Summary. Insolvency touches most businesses from one of three positions: as a debtor deciding whether and how to file, as a creditor deciding what to do about someone else's filing, or as a counterparty whose contract, collateral, or receivable is suddenly governed by different rules. This toolkit organizes all three — the out-of-court alternatives frequently better than a case, the chapters and the choice among them, the first-day mechanics that determine whether a business survives its own filing, the creditor's sixty-day window, avoidance exposure and its defenses, and the guarantor and successor questions that survive everything else.

What this toolkit is for, and who should use it

Distress arrives before anyone calls it that. A customer stretches payables, a borrower misses a covenant, a supplier asks for cash in advance. The decisions made in that period — whether to keep shipping, whether to take a security interest, whether to demand payment, whether to file — determine outcomes far more than anything that happens in court.

This toolkit is for a business owner facing insolvency, for a credit or finance executive managing exposure to a failing counterparty, and for the counsel advising either. It assumes a middle-market or small business rather than a large restructuring.

Roadmap at a glance

  1. Diagnosing distress and the duties that shift.
  2. Out-of-court alternatives — workouts, ABCs, receiverships, Article 9.
  3. Choosing a chapter.
  4. Filing a business case — the first-day work.
  5. Operating in Chapter 11 and confirming a plan.
  6. Subchapter V, and why it changed the calculus.
  7. Chapter 7 liquidation for a business.
  8. The creditor's first sixty days.
  9. Secured creditor practice — stay relief, adequate protection, and valuation.
  10. Avoidance actions — exposure and defenses.
  11. Guarantors, insiders, and successors.
  12. After the case.

Stage 1 — Diagnosing distress

  • Financial indicators: negative operating cash flow, covenant breaches, stretched payables, borrowing base deficiencies, and lender forbearance.
  • Legal consequences of insolvency: directors of an insolvent corporation owe duties to the corporate enterprise, and creditors may bring derivative claims. There is no direct creditor claim for breach of fiduciary duty in Delaware, and no "deepening insolvency" tort.
  • Stop the conduct that creates personal exposure: unpaid trust fund taxes, which carry personal liability for responsible persons; distributions and insider repayments; and transfers to family.
  • Preserve records and stop any routine destruction.
  • Assemble the picture: a thirteen-week cash flow, a liability schedule classified by priority and by contingency, a collateral and perfection review, and a list of every personal guaranty.

Resources

Stage 2 — Out-of-court alternatives

Frequently better, faster, and cheaper than a case.

  • Workout and forbearance with the senior lender, with a budget, milestones, and releases.
  • Assignment for the benefit of creditors — a state-law liquidation in which an assignee sells the business, often as a going concern, within weeks. Private, cheap, no automatic stay, and generally no avoidance powers.
  • Article 9 foreclosure sale, sometimes to a pre-arranged buyer, requiring commercial reasonableness and proper notice under UCC § 9-610.
  • Receivership, state or federal, where a neutral is needed.
  • Simple dissolution where creditors are few, following the state's claims procedure to cut off director exposure.
  • Composition or standstill with trade creditors.

Illustration. A distributor with $4 million of debt, one secured lender, and forty trade creditors completes an assignment for the benefit of creditors in six weeks, with the business sold as a going concern. A Chapter 7 would have taken a year and produced less.

Resources

Stage 3 — Choosing a chapter

  • Chapter 7 — liquidation by a trustee. No discharge for a corporate debtor; the benefits accrue to creditors and to the avoidance estate.
  • Chapter 11 — reorganization or a going-concern sale, with the debtor in possession. Expensive for a small company under the traditional framework.
  • Subchapter V of Chapter 11 — the small business track. No disclosure statement, no creditors' committee, no quarterly fees, no absolute priority rule, and administrative expenses payable through the plan.
  • Chapter 13 for an individual with regular income within the debt limits.
  • Section 363 sale in Chapter 11 where the value is in a fast sale rather than a plan.

Resources

Stage 4 — Filing a business case

  • Negotiate cash collateral in advance. Without it the business stops in week two.
  • Build a thirteen-week budget the debtor can defend, and a three-to-five-year projection that will become the plan's feasibility showing.
  • First-day motions in order of urgency: cash collateral or DIP financing; employee wages and benefits; utilities under § 366; cash management; insurance; critical vendors where genuinely necessary; taxes; joint administration; and professional retention.
  • Schedules and the statement of financial affairs completed carefully. Disclose the transfers that look bad.
  • Operating obligations from day one: DIP accounts, no prepetition payments without an order, no transactions outside the ordinary course without notice and a hearing, current post-petition taxes, maintained insurance, and monthly operating reports filed on time.

