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. 

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

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.

Sales Tax Obligations and Chapter 11 Business Reorganization

Minnesota Department of Revenue levies sales tax on any number of transactions common to small businesses, most often being on sales of taxable goods and services. Sales tax is considered a “trust” tax, as it is collected by the retailer and must be held in trust for the State until remitted on the appropriate due date. Responsibility for paying sales tax falls not only on the business but also at times on the company’s principals.

Since the sales tax money collected never actually belongs to the business, use of the tax money for any purpose other than direct remittance to the State is expressly  disallowed. In practice, however, it is common for businesses to merge the sales taxes collected with its own operating funds, thus at times risking that some of the taxes may be used to cash flow general operating expenses rather than remittance to the State. When this happens and a business cannot timely remit the sales tax to the State, the domino effect happens quickly and can be synonymous with the end of business operations. For retailers, non-payment of sales tax obligations means their sales tax vendor permit may be quickly revoked. Once revoked, no more sales are allowed. For a business such as a restaurant or bar, their liquor license additionally can be posted and the business prevented from further purchases of liquor, wine and beer inventory.

When past due sales tax is the problem, Chapter 11 can leverage certain relief that  may not otherwise be available to the small business in a non-bankruptcy context.  Specifically in Chapter 11 business reorganization, past due sales taxes can be statutorily repaid over five years at low interest, and under some circumstances sales tax permits and liquor licenses can be reinstated while personal collection may also be stalled to allow time for the business to reemerge with a confirmed Chapter 11 plan.

While a multitude of factors should be considered before filing Chapter 11 business reorganization, the repayment of sales tax obligations over five years that is prescribed by the Bankruptcy Code can offer significant relief that may not otherwise be available without a bankruptcy filing. Sales tax is just one example of the various circumstances that often lead to Chapter 11 bankruptcy.

Contact Chapter 11 attorney Lynn Wartchow for an initial Chapter 11 consultation to review tax and other business liabilities affecting a Chapter 11 bankruptcy proceeding. Office located in Edina, Minnesota.

Recognize the Circumstances that Often Lead to Chapter 11

The factors commonly precipitating a Chapter 11 business proceeding are numerous: lawsuits filed by unsecured creditors, reluctance of secured lenders to extend or continue financing terms, attachment of business assets including bank account levies, foreclosure or repossession of key assets used in business, adverse administrative actions such as license posting by the state, aggressive tax collection, a commercial eviction proceeding and the list goes on.

Businesses are often cyclical in their financial condition, and experience financial highs and lows the same as individuals. Not every ailment justifies the time and expense of a Chapter 11 business proceeding, and an experienced and principled Chapter 11 attorney can advise if that is the case for your business. Sometimes, however, a situation that warrants Chapter 11 is a “one-off” of sorts: an unexpected lawsuit or judgment brought against the business, an isolated but escalating event such as an eviction proceeding or sales tax audit, or a recurring temporary circumstance that the business just  can’t get out from under.  In situations such as these, the expense of a Chapter 11 may be justified since it provides both immediate relief and a permanent solution.

Chapter 11 opens the door to new avenues of relief that are not available outside of the context of bankruptcy. As a simple yet common example to many small businesses, the nonpayment of sales tax can effectively put a business out of business in as little as a few months. The Minnesota Department of Revenue, charged with collecting revenue to offset the State’s huge deficit, is necessarily aggressive in the collection of sales tax and provides extremely little, if any, breathing room for businesses that cannot immediately pay delinquent tax obligations. Unpaid sales tax quickly threatens any business. Outside of bankruptcy, unpaid sales tax can result in license posting and a revocation of sales tax permit that is tantamount to the death of operations, as well as the pursuit of personal liability against principals of the business. Inside Chapter 11, by contrast, unpaid sales or withholding taxes can be statutorily repaid over five years at low interest, and often personal collection is put on hold while the business reemerges under a confirmed Chapter 11 plan.

Keep reading for more information about Sales Tax Obligations and Chapter 11 Reorganization and Commercial Leases and Chapter 11 Reorganization: The Requirements and Timelines under the Bankruptcy Code.

