Chapter 11 Bankruptcy and Discharged Debts

Discharged debts (i.e., old debts that a debtor is no longer required by law to pay) offer business owners a chance to start over. Most, but not all, debts incurred prior to declaring bankruptcy are dischargeable, including business debts, back rent, and credit card bills. The discharge operates as a permanent order to the debtor's creditors that prevents them from taking further legal action and communication with the debtor, including telephone calls, letters, and personal contacts.

Ultimately, the availability of discharge depends on the Chapter under which the bankruptcy proceedings are conducted (Chapter 11 in the case of most businesses), and whether the debtor is a person or organization. One rule which applies in all Chapters is that a debtor guilty of misconduct during the course of the bankruptcy proceeding will be denied discharge.

Non-Dischargeable Debts

The most common types of non-dischargeable debts include certain types of tax claims, debts not included by the debtor on the lists and schedules the debtor must file with the court, debts to governmental units for fines and penalties, debts for most government-funded or guaranteed educational loans or benefit overpayments, debts for personal injury caused by the debtor's operation of a motor vehicle while intoxicated, and debts for certain condominium or cooperative housing fees.

Paying Back Discharged Debts

Chapter 11 allows businesses facing financial difficulty to restructure and reorganize their existing debt load in order to continue business operations. Businesses seeking the protection of Chapter 11 usually face a four-month process as their debt is addressed with creditors. Once the Chapter 11 bankruptcy plan is complete, the business emerges from the proceeding and continues operations. Although at this point the discharged debts can no longer be legally forced, the debtor may feel that not paying them will adversely affect any business relationship that they are seeking to continue, and he or she may choose to pay the debts when able to.

A sole proprietor should keep in mind that a bankruptcy filing must include all of the debtor entity's debts, regardless of how or why they were incurred. So it would be difficult for a sole proprietor to treat business debts separately from his or her personal finances. The assets of a sole proprietorship, like business equipment or receivables, are property of the bankruptcy estate unless claimed exempt or abandoned by the trustee.

Debtor in Possession

Upon the filing of a voluntary petition for Chapter 11 relief, you automatically assume the identity of "debtor in possession." The debtor remains a debtor in possession until his or her reorganization plan is confirmed, until the case is dismissed or converted to Chapter 7, or until a Chapter 11 trustee is appointed. Note the appointment or election of a trustee occurs only in a small number of cases. Generally, the debtor in possession operates the business and performs many of the functions that a trustee performs in cases under other chapters.

The Small Business Debtor

According to the Bankruptcy Code, a small business debtor is a person engaged in commercial or business activities that has aggregate that do not exceed $2,000,000. If a debtor qualifies and elects to be considered a small business, the case is put on a "fast track" and treated differently than a regular chapter 11 case. For example, the appointment of a creditors' committee and a separate hearing to approve the disclosure statement are not mandatory.

A small business case proceeds faster than a regular Chapter 11 case because the court may conditionally approve a disclosure statement, subject to final approval after notice and a hearing, and solicitation of votes for acceptance or rejection of the plan. Thereafter, the disclosure statement hearing may be combined with the confirmation hearing.