as to the business. Also this means that a partner can still be personally collected upon for existing judgments and still be personally assessed for business taxes in spite of the business bankruptcy proceeding. While personal collection efforts are often voluntarily put on hold by creditors when the business files chapter 11, the automatic stay nevertheless only applies to the business. For this reason, partners with significant personal guarantees may themselves need to file an individual bankruptcy proceeding.

The Chapter 11 Attorney Represents the Business, Not the Partners

It is a conflict of interest for the business chapter 11 attorney to render legal advice or formally represent the partners or equity security holders while representing the business. This can seem like an inconsistency when the partner maintains a primary, close and constant relationship with the business counsel. While it can be difficult for a partner of a closely held company to distinguish between the interests of the company and their own personal interests, occasionally events occur that could give rise to a conflict between what is best for the company and what is best for the partner. In all instances, however, the partner has a fiduciary duty to act in the best interests of the company and not himself, and the chapter 11 likewise has an obligation to represent the interests of the business alone. Due to this conflict of interest, partners may wish to consult with independent counsel on how their rights may be impacted by the business chapter 11 proceeding.

Personal Guarantees and Liabilities are Rarely Extinguished by the Chapter 11 Plan

The majority of chapter 11 plans do not allow for third-party releases or injunctions to protect guarantors, insiders and other non-debtor parties from lawsuits, collection efforts or otherwise. While there are exceptions to this general rule, partners and guarantors will need to find a resolution outside of the business chapter 11 proceeding.

Partners May Need to Contribute New Capital to the Plan Funding

Also called the Absolute Priority Rule, the general idea is that if creditors are going to take a financial hit, so should the partners.  The rule of thumb is that unless the plan proposes to repay all creditors in full, the partners must contribute new value in a reasonably equivalent amount to the value of the ownership interests retained. There are deviations on this rule, including that a partner may contribute new capital, cash or letters of credit to the business. The rule is not always enforced and

Other Risks: Preference Payments to Partners and Other Avoidance Actions

 Article V avoidance actions are fairly common in all chapters of bankruptcy, and particularly so in chapter 11 proceedings. Both partners and creditors alike can be subject to actions to avoid transfers of funds or assets so that those funds can be recovered for the benefit of the bankruptcy estate and unsecured creditors. While a reasonable salary paid to a partner for managing the business won’t necessarily be avoided, partner distributions and withdrawals made while the business was insolvent may be subject to avoidance. The general look back for avoidance actions is 90 days for non-insider creditors/other parties and up to one year for insiders such as partners, related companies and others having a close relationship with the debtor business. There are specific rules and limitations as well as affirmative defenses for preferences actions and transactions need to be evaluated on a case by case basis. Future compensation and salary to be paid to partners must also be disclosed in the chapter 11 plan and will need to reasonable and necessary or otherwise the plan could draw an objection.

The Archdiocese of St. Paul and Minneapolis Files Chapter 11 Bankruptcy: A Review of the First Day Filings

For more detailed discussion on chapter 11 procedure, common issues and more, be sure to read Wartchow Law’s Chapter 11 Blog.

On January 16, 2015, the Archdiocese of St. Paul and Minneapolis filed a petition for relief under chapter 11 of the United State Bankruptcy Code. The partially complete chapter 11 filing today in the United States Bankruptcy Court for the District of Minnesota lists, among other claims, the contingent and unliquidated claims of at least twenty-one individual personal injury plaintiffs identified only as John Doe and in amounts unknown as of the date of the commencement of the bankruptcy proceeding. In its filings, the Archdiocese states its intent “to move this case forward as quickly as possible in order to minimize professional fees and to maximize the recovery to victims in this case.”

The first day filings also make mention that the 187 parishes within the Archdiocese of St. Paul and Minneapolis are separate and distinct legal entities which manage their own property and assets, and which have not otherwise sought bankruptcy protection as part of this proceeding.

As of the time of this post, the Archdiocese has yet to indicate on public record with the bankruptcy court what, if any, transfers of assets or cash it made outside the ordinary course of its business affairs in the past two years. Under federal law, preferential and fraudulent transfers and transactions made by a debtor within certain proscribed periods prior to filing bankruptcy may be avoided, essentially undone and “clawed-back” into the bankruptcy estate for the benefit of the creditors. Under the Bankruptcy Code, a preferential transfer is typically a payment or transfer made within a specific period of time prior to filing bankruptcy which conferred an unfair benefit on one creditor over other creditors of the debtor at that time. See 11 U.S.C. § 547. Fraudulent conveyances are defined as done with the actual intent to hinder, delay or defraud one’s creditors while insolvent, or for which the soon-to-be debtor received less than equivalent value in exchange for such transfer while insolvent, or for which the transfer was made to or for the benefit of an insider of the debtor. See 11 U.S.C. § 548.

