Preparing for Chapter 11: What to Do and What Not to Do

For a business facing financial distress, the weeks or months leading up to a Chapter 11 bankruptcy are often critical. The success or failure of a reorganization is frequently determined not by what happens in court but by steps or missteps made just before filing. Businesses unwittingly can undermine their own cases by delaying action, paying the wrong parties or making last-minute changes that invite litigation once bankruptcy begins. 

For owners and managers, careful planning for Chapter 11 establishes credibility, reduces the risk of litigation and helps maintain stability during the critical early weeks of the case, when cash flow, employee confidence and creditor relationships are at their most vulnerable.

The following actions can strengthen a business’s position for entering Chapter 11:

• Stabilize cash flow — Management should create a short-term cash plan that prioritizes essential expenses and preserves liquidity. Decide which obligations can be deferred and which payments must be made to avoid jeopardizing operations or triggering personal liability.
• Organize financial information — Up-to-date financial statements, tax filings and internal records are essential to the bankruptcy process. Accurate data is critical for bankruptcy schedules, negotiations with creditors and for accessing debtor-in-possession (DIP) financing.
• Review contracts and leases — Businesses must identify burdensome agreements that may be rejected in Chapter 11 and flag important contracts such as customer, vendor and supply agreements, which may require protection to continue operations.
• Strategically communicate with key creditors — This can reduce the risk of pre-filing collection actions that harm the business. Discussions should be documented and should avoid any promises that could complicate the bankruptcy case.
• Align internal leadership — Management must agree on the business objective, whether it is a reorganization, a sale or a structured wind-down. They should also clarify roles to ensure a coordinated approach during the first weeks of the case.

At the same time, companies should avoid the following actions that can harm a case before filing:

• Selective or insider payments — Transferring money or property to officers, relatives or favored creditors while ignoring others creates avoidable preference claims. Taking on new debt or engaging in insider transactions invites scrutiny and may be reversed by the court.
• Moving assets out of the business, especially to insiders or affiliates — This can trigger allegations of fraudulent transfers. Failing to meet tax obligations, particularly payroll and sales taxes, can result in personal liability for managers and complicate the overall restructuring.
• Waiting until cash is nearly exhausted before filing — The later the business waits, the fewer options remain, reducing negotiating leverage and perhaps making reorganization impossible.

The importance of retaining experienced restructuring counsel at the earliest sign of distress cannot be overstated. Early legal guidance protects against preference exposures, fraudulent transfer claims and inadvertent actions that could weaken the automatic stay or jeopardize the reorganization.

The Law Offices of Michael Jay Berger in Beverly Hills is one of Southern California’s most experienced Chapter 11 bankruptcy law firms. If your company needs help with debt reorganization, contact us online or call 310-271-6223 to schedule a consultation.