Demystifying the Ch. 11 Process: What Every Business Debtor Needs to Produce Right After a Filing

Written by Amy Weston, Paralegal and Salene Mazur Kraemer, Esquire

        Fear of the unknown.  The Ch. 11 process is unknown to many.  C-level executives dread  discussions about bankruptcy options.  We just recently filed a new Chapter 11 case and thought we would write a series of posts on basic Ch. 11 procedural matters so as to demystify the process.

      Filing Chapter 11 (reorganization/restructuring) is a powerful tool that can be invoked by businesses and certain individuals pursuant to Title 11  of the United States Code (aka the “Bankruptcy Code”).   As a practitioner,  I am privileged to be able to  facilitate such restructurings.  Here is the first post in this series on Ch. 11 basics.

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           The administrative burden of filing a case can be heavy.  Often, a paralegal is running the “paper pushing” ship just before and shortly after a case is filed.   Information gathering.  Data compilation.  Report generation.  A debtor’s bookkeeper, accountant and/or CFO all work with Debtor’s counsel and paralegal staff to gather  necessary documentation and to fulfill requirements imposed by the Court and the United States Trustee (appointed by Department of Justice).  Each office has very specific document requests, rules and procedures.

          In furtherance of a U.S. Trustee’s monitoring responsibilities, here is a list of what the U.S. Trustee wants prior to the Initial Debtor Interview.  Most of the documentation requested is straightforward and anticipated:

• Bank account statements.
• Latest filed Federal Tax Returns or copy of extension to file.
• Financial statements.
• Payroll detail.
• Rent roll.
• Accounts receivable detail.
• Recently filed sales tax
• Recently filed payroll returns.
• Detail of intercompany transactions.
• Accounts payable detail.
• Check register for last 60 days.
• Filed Scheduled and Petition

Other requirements are not as obvious. Two that specifically need explanation are:

• Proof of establishment of Debtor-In-Possession account(s)
• Proof of insurance indicating that the Office of the U.S. Trustee is an additional certificate holder.

DIP Accounts

         Once a debtor has filed a bankruptcy petition, it must close existing bank accounts and open new accounts which identify the debtor as a debtor in possession (“DIP”). All money from the bankruptcy “estate” (i.e. anything the debtor owns) must be put into these accounts.  The title of “Debtor in Possession” must be printed on the checks along with the bankruptcy case number.  The Bank will not issue a debit card for a DIP account.

        While this seems complicated at first, the good news is that this is standard procedure. So, any bank should be familiar with this request.  However, a debtor cannot go to just “any” bank. The U.S. Trustee’s Office will only accept DIP accounts from approved depositories.  A current list of such institutions is available through the U. S. Bankruptcy Court in the district where the bankruptcy was filed.  Approved Banks DIP

              Within 15 days of receipt from the bank, a debtor must serve copies of monthly bank statements upon all creditors and interested parties, together with a monthly operating report (MOR) of gross receipts and disbursements.  Both the monthly operating report (MOR) and DIP bank statements are publicly filed on a debtor’s docket.

Proof of Insurance

          A debtor must maintain all insurance coverage during the bankruptcy process.   This includes: general comprehensive liability; property loss from fire, theft or water; vehicle; workers’ compensation; and any other coverage that would be customary in line with the debtor’s business.

           In addition to maintenance, a debtor must list the Office of the U.S. Trustee listed as an additional certificate holder and provide proof of such.  The documentation of proof must include the type and extent of coverage, effective dates, and insurance carrier information.  In order to fulfill the Trustee’s requirements, the debtor will usually have to provide proof of the request.   The proof of insurance and additional certificate holder requirement is standard, so the insurance company should not have any trouble fulfilling a debtor’s request.

          Please TAKE NOTE that a debtor’s failure to comply could result in DISMISSAL of the case or conversion to a Chapter 7.

If the case is a designated as a small business case or as a subchapter V small business case, there are additional  requirements.

This post does not constitute legal advice.  Consult an attorney about your specific case.

The Basics of Franchising: Will You Start the Next “Subway”?

Written By: Daniel Hart

Edited By: Salene Kraemer

                   From time to time, we have clients buy into a franchise or occasionally want to franchise his or her own business concept.

                 Franchising is a business model that combines aspects of working for yourself and working for someone else.  It is an efficient system for an individual who wants to own/run a business but lacks the experience to do so.  Within the United States, there are about 3,000 established franchise brands operating in over 200 different lines of business.  A franchise is a legal and commercial relationship between the owner of a trademark, trade name, and business system (franchisor) and an individual or group wishing to use that identification in a business (franchisee).  The most common form of franchising is product/trade name franchising in which a franchisor owns the right to a trade name and/or trademark and licenses the rights to use those.

Buying a franchise offers many advantages that is not available to an individual starting a business from scratch.  Here are a few examples:

•  Proven business system and brand name. Through years of experience and trial and error, franchisors have developed a business system and brand name that are successful.
• Pre-existing business relationships. Many franchises have existing relationships with suppliers, distributers, and advertisers that franchisees can utilize.  Entrepreneurs must develop these relationships on their own.
• Quality market research. Typically, a franchisor will perform substantial market research into competition and the demand for the product or service in a specific location before allowing a franchisee to open a franchise there.