While treatment of the alleged victims’ claims can hardly be gleaned from the mere first day filings in this chapter 11 case—as in most chapter 11 cases, first day filings seek to establish the procedure by which the case will proceed in the coming weeks and months—the Archdiocese’s papers do provide some indication that this purpose behind its reorganization proceeding will “focus on the creation of a mechanism for the payment of fair compensation to abuse victims… similar to bankruptcy cases commenced by other dioceses in the United States.” Such other cases may include the bankruptcy proceedings previously filed by the archdiocese in Portland (filed July 2004), Tucson (filed September 2004), Davenport, Iowa (filed October 2006), San Diego (filed February 2007), Milwaukee (filed January 2011), Gallup, New Mexico (filed November 2013), and most recently in Helena, Montana (filed February 2014). These cases also involved sex abuse cases whose aggregate compensation payments to date have totaled in the billions of dollars. (Source: http://en.wikipedia.org/wiki/Settlements_and_bankruptcies_in_Catholic_sex_abuse_cases)

In addition to the three-page petition, the list of Creditors Holding the 20 Largest Claims, and the Statement of Authority to File Petition signed by Joseph F. Kueppers, member of the Board of Directors, attorneys for the Archdiocese also filed several motions seeking expedited relief, including a motion authorizing certain documents and pleadings to be filed under seal to maintain the anonymity of uts alleged victims. The expedited motion essentially seeks to limit public access to several portions of the bankruptcy schedules and creditor matrix that would otherwise identify the names and addresses of potential and alleged victims of sexual abuse by clergy or other members of the Catholic entities, including both individual claimants already represented by counsel in Ramsey County actions as well as other potential claimants known to the Archdiocese who may still assert claims of misconduct. Section 107(b) of the Bankruptcy Code authorizes the protection by seal of documents containing such individuals’ identities due to the “scandalous or defamatory” public exposure that may be caused by naming them in the otherwise public bankruptcy filings. The Archdiocese has also requested that the deadline for filing proofs of claim to be established at a later date rather than within the standard one or two days of commencement of the case.

Additionally in its first day filings, the Archdiocese seeks for the court to waive the United States Trustee’s standard requirement mandating the closure of all prepetition bank accounts in favor of establishing new “debtor-in-possession” bank accounts. Instead, the Archdiocese seeks court authorization for it to maintain its various pre-petition accounts held at US Bank, Wells Fargo, Premier Bank and Bremer Bank, citing reasons of both administrative convenience in payment of future expenses, accounting and for investment purposes as well as “to protect the safety and integrity” of such accounts.

Unless and until such time that a trustee is appointed to administer its financial affairs, a chapter 11 debtor continues to possess its assets and operate and manage its business affairs as a debtor-in-possession of its own affairs. This means that the Archdiocese’s assets and operational income are at least temporarily protected from liquidation, attachment or execution to satisfy claims of its creditors while, simultaneously, the automatic stay confers protection from the continuance of most other legal proceedings and actions against it.

The Archdiocese is represented in its chapter 11 proceeding by the law firms of Briggs and Morgan and Lindquist & Vennum, LLP. As of the date of this post, the case has been assigned to Judge Robert J. Kressel of the U.S. Courthouse located in Minneapolis, the local Minnesota Office of the U.S. Trustee has yet to appoint an attorney to the matter and no trustee has been appointed.

The Absolute Priority Rule Applies in Individual Chapter 11 Cases in Minnesota and the 8th Circuit.

For more detailed discussion on chapter 11 procedure, common issues and more, be sure to read Wartchow Law’s Chapter 11 Blog.

November 2015 caselaw update: The Bankruptcy Appellate Panel of the Eighth Circuit has recently aligned itself with several other jurisdictions in deciding that the Absolute Priority Rule applies in individual chapter 11 cases. This is according to the August, 2015 ruling in In re Woodward, 537 B.R. 894 (B.A.P. 8th Cir. 2015), with Judge Schermer stating: We hold that the absolute priority rule still applies in individual Chapter 11 cases to prevent debtors from retaining prepetition property. Our holding is supported by: (1) the language and context of § 1129(b)(2)(B)(ii) and 1115; (2) the absence of a clear indication by Congress of an intent to abrogate; and (3) the weight of existing authority.

