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.

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.

When sales tax threatens a business: Chapter 11 may be the answer

When I became aware of a popular local restaurant and bar recently close its doors due to unpaid sales tax and subsequent state shutdown, I had to wonder why no one suggested that the owners file a Chapter 11 business reorganization. True, I cannot be sure that the owners did not consult an attorney and make the decision not to file Chapter 11, but I have my doubts. The establishment was a long-standing popular Minneapolis hotspot, overflowing with patrons bursting out the doors even on weeknights—how could they not be making a decent profit? The zoning of the neighborhood may be to blame, which dictates a mandatory portion of receipts must be from food rather than alcohol, or the sales tax and penalties spike. Here in Minnesota, if a business that sells alcohol is delinquent in paying its sales tax, it can expect to have its liquor license posted within a month. Once a liquor license is posted, the business is not allowed to purchase liquor from wholesalers and distributors until they pay the tax in full, thereby leaving the business with a dwindling supply of inventory to sell to the public while it tries to generate enough revenue to pay the tax bill. Unlike other types of creditors that may be more negotiable, the state’s taxing authority is an unyielding force of government that demands payment under the threat of immediate adverse action. With the Minnesota Department of Revenue, you have to pay to play, and if you want to run a bar, you better pay your sales tax on time each month.

With one not-so-obvious exception: Chapter 11 business reorganization. While this means a business must file for bankruptcy, bankruptcy doesn’t necessarily mean it will go out of business. Quite the opposite—Chapter 11 is a mechanism established under federal law that provides significant flexibility for businesses to reorganize any number of liabilities so long as they can achieve future cash flow to actually stay in business. First and foremost, from the moment the Chapter 11 is filed, the state cannot post the liquor license—this is why it’s so important to head off the posting ideally before it happens. As for resolving the unpaid sales tax bill, the Bankruptcy Code generously allows businesses five years to repay federal and state tax liabilities. A five-year tax repayment plan sure beats the one month notice of liquor license posting.

Of course, other debts can also be reorganized in Chapter 11. Unsecured debt may be reduced to a fraction and paid over time while secured debts and financing agreements may likewise be restructured over more time with principal and interest reduced, and any other number of issues are given more flexibility inside a Chapter 11 bankruptcy proceeding. It should go without saying that, just as with most everything in life, it’s best to explore the bankruptcy option as early as possible and get an idea of what Chapter 11 may look like under your business’s specific circumstances.

The best general advice for a restaurant or bar struggling under sales tax liability: Talk to an attorney that does Chapter 11, and ideally before things go from bad to worse. Even if “bankruptcy” has not been part of your vocabulary before, it could be the solution that keeps your doors open and gets your business back in the black. As for the local favorite restaurant and bar I mentioned earlier in this post, I wish we had met sooner and hope you reopen soon.

Keep reading for more information about Sales Tax Obligations and Chapter 11 Business Reorganization.

Attorney Lynn Wartchow has represented Chapter 11 business reorganizations proceedings involving restaurants, bars, nightclubs and other businesses in Minneapolis since 2008.