BWSmallBiz -- Bankruptcy February 13, 2009, 5:00PM EST

Bankruptcy 101

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We fell short," says Thomas Franke, the company's executive vice-president, whose great-grandfather started the business in 1925. Riemeier closed its doors at the end of 2008.

As you're lining up financing, you should also be preparing to file a petition in your local bankruptcy court, describing your reorganization plan. Once you file, the proceedings become a matter of public record. "You are in a glass house at this point," says Joshua Klein, bankruptcy attorney at Fox Rothschild in Philadelphia. "Anyone can take a look at the company." You'll also be required to file monthly operating reports, including your balance sheet and bank statements.

The reorganization plan needs to include a myriad of details, starting with an itemization of your business assets and liabilities. You must provide information about business equipment you own, any commercial property you own or lease, and bank balances. You'll need to break out employees' wages plus the cost of any retirement and health insurance plans. And of course you'll have to spell out all your secured and unsecured creditors, and how much each is owed.

After Immunicon filed for Chapter 11, management had to work triple-time to deal with the court proceedings and still keep the business running. "It puts an incredible amount of workload on accounting staff," Hewett says. His company's 10-person accounting group worked nonstop to document all cash, assets, liabilities, and customers who had ever bought from the company. Bankruptcy experts warn that more complicated Chapter 11 cases require a separate "shadow" management team just to deal with the filing.

Once you're in Chapter 11, secured lenders are first in line to get paid, followed by taxing authorities such as state and local governments. Next come unsecured creditors, bondholders, and people with legal claims against the company. Shareholders are dead last. But even secured lenders have reason to negotiate. "Their other option is having to foreclose on all collateral, and that could take years in state courts and would cost a lot of money," says Klein. Unsecured creditors often take as little as 5 cents to 10 cents on the dollar. Some creditors may accept equity in the reorganized company in exchange for forgiveness of old debts.

INCENTIVES FOR CREDITORS

In addition to the judge overseeing your case, your reorganization plan will have to be approved by creditors, who get to vote on it. In most cases, if you have assets of more than $5 million, the unsecured creditors can form a committee to look out for their interests—and review everything you do while in Chapter 11.

While in bankruptcy, you must pay all of your current expenses. Otherwise you'll be thrown into Chapter 7, which is liquidation. New loans, lines of credit, and bills take priority over the old ones, which gives vendors and financiers an incentive to keep doing business with you. That was the case for one New York City restaurateur who emerged from Chapter 11 in April 2008 (and who didn't want to be identified because he feared associating his bistro with the filing). He opened for business in winter 2006, but about five months later, major construction began outside the restaurant. That prevented outdoor seating and made indoor dining a nightmare of noise and dirt. "Who wants to sit inside a restaurant with holes and construction?" the owner says. "You see that and you keep walking." Annual revenues in that first year had been on track to reach about $100,000 but plummeted 40%. The restaurateur fell behind on his rent. He owed his purveyors $50,000, but they kept doing business with him under Chapter 11. "They did not want me to go under," the restaurant owner says. "They decided they would rather get paid later as opposed to never." They sometimes agreed to be paid every six to seven weeks instead of every two weeks, so shipments of fish, wine, and vegetables continued to flow in while the owner reorganized the business.

Chapter 11 also gave the entrepreneur leverage with his landlord, who gave him extra time to catch up on about $24,000 in back rent. Con Edison, his electric utility, had been threatening to cut off power, but agreed to allow the $6,000 in overdue bills to be paid over the course of a year. Now the 11-person company has worked its way back to solvency, posting $700,000 in sales last year.

ACT SWIFTLY

One more thing to consider: "Time is the enemy," says Howard Brod Brownstein, principal at turnaround management firm Nachman Hays Brownstein in Narberth, Pa. If you don't emerge within 12 months you risk alienating customers, employees, creditors, and financiers. Hewett says Immunicon's bankruptcy, which lasted just five months, was still a blow to the company and employee morale. "But the employees stuck with us and pulled for us," he says. "We needed people to stay so we would have a business to sell." Ultimately the company reorganized, and its onetime legal foe, Veridex, bought it for $33 million, wiping out all its debts and obligations. All but 10 of Immunicon's 56 employees stayed on.

Hewett, who resigned from Immunicon in November 2008 and is now executive chairman at another biotech, describes the bankruptcy as "painful" and "not a process I was looking forward to or ever want to go through again." He adds: "For me, there were no benefits as CEO." But the company did benefit in other ways. "It allowed for an orderly transition, and I did my duty to the best of my ability." Given the alternative, that's not half bad.

Return to the BW SmallBiz Feb/March 2009 Table of Contents

Quittner is a staff writer for BusinessWeek in New York.

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