The Absolute Priority Rule (“APR”) is codified in section 1129(b)(2)(B)(ii) of the Bankruptcy Code. Like chapter 11 law itself, the APR was envisioned for application to business chapter 11 cases and neglects to address the reasonable differences faced by individual debtors who, for one reason or another, file chapter 11 cases. (See also What is Individual Chapter 11 Bankruptcy and Why Would I file an Individual Chapter.)

At its most basic, an individual chapter 11 plan works similar to a chapter 13 plan as it regards the minimum distribution to general unsecured creditors: Individual debtors must pay the equivalent of their disposable income for 5 years to their unsecured creditors in order to be granted a discharge of the unpaid balance of debts. (Of course, there are other requirements in both chapters 11 and 13 regarding the payment of priority and secured debts, which this article does not address.) The Absolute Priority Rule further adds a second source of funds for distribution to creditors, in that it essentially directs an additional amount must be paid to the general unsecured creditors in order for the debtor to achieve reorganization and receive a discharge of debts. So what does that mean, exactly?

When the Absolute Priority Rule applies, the chapter 11 debtor must contribute “new value” in the form of funds equivalent to the value of all property of the bankruptcy estate that is retained by the debtor, presumably subject to the debtor’s available exemptions. This new value is in addition to the debtor’s 5 years’ disposable income requirement and, logically, new value cannot be funded from the debtor’s income since that income is already spoken for under the disposable income requirement. For the average chapter 11 debtor (and no chapter 11 debtor is ever really “average” otherwise they would file under another chapter), this means that they may keep almost nothing after reorganization: no income-producing real estate, not any business interests which generate the 5-year disposable income, essentially nothing of real value other than a debtor’s minimal exempt property. Fundamentally the APR requires that a chapter 11 debtor sell off all non-exempt assets to the highest bidder in order to reorganize, thus nullifying the very purpose behind chapter 11 and making plan confirmation over a creditor objection a practical impossibility. Very few (if any) individual debtors are willing to self-liquidate in this manner, as the very purpose behind chapter 11 is to enable the debtor to repay his or her unsecured creditors as much as is feasible over five years while retaining the very assets which form his/her livelihood and which typically generate the eventual distribution to unsecured creditors.

Arguably, the Absolute Priority Rule is only triggered when the chapter 11 plan is rejected, in that it does not receive the requisite class acceptance by vote of all creditor classes within the plan, or when the holder of an unsecured claim objects to confirmation of the chapter 11 plan. (‘Arguably’ because the 8th BAP in In re Woodward nevertheless applied the APR even though the plan was accepted by an impaired class and where there was a plan objection otherwise.) When a plan is rejected by a class of creditors, the additional “cramdown” confirmation requirements of 1129(b) are invoked, including the requirement that the plan be “fair and equitable”. In contrast, if a debtor’s plan receives the requisite class acceptance while only devoting his/her 5-year disposable income, then the requirements of APR may not be invoked assuming there are no plan objections otherwise.  However, if the plan is rejected by the general unsecured class—which can easily happen if there is one large creditor holding the majority of unsecured claims—the court may invoke the APR. When the APR applies, essentially it means that the debtor cannot retain the value of any non-exempt property and such value must be paid to his/her creditors.

Prior to the 2005 amendments, section 1115 of the Bankruptcy Code included a very narrow definition of property of the estate, so that in practice the chapter 11 debtors could only retain a nominal amount of equity in one vehicle, in their homestead and a handful of other exempt assets. This is the reason very few individual chapter 11 cases were filed prior to 2005 and almost none were successfully confirmed over a creditor objection. The 2005 amendments to the Bankruptcy Code expanded the definition of ‘property of the estate’ under 1115, accordingly making cramdown possible for individual debtors for the first time.

Since 2005, courts have been divided over whether the Bankruptcy Code amendments impliedly repealed the Absolute Priority Rule as it applies to individuals, with most to date taking the position that the APR applies to indivuals. For the courts that find that the APR still applies to individuals (including now Minnesota and the rest of the 8th Circuit as well as at least the 5th, 9th and 10th Circuits), these courts hold to the old standing practice that a chapter 11 debtor cannot achieve reorganization without paying his/her creditors not merely his/her 5-year disposable income but also the value of all assets, thereby forcing such individuals to liquidate their income-producing assets (again, an option which runs contrary to the purpose behind chapter 11 to achieve reorganization rather than liquidation). These courts that hold the APR applies to individuals are said to take a “narrow” view of the 2005 amendments. See In re Woodward, 537 B.R. 894 (B.A.P. 8th Cir. 2015); In re Lively, 717 F.3d 406 (5th Cir. 2013); Zachary v. California Bank & Trust, 811 F.3d 1191 (9th Cir. 2016); and In re Stephens, 704 F.3d 1279 (10th Cir. 2013).