Similar to an entrepreneur opening their own business, a franchisee must spend a substantial amount in order to obtain their own franchise.

• First, there is an initial franchise fee, which is a one-time charge assessed to a franchisee in order to use the business concept and trademarks, attend training program, and learn the entire business.  Franchise fees can have varying ranges depending on the size of the franchise system.  This can range from as low as $2,000 to over $100,000.
• Depending on the specific type of business that you franchise, a variety of additional up-front costs can occur.  These costs include rent/construction cost of building new facility, equipment, signage, initial inventory, working capital, and advertising fees.

After these initial costs and fees, a franchisee generally pays the franchisor royalties running around 5 to 8 percent of gross revenue plus contributing funds to a company-wide advertising program.

Many people may ask “why should I pay tens of thousands or hundreds of thousands of dollars before I start and then a royalty percentage every year after that?”  For some, the answer is clear.  By opening their own franchise of an already successful name-brand business, many can make more money quicker than opening their own business.  Also, there is a greater likelihood that long-term return on their investment will be realized.

As with starting any business, it is vital to perform due diligence before investing in a franchise.  Here are some examples of basic information you need to discover before committing to a franchise:

 

• Research growth potential. Simply, you need to make sure that there is a strong-likelihood that you can increase profits and have a successful business.  Also, is there a market for your business where your location will be?
• Check consumer and franchise regulators. Check these within your state to see if there are any serious problems with that company. Check with the Better Business Bureau for any complaints against the company.
• Search public court records. Is the company involved in any litigation? If so, determine the nature of the lawsuit.  If the nature of the lawsuit involves fraud or regulatory violations, that is a bad sign.
• Request a Franchise Disclosure Statement: By law, this document must be given to all prospective franchisees at least 10 business days before any agreement is signed. A franchise disclosure statement (FDD) contains an extensive description of the company.  It includes information such as amount of fees required, any litigation/bankruptcy history, trademark information, advertising program, equipment you are required to purchase, and the contractual obligations of both franchisor and franchisee.  If a franchise will not give you a FDD, you probably should not do business with that company.
• Contact other franchisees: The FDD should contain a list of existing and terminated franchisees. Use this list to your advantage.  Contact current franchisees in order to gain insight as to whether or not the training was helpful, how well the franchisor responds to your needs, and whether sales/profits met their expectations.  Reach out to a couple terminated franchisees as well.  Ask why their franchise agreement was terminated.  Was it due to lack of business, bad franchisor, or for some other reason?  Also, if the list of terminated franchisees is quite lengthy, that might be a sign that that franchise is not doing well.
• Visit a current franchise location: This can give you a lot of information. You can determine whether or not that franchise has a healthy flow of customers.  You might get an in-person conversation with a current franchisee and see how the operations are run.

By performing due diligence, you will have a clear picture as to whether or not you will buy a successful franchise and whether or not you will be doing business with a helpful franchisor or not.

Finally, work with a lawyer and accountant when undergoing the franchising process.  Lawyers have expertise in performing research and can assist in reviewing and negotiating the franchising contract.  An accountant can review any financial reports concerning the franchise and project profitability for the future.

Avoiding Emergency Bankruptcy Filings

It was the day before Thanksgiving.  A friend of mine called me in a panic.   She received a notification that her bank account was frozen by a creditor; she was to get a direct deposit of her salary in the next 2 days, which was two weeks before Christmas.  She needed to file bankruptcy fast in order to trigger the automatic stay (legal principle that means no creditor can take action to harm you).

I stayed up until midnight that day in order to get the case filed for her.  Her business had gone bad and this was the fallout from it.

Often, bankruptcy cases are filed on an emergency basis. In many instances, time may be of the essence and you need to file the case immediately (e.g. a creditor  has a judgment against you and has sent the Sheriff to your home or business; you have received a notice of garnishment of your wages or bank account by a taxing body).  If this firedrill can be avoided, it should be.

Rushing into a case is pretty much never a good idea.   Filing the petition on an emergency basis only increases the costs of your case and there may not be enough time to research potential issues that may arise during the course of your case.   You may omit important creditors.  You may omit assets.  If the schedules are not accurate,  you will need to amend them and that costs more money to do.  Substantial, repeated amendments do not leave favorable impressions upon the U.S. Trustee or the Ch. 7 Trustee.

A debtor is permitted to file a barebones “emergency “bankruptcy petition together with a list of 20 largest creditors. The full set of schedules must be submitted within 14 days, unless extended.

Regardless of whether the case is an emergency filing or not, if you are an individual, you MUST complete pre-bankruptcy filing credit counseling course at least 24 hours before any case is filed.

BOTTOM LINE:

• Talk to an attorney.  He or she can give you the questionnaire you need to fill out well ahead of time. He or she will also give you a list of documents you will need You can start gathering that info.  If the case is billed hourly, you will save yourself money by gathering up this information rather than having a paralegal do it.
• Pre-bankruptcy planning is always advisable for any individual or business.  You don’t want to throw good money after bad (meaning you don’t want to pay down debt that ultimately may be discharged). You don’t want to make preferential or fraudulent transfers.    Often, there are non-bankruptcy options, particularly for businesses (but that can be a topic for another blog post).

DISCLAIMER:  This does  not constitute legal advice.  This post does not create an attorney client relationship.  Consultant an attorney for more information re: this topic.