Read some of the recent Chapter 11 success stories handled by Wartchow Law Office.

Lynn Wartchow is a Chapter 11 attorney located in Edina, MN. Contact Wartchow Law Office for an initial Chapter 11 consultation to review business liabilities and other circumstances affecting a Chapter 11 bankruptcy proceeding, and for guidance on options and solutions that Chapter 11 can provide to keep a business operating and improve future prospects. 

Intro to Chapter 11 Business Reorganization: The Process, Time and Fees Involved

Many initial calls regarding a potential Chapter 11 business reorganization seek just the basic information: Does my business have to go out of business if it files bankruptcy? Can reorganization help my business resolve a particular debt or situation (i.e., unpaid withholding or sales taxes, judgments, collection efforts, commercial eviction, lawsuits)?  What is Chapter 11 anyway? How much does Chapter 11 cost? How long does it take for a plan to be confirmed?

At its most basic principle, Chapter 11 reorganization is a way that a financially distressed business can obtain immediate and lasting relief so that it can keep operating and stay in business. As the name “reorganization” suggests, that financial relief comes in the form of reorganizing and restructuring debts and other liabilities. A confirmed Chapter 11 plan of reorganization can accomplish this in any number of ways, from restructuring financing terms to extend the payback period, reduce interest rate and bifurcate secured claims (i.e., principal reduction), to discharging or significantly reducing unsecured claims, to providing a five-year payback period for most tax liabilities, to halting lawsuits and administrative actions, to reinstating a suspended license and more. The favorable results that can be attained in a confirmed Chapter 11 plan of reorganization are open ended and limited only by the parties involved.

The Chapter 11 process starts by consulting an attorney as soon as the business
finds itself in financial dire straits. Time is of the essence and non-bankruptcy options such as bank/creditor workouts or other out-of-court arrangements may be explored if time permits. However, Chapter 11s are often filed after such efforts fail or reach a standstill. At that point, the business can file Chapter 11 to obtain immediate relief in the form of the automatic stay prescribed under the Bankruptcy Code.  At the moment of filing, the automatic stay puts an immediate moratorium on debt collection efforts, including the suspension of pending lawsuits, judgments, foreclosure, levies, etc. While the automatic stay will not permanently deprive all creditors from pursuing their legal remedies, it often is the curveball that has that result. The automatic stay provides the debtor with breathing room and time to consider new routes to improve business prospects. Moreover, Chapter 11 offers a new platform upon which to leverage legal possibilities that may not be available outside of Chapter 11 bankruptcy.

Once filed, multiple parties become necessarily involved in a Chapter 11 proceeding. Of course there is the Chapter 11 debtor and its attorney, and also the Office of the US Trustee—which is a federal office organized under the U.S. Department of Justice—which has the duty to monitor and participate in Chapter 11 proceedings as necessary to ensure the procedural process and certain mandatory reporting requirements are properly followed. It is also possible that a committee of the business’s creditors may be formed however this is somewhat less likely to happen in smaller cases. Additionally, a bankruptcy judge is assigned to the case who serves as the ultimate arbitrator over the Chapter 11 proceeding and all disputes, if any, that may arise between the debtor and other parties in interest.

During the course of a Chapter 11 proceeding, the debtor can expect to make several appearances before the judge and with the attorney for the Office of the US Trustee assigned to the case. The debtor can also expect to prepare and file detailed monthly financial reports of the business’s operations, and to participate in negotiations with key creditors. Chapter 11 requires the business to be an “open book” for the duration of the proceeding, and transparency in most areas of the business is critical to a successful Chapter 11.

The duration of a Chapter 11 proceeding can vary widely, with a simple uncontested
case lasting a few months or more while a large business in an embattled case having multiple secured creditors and contested actions taking years to complete. An experienced Chapter 11 attorney can review the business’s circumstances, advise of the potential pitfalls that could arise to complicate a Chapter 11 proceeding, and provide an estimated range of attorney fees and other costs involved in Chapter 11 proceedings.

Lynn Wartchow 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.