Fewer courts have taken the “broad” view of the 2005 amendments to recognize that the Absolute Priority Rule undermines the essential purpose of chapter 11 law as applied to individual debtors. These courts identify the practical impossibility that APR poses to plan confirmation in almost every conceivable individual chapter 11 case that does not achieve majority acceptance from each creditor class. In finding that the 2005 amendments expand the definition of property of the estate that may be retained by a debtor, these courts rule that the APR is inapplicable in chapter 11 cases filed by individual debtors, such that debtors’ retention of their equity interests in businesses and other assets owned prepetition does not prevent them from “cramming down” plan that would result in less than a 100% distribution on unsecured claims. In other words under the “broad” view of APR, an individual debtor is entitled to retain most prepetition and postpetition property and nonetheless cram down a plan over an unsecured creditor’s objection. See In re Anderson, No. 11–61845–11, 2012 WL 3133895 (Bankr.D.Mont. Aug. 1, 2012); In re Shat, 424 B.R. 854 (Bankr.D.Nev.2010); In re Roedemeier, 374 B.R. 264 (Bankr.D.Kan.2007).

The Absolute Priority Rule is rooted in business chapter 11 law and was never intended to address the fundamental uniqueness of individuals utilizing chapter 11. The drafting of the Bankruptcy Code, including the 2005 amendments, fails to differentiate between an individual and a business. This futility of chapter 11 law has been further perpetuated by bankruptcy judges taking the narrow view APR, essentially leaving those unique, albeit few, individual debtors who are not eligible for either chapter 7 or chapter 13 without a practical bankruptcy solution. In this author’s opinion, the APR forces the individual chapter 11 debtor to self-liquidate in such a manner that undermines reorganization process when retention of such assets is necessary for funding the creditor distributions and, more importantly, essential to rehabilitation of the debtor.

Wartchow Law Office provides a comprehensive review of your liabilities and circumstances affecting a possible chapter 11 proceeding to best advise on all options including what chapter 11 can do to improve your future prospects. 

Restaurant & Bar Chapter 11s: Top 15 Signs that Your Restaurant May Benefit from Filing a Chapter 11 Bankruptcy

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.

Commercial Leases and Chapter 11 Reorganization: The Requirements and Timelines under the Bankruptcy Code

Problems with commercial leases of real property are one of most common precursors to a Chapter 11 Business Reorganization bankruptcy filing, at least in this attorney’s experience. What a lessee can and cannot do with a problematic commercial lease is something that should be fully considered before a Chapter 11 bankruptcy is filed. It is essential to have careful course of action regarding a commercial lease since timelines are short and monetary obligations come quickly once the Chapter 11 is filed. This article intends to give a comprehensive yet general enumeration of the timelines and lease options under the Bankruptcy Code that a debtor-lessee (i.e., the tenant) can expect with regard to their commercial lease of real property. Note: Leases of personal property have different timelines and requirements than leases of real property.

(For other detailed discussions on chapter 11 procedure, common issues and more, be sure to read Wartchow Law’s Chapter 11 Blog.)

Terminated Leases and Expired Leases may not be Assumed in Chapter 11

What has transpired as of the date that a Chapter 11 is filed—also called the ‘date of the order for relief’—is determinative of the rights of both the debtor-lessee and the lessor (i.e., the landlord) and what course of action may be undertaken in the Chapter 11 proceeding. If the lease has expired or terminated under its own terms and/or under state law prior to filing the bankruptcy proceeding, the lease is unlikely to be resurrected in the bankruptcy except by agreement with the lessor. While the filing of Chapter 11 bankruptcy may stall an eviction proceeding and generally buys more time for the debtor-lessee to negotiate terms of a lease with its lessor, bankruptcy cannot ‘un-ring the bell’ of a lease that has already terminated or expired prior to filing. Simply stated, a terminated or expired lease cannot be assumed in the Chapter 11 proceeding except by voluntary agreement with the landlord. Bankruptcy also will not restore the rights of an already evicted tenant.

A pending eviction proceeding does not necessarily imply that the lessor has also terminated the lease or that the lease has already expired and a tenant in midst of an eviction proceeding may nonetheless still have a lease that may be cured and assumed in Chapter 11. This is why it’s imperative to know the precise status of the lease—terminated, expired and/or evicted—in order to determine what opportunities may be presented by a Chapter 11 filing. For more information on eviction and Chapter 11, see Chapter 11 Bankruptcy: Can it Stop Eviction under a Commercial Lease?

