Navigating Chapter 11 Bankruptcy: A Guide for Small Businesses on Managing Pre-Existing Bank Accounts

Chapter 11 bankruptcy can be a lifeline for small businesses facing financial distress. It allows businesses to reorganize their debts and operations while continuing to operate. One critical aspect of this process is the handling of pre-petition bank accounts.

When filing for Chapter 11 protection, it is a common practice to require the business debtor to open new, “debtor-in-possession” bank accounts with an institution that has signed a Uniform Depository Agreement with the Office of the United States Trustee. Generally, one account is for operating expenses, and a second account is for payroll and related trust fund taxes. For many small businesses that lack a “financial department” switching bank accounts can be burdensome and disruptive as existing payment systems will need to be updated and new checks ordered. Under the right circumstances, small businesses in Chapter 11 may be allowed to maintain their existing bank accounts notwithstanding the local rules, orders and processes in place to force a change in bank accounts upon filing a Chapter 11 bankruptcy case.

Understanding Chapter 11 Bankruptcy

Chapter 11 bankruptcy, often referred to as "reorganization bankruptcy," is designed to help businesses restructure their debts and assets. Unlike Chapter 7, which involves liquidation, Chapter 11 allows businesses to propose a plan to repay creditors over time while maintaining operations. This can be particularly beneficial for small businesses that need time to stabilize their finances and return to profitability. Chapter 11 is particularly powerful because it allows the debtor in possession to value secured claims to bifurcate a creditor’s claim in to secured and unsecured portions, and if a sale is desired, Chapter 11 provides the mechanism to sell a business “free and clear” of any interest in the debtor’s property.

The Role of Pre-Petition Bank Accounts

Pre-petition bank accounts are those that the debtor in possession is using before filing bankruptcy. Here are some key points to consider:

• Automatic Stay: Upon filing for Chapter 11, an automatic stay is imposed, halting all collection activities by creditors. This includes freezing pre-petition bank accounts.

• Cash Collateral: Most often, pre-petition bank accounts are subject to the security interest of one or more of the debtor in possession’s lenders. The business must seek court approval to use these funds. This often involves negotiating with creditors and demonstrating that the use of cash collateral is essential for the business's operations and that the lender’s interests in the funds as of the petition date is “adequately protected,” which is commonly done by providing the lender post-petition liens in the debtor’s property to the same extent of the lender’s pre-petition liens and by providing the lender with a stream of periodic payments while operating in Chapter 11.

• Debtor-in-Possession (DIP) Accounts: To ensure transparency and proper management of funds, businesses are typically required to open new bank accounts known as DIP accounts. These accounts are used for all post-petition transactions, providing a clear separation between pre- and post-petition finances.

• No Payment of Pre-Petition Debts: The bankruptcy petition date operates as a “snapshot” in time. Debts that existed before the petition was filed are pre-petition debts that may only be paid through a Chapter 11 plan, or by court order. Pre-petition debts are subject to being discharged in Chapter 11 and may receive pennies on the dollar. Post-petition debts are not discharged and must be paid in full. For a debtor in possession to maintain pre-existing bank accounts in the post-petition period, the debtor must take action and have a system in place to ensure that pre-petition debts are not paid out of the debtor’s pre-petition bank accounts. Commonly, all critical vendors, employees and professionals should be paid before filing. If that is not possible, then critical vendor motion and a motion to pay pre-petition wages should be filed on the first day of the case and heard on an expedited basis.

• FDIC Insured Banks and Highest Intermediate Balance: To have success in requesting that the business debtor have permission to continue to use the businesses pre-petition bank accounts, the highest intermediate balance over the past several months should be less than the FDIC insurance limits, currently set at $250,000.00. FDIC insured depository institutions are approved by 11 U.S.C. § 345(b) of the Bankruptcy Code, but if the debtor’s deposits exceed these limits, then additional collateral may be required to secure the depositions, such as the collateral may available by those institutions that have signed the Office of the United States Trustee’s Uniform Deposit Agreement.

Conclusion

Navigating Chapter 11 bankruptcy can be challenging for small businesses and understanding the rules surrounding pre-petition bank accounts is important to ensure that the case does not stumble immediately after filing. If you are a small business owner and want to know more about how to unlock the power of a Chapter 11 bankruptcy to rehabilitate your business and return it to profitability, call JLS for a free consultation.