“Post-Petition” Rent and Other Lease Obligations are Timely Due after Filing

Assuming the debtor-lessee is operating under a non-terminated and unexpired lease, the Bankruptcy Code requires that once a Chapter 11 is filed all obligations under the commercial lease must be timely performed. Typically this means that as soon as a Chapter 11 is commenced, the next payment of rent is still due and owing on the regular rent due date under the terms of the lease. Some lessors may even push for the balance of the current month’s rent to be paid on a prorata basis, and in this case the Chapter 11 debtor will pay the prorated rent due from the file date of the Chapter 11 case to the end of that first month of the bankruptcy proceeding and all subsequent months’ rent when those become due. For this reason, a Chapter 11 business debtor should be confident in its ability to pay all normal rent going forward as well as anticipate the timely performance of all other obligations under the lease including any tax payments that may be due after filing Chapter 11 as well as most non-monetary lease obligations.

The Chapter 11 Debtor-Lessee has 120 Days to Assume the Commercial Lease

The Bankruptcy Code specifies that a non-residential real property lease must be either assumed or rejected within 120 days of the Chapter 11 case being filed, with one extension of this deadline available for good cause. Lease assumption is essentially a reaffirmation of all terms of the commercial lease along with whatever changed terms may be negotiated between the parties. Lease assumption requires that the debtor-lessee cure monetary and non-monetary defaults under the lease and provide adequate assurance of future performance. Adequate assurance may take the form a replacement deposit particularly if the former lease deposit has already been set-off by the lessor prior to filing Chapter 11. Generally, the bankruptcy court will approve a lease assumption even over a lessor’s objection if the lease is not terminated or expired, a full cure of defaults can be immediately made, additional adequate assurance will be provided if needed, and there is the likelihood that the business can reorganize under Chapter 11.

If a commercial lease is not assumed within 120 days, the lease is deemed rejected under the law and the debtor-lessee must immediately vacate and surrender the property to the lessor. If a lease is rejected, the lessor may also be entitled to rejection and termination damages as claims that can be reorganized.

Rental Arrears and Other Defaults must be Cured in Full for the Lease to be Assumed

In addition to the timely payment of post-petition rent, if there has been a default under the lease, that default must be cured at the time the lease is assumed, i.e., 120 days after the case is filed at the earliest. The cure of the pre-petition date default may involve both monetary compensation for unpaid pre-petition rent as well as unpaid real estate taxes due under the lease and sometimes compensation for the lessor’s actual expenses such as attorney fees. The cure required upon lease assumption may also mandate the debtor-lessee’s actual performance of other, non-monetary defaults under the lease such as operational restrictions and an affirmative responsibility to improve or repair the premises. Note that the act of filing of bankruptcy itself is not an event of default under the law that must be cured even if the lease says otherwise. Such anti-bankruptcy provisions are sometimes called “ipso facto clauses” and are rarely enforceable with the bankruptcy court. Once a commercial lease is assumed, the debtor-lessee’s rights under that lease are fully resurrected (except as may be altered by the terms of the lease assumption) including future lease renewal options.

The bottom line: A Chapter 11 business debtor-lessee should fully expect to pay all ‘post-petition’ rent as it becomes due immediately once a Chapter 11 case is filed. Additionally if the debtor wishes to keep operating the premises under the lease, they also must cure all pre-petition defaults including rental arrears within a short period after filing bankruptcy or otherwise plan to vacate the premises within this same short period of time. While commercial leases are often are renegotiated in the course of a Chapter 11 proceeding with a cooperative landlord, sometimes the most that a debtor-lessee can expect is for Chapter 11 to provide a relatively short window of opportunity to either make good on a defaulted lease or move into another suitable property without the immediate threat of eviction.

You should always consult an attorney regarding your specific rights under your particular circumstances. Lynn Wartchow of Wartchow Law Office is an experienced Chapter 11 attorney with a track record of successful Chapter 11 reorganizations in MinnesotaContact Wartchow Law for a consultation.

Chapter 11 Bankruptcy: Can it Stop Eviction under a Commercial Lease?

(For other detailed discussions on chapter 11 procedure, common issues and more, be sure to read Wartchow Law’s Chapter 11 Blog.)

As for many issues in bankruptcy, whether filing bankruptcy can stop an eviction under a commercial lease depends on several factors, including the precise legal status of the lease as of the file date of the Chapter 11 bankruptcy case–has the lease been lawfully terminated or expired, or is it simply in default–and the legal steps taken by the landlord pursuant to the Minnesota eviction process before the bankruptcy is filed. The ideal chapter 11 scenario to stop a commercial eviction (or residential eviction for that matter) is to file a bankruptcy petition before the lease is terminated or expired either under the law or under the terms of the lease and also before a judgment of possession is ordered by district court. If these two factors are present, the lease can still be cured in a chapter 11 and, even if the debtor decides not to keep the lease, at least the debtor will have significantly more time to vacate the premise and relocate under a more favorable lease.

In Minnesota, the eviction process is typically an expedited proceeding, meaning that once a commercial landlord petitions the district court for eviction—usually for non-payment of rent or other default by the tenant—relief in the form of eviction can be ordered in a matter of weeks. The key to bankruptcy stalling an eviction proceeding is timing: ideally the bankruptcy should be filed before a judgment of possession is entered in a commercial eviction proceeding.

The very first matter that must be considered is the legal status of the lease, since this will greatly impact the debtor’s rights regarding the lease and, accordingly, also the length of time that the chapter 11 debtor can continue to use the premises. If the lease is expired or otherwise has terminated prior to the bankruptcy filing–or if the landlord has obtained a judgment for possession–eviction may only be stalled for a short period of time, perhaps as little as a week or two. Even though chapter 11 provides a new platform for potential lease re-negotiations, it cannot resurrect a lease that is no longer valid under the law without the cooperation of the lessor. Put another way, while eviction proceedings will be stayed by the filing of chapter 11 (or any form of bankruptcy for that matter), it will not breathe new life into a lease that was already dead (terminated or expired) before the bankruptcy was filed. Even if the lease is expired or terminated, a well-advised landlord will still first go through the bankruptcy court before continuing with the eviction, however even this initial procedure in bankruptcy court can be expedited to a matter of a week or two. in contrast if the lease is not yet terminated or expired, the landlord faces a longer process in the bankruptcy court because the debtor has an unequivocal right to cure and assume (i.e., “make good”) on the defaulted lease so long as the debtor can evidence its practical and financial ability to do so. Whether a particular lease has terminated or expired will depend on the terms of the lease and/or if the landlord has taken the requisite steps to terminate the lease prior to the filing of bankruptcy. Often this “lease termination” step is missed in the course of an eviction proceeding, thus a business on the doorstep of eviction may still have an opportunity to make good on their lease and, unlike many state laws, chapter 11 will affords the necessary time and legal process to cure a defaulted lease.

Assuming the lease is not terminated or expired and even though the tenant is in default, chapter 11 provides a temporary respite from eviction process during which time the tenant must have a plan to cure any defaults in order to continue under the lease. A qualified Chapter 11 attorney can advise a commercial tenant (i.e., the prospective debtor) of the cure period afforded in a Chapter 11 filing, their rights in bankruptcy to stop the eviction and reorganize debts as well as the timeline and costs expected regarding the options to either assume or reject the troubled lease.

For more detailed information about chapter 11 and commercial leases, see also Commercial Leases and Chapter 11 Reorganization: The Requirements and Timelines under the Bankruptcy Code.

For other issues typically involved with chapter 11, keep reading to Recognize the Circumstances that Often Lead to Chapter 11 including Sales Tax Obligations in Chapter 11.

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. Chapter 11 is also available to individual Chapter 11 debtors having unique circumstances. 

Managing the Business During Chapter 11: Reporting and Other Requirements

When a business files Chapter 11, it becomes a “debtor-in-possession” of its own affairs as a fiduciary to the bankruptcy estate. What this means is that management of the business during the Chapter 11 case will remain under the control of its prepetition management and principals, subject to certain duties to report and maintain the business in a manner consistent with the procedural rules of Chapter 11 business reorganization bankruptcy. While these mostly financial and administrative requirements for operating the business during Chapter 11 are relatively straight-forward and generally represent good business practices, failure to follow these requirements can result in an appointment of a trustee to takeover operations of the business or dismissal or conversion of the case to liquidation.

While the business is in Chapter 11 bankruptcy, it has an obligation to file both a comprehensive initial financial report as well as ongoing monthly operating reports. The monthly operating reports provide an itemization of cash receipts and disbursements, profit and loss statement, balance sheet, copies of all bank account statements and other financial information that facilitates an ongoing review of the debtor’s finances while it is in bankruptcy. These monthly operating reports may be reviewed by any party in interest to the case and also form a basis to determine the feasibility of a plan of reorganization. If the debtor continually sustains a monthly net loss as demonstrated on the monthly operating reports, its hope for reorganization may be diminished.

Additionally, the business debtor must also stay current in the filing of all applicable tax returns and payment of taxes, including monthly sales tax and employee withholding tax obligations. This may be a challenge for businesses that do not maintain regular accounting books and records, or may routinely default in the payment of taxes. If the business accounting records and tax reporting is not current or accurate prior to the Chapter 11 being filed, an effort should be made as soon as possible to arrange the resources necessary to ensure that correct and timely tax filing and payments are made as soon as the Chapter 11 is filed. Tax obligations accrued prior to the bankruptcy may be dealt with in the plan, which often means that pre-petitiion sales tax obligations in Chapter 11 are repaid over five years at low interest.

The Chapter 11 business debtor has additional requirements to these, including the requirement to immediately open new debtor-in-possession bank accounts and close all pre-petition bank accounts, to maintain all insurance standard in the debtor’s particular industry, to pay a quarterly fee to the Office of the U.S. Trustee that monitors the debtor’s finances throughout the Chapter 11 proceeding, to attend various interviews and hearings conducted by the U.S. Trustee, as well as adhere to other restrictions on compensation, partner distributions, use of cash and more.

Keep reading for more on the Chapter 11 process, timeline and fees involved in a reorganization.

A qualified Chapter 11 attorney can advise your business of all the requirements and obligations before a Chapter 11 bankruptcy case is filed. Wartchow Law Office provides initial Chapter 11 consultations to review the business liabilities and other circumstances affecting a possible Chapter 11 bankruptcy proceeding, and to advise on possible options and solutions that Chapter 11 can provide to keep a business operating and improve future prospects.

What is Individual Chapter 11 Bankruptcy and Why Would I File an Individual Chapter 11?

The vast majority of individuals who file bankruptcy chose to do so under either Chapter 7 or Chapter 13, which are the most common forms of consumer bankruptcy. However, there are certain individuals that may instead take advantage of the greater flexibility that Chapter 11 can provide, especially when the individual has considerable and/or income-producing assets to protect and distinctive objectives to attain in bankruptcy.

(For other detailed discussions on chapter 11 procedure, common issues and more, be sure to read Wartchow Law’s Chapter 11 Blog.)

Chapter 11 arguably offers greater flexibility for an individual than other chapters of bankruptcy. A successfully confirmed individual Chapter 11 plan can restructure secured debts such as mortgages on rental properties and liens on other assets, yet without the close supervision of an appointed bankruptcy trustee. While some restructuring can be accomplished in Chapter 13, a Chapter 11 debtor maintains a higher level of control and input in the terms of the restructured debts as negotiated with creditors.

Especially for individuals having multiple real estate holdings, Chapter 11 provides an opportunity to protect non-homestead real estate equity which could otherwise be lost in Chapter 7 or Chapter 13, and opportunity to reorganize the underlying mortgages to rewrite more favorable terms including potentially stripping a wholly unsecured mortgage from commercial and rental real estate.

An individual may also opt to file Chapter 11 bankruptcy when they do not otherwise qualify for Chapter 7 or Chapter 13. In Chapter 7, individuals must be below a certain income level in order to be eligible for Chapter 7 pursuant to the “means test”. For higher income earners that do not qualify for Chapter 7, most can still file under Chapter 13, which typically involves a partial repayment plan over five years after which time any remaining debt is then discharged. Chapter 13 has certain statutory debt limits that, while for most people do not normally present a problem, pose a challenge for individuals that exceed those debt limits, in particular individuals that may have multiple real estate holdings with corresponding mortgages which easily aggregate to exceed the debt limits of Chapter 13. As of the date of this post, the statutory debt limits for Chapter 13 bankruptcy are $1,081,400 in total secured debt plus $360,475 in unsecured debt (see the current Chapter 13 debt limits).

As few general consumer bankruptcy attorneys practice individual Chapter 11s, it is especially important to consult with an attorney who has filed individual Chapter 11s before and can guide you through the more rigorous, yet arguably much more flexible process, on an individual Chapter 11 bankruptcy.

Lynn Wartchow provides initial Chapter 11 consultations to review liabilities and assets affecting an individual Chapter 11 bankruptcy proceeding. For more information on how Chapter 11 bankruptcy may impact your situation, contact Wartchow Law Office for a free bankruptcy consultation. Located in Edina, Minnesota, Wartchow Law represents clients in all forms of bankruptcy throughout the Minneapolis and St. Paul metro area of Minnesota.

The Role of the “Trustee” in Chapter 11

Unlike under other Chapters of the Bankruptcy Code, Chapter 11 is unique in that there is no initial appointment of a trustee. In contrast, an independent trustee is appointed in a Chapter 7 business bankruptcy to manage the business operations if the business is still operational and effectuate an orderly liquidation. However in Chapter 11 where the intent of the bankruptcy proceeding is to reorganize, having an independent trustee manage the business operations is often expensive, unnecessary and even counterproductive to the reorganization process. After all, the principals of a business are usually the best suited to run their own business and continuity of current management typically minimizes overhead costs, best maintains vendor and client relationships and operates the business in its most efficient manner. The appointment of a trustee in a Chapter 11 case can be akin to a death sentence if the trustee appointed decides to unseat the current management or principals and/or to convert the business to Chapter 7 liquidation.

While somewhat uncommon here in Minnesota, a Chapter 11 bankruptcy trustee or examiner can be appointed under specific circumstances, usually when the principals of a Chapter 11 debtor have utterly mismanaged the debtor’s finances and business. The appointment of a trustee or examiner in a Chapter 11 business reorganization must be made by request of a party in interest—usually that party is the attorney for the United States trustee—and must be based on one of the grounds recognized under the Bankruptcy Code, including for fraud, dishonesty, incompetence, or gross mismanagement of the affairs of the debtor by current management, either before or after the commencement of the case. Appointment of a trustee in a Chapter 11 case is an extraordinary consequence and generally should be avoided. The best plan to avoid the appointment of a trustee in Chapter 11 is to follow the rules and procedure, read and observe the Operating Guidelines and Reporting Requirements of the U.S. Trustee (as well as follow all Reporting and Other Requirements in Chapter 11), and always ask your Chapter 11 attorney before doing anything that may be outside the ordinary course of business.

Lynn Wartchow is a Minnesota Chapter 11 attorney advising business clients on their options and Chapter 11 solutions to keep a business operating and improve future prospects. Located in Edina, Minnesota, Wartchow Law Office represents clients throughout Minneapolis, St. Paul and surrounding areas in Minnesota.

Defined: The Bankruptcy “Trustee” and the “United States Trustee”

The terms “trustee” and “United States Trustee” sound similar and often encompass similar objectives, however the role of the trustee in bankruptcy proceeding is distinctly different than that of the United States Trustee.

The “United States Trustee” (also called the U.S. Trustee or “UST”) is essentially a federal office within the U.S. Department of Justice that oversees the administration of all bankruptcy cases in a certain district. Here in the district of Minnesota as in other districts, the office of the U.S. Trustee employs a group of staff attorneys, financial analysts and other professionals all charged with the responsibility to promote the efficiency and protect the integrity of the federal bankruptcy system. The Office of the US Trustee does not always directly engage in consumer Chapter 7 and Chapter 13 bankruptcy proceedings, however does monitor each case to determine whether legal action needs to be taken in order to enforce the requirements of the Bankruptcy Code and to prevent fraud or abuse. The UST often reviews petition and schedules filed with the Court to determine whether fraud exists or if an audit must be conducted to uncover more information. However in the majority of consumer Chapter 7 and Chapter 13 bankruptcy cases, the individual debtors will never hear from the United States Trustee or be subject to its action. In Chapter 11 cases, the Office of the US Trustee becomes a principal player in monitoring the business reorganization proceeding.

In contrast, the “trustee” (also called a “panel trustee” or a “standing trustee” in Chapter 13 cases) is often a private attorney charged with the responsibility to administer a bankruptcy, hold the meeting of creditors, and distribute any non-exempt assets to creditors. A bankruptcy trustee is appointed to every individual’s Chapter 7 or Chapter 13 consumer bankruptcy case. In the District of Minnesota, there are approximately 25 such attorneys that serve as Chapter 7 and Chapter 13 trustees. Unlike the US Trustee whose main objective is to ensure the integrity of the bankruptcy process, the role of the Chapter 7 trustee is to collect any non-exempt assets of the debtor, liquidates those assets, and then distribute the proceeds to creditors. In Chapter 13, the trustee additionally evaluates the debtor’s financial affairs, makes recommendations to the Court with regard to the Chapter 13 plan and ultimately administers a the Chapter 13 plan by collecting payments from the debtor and disbursing the funds to creditors. In Chapter 11, no trustee is initially appointed and the debtor effectively operates as its own trustee, i.e., the “debtor in possession”.

Lynn Wartchow is the founding attorney of Wartchow Law Office located in Edina, Minnesota and representing consumer and business clients in Chapter 7, Chapter 13 and Chapter 11 bankruptcy proceedings throughout the Minneapolis and St. Paul and surrounding areas.