Resources

Stage 5 — Operating and confirming

  • Executory contracts and leases — assume, assume and assign, or reject under § 365, with cure and adequate assurance on assumption and a shortened deadline for nonresidential real property leases.
  • Section 363 sales free and clear, with liens attaching to proceeds and an auction procedure.
  • Exclusivity, the disclosure statement, solicitation, and confirmation.
  • Cramdown under § 1129(b) where a class rejects, requiring fair and equitable treatment and — outside Subchapter V — satisfaction of the absolute priority rule.
  • Third-party releases. Nonconsensual releases of claims against nondebtors are not authorized; consensual releases, properly solicited with genuine opt-in, remain available.

Resources

Stage 6 — Subchapter V

  • Eligibility turns on the debt limit and on more than half of the debt arising from business activities. Confirm the current limit, which has changed twice.
  • A Subchapter V trustee is appointed to facilitate a consensual plan; the debtor remains in possession.
  • Status conference within 60 days, with a report on efforts toward consent due 14 days before.
  • Only the debtor may file a plan, within 90 days.
  • Consensual confirmation produces a discharge at confirmation; nonconsensual confirmation requires committing projected disposable income for three to five years and delays the discharge until payments are complete.
  • Work hard for consent — non-voting creditors are not counted, so consensual confirmation is more achievable than debtors expect, and it avoids the unresolved question whether § 523 exceptions reach corporate debtors.

Resources

Stage 7 — Chapter 7 for a business

  • No discharge, no continued operation beyond a brief authorized wind-down.
  • The trustee collects, liquidates, and distributes by the § 726 waterfall, and pursues avoidance actions.
  • Right where there are assets to administer, avoidance value, or a need for a neutral. Wrong where there is nothing unencumbered — dissolution accomplishes as much for less.

Resources

Stage 8 — The creditor's first sixty days

  • Stop collection immediately. Stay violations produce damages and fees.
  • Docket the § 341 meeting, the claims bar date, the § 503(b)(9) deadline, and — in an individual case — the sixty-day dischargeability deadline, which is fatal if missed.
  • Determine status and, if secured, confirm perfection as of the petition date.
  • Identify goods delivered in the twenty days before filing for an § 503(b)(9) administrative claim, and evaluate reclamation, which has a very short window.
  • Locate your property — consigned goods, tooling, bailed equipment.
  • Compute preference exposure and preserve the records supporting the ordinary course and new value defenses.
  • Pursue guarantors, who are not protected by the debtor's stay.
  • Attend the § 341 meeting and consider a Rule 2004 examination.
  • File the proof of claim, weighing the jury trial waiver where preference exposure is significant.
  • Vote the ballot. A class in which nobody votes cannot reject.

Resources

Stage 9 — Secured creditor practice

  • Adequate protection — periodic payments, replacement liens, or an equity cushion — demanded for any collateral the debtor uses.
  • Object to cash collateral use where protection is inadequate; negotiate a stipulation with a budget and reporting covenants.
  • Stay relief under § 362(d) for cause or where there is no equity and the property is not necessary to an effective reorganization; note the thirty-day automatic termination absent a court order after a preliminary hearing.
  • Valuation under § 506(a) bifurcates an undersecured claim; an oversecured creditor may claim post-petition interest and fees under § 506(b).
  • The § 1111(b) election where collateral is undervalued and the deficiency claim is worth less than full treatment of the secured claim.
  • Monitor § 363 sales of collateral and confirm liens attach to proceeds.

Resources

Stage 10 — Avoidance actions

  • Preferences under § 547: a transfer to a creditor on account of antecedent debt, while insolvent, within ninety days (one year for insiders), enabling the creditor to receive more than in a Chapter 7. No intent is required by anyone.
  • Defenses, in the order to assert them: subsequent new value; ordinary course of business (subjective or objective, disjunctively); contemporaneous exchange; purchase-money security interest perfected within thirty days; the floating lien improvement test; and the small-transfer and venue thresholds.
  • The 2019 due diligence requirement obliges the trustee to account for known defenses — so respond to the demand letter in writing, with the payment history, the days-to-pay baseline, and the new value schedule.
  • Fraudulent transfers under § 548 and, through § 544(b), under state voidable transaction law with a longer reach-back.
  • Section 502(d) disallows the creditor's entire claim until an avoidable transfer is returned; § 502(h) gives an allowed claim for what is returned.
  • The strong-arm power avoids unperfected liens as of the petition date.

Resources

Stage 11 — Guarantors, insiders, and successors

  • Guaranties survive the borrower's bankruptcy; the automatic stay does not extend to guarantors, and the corporate debtor's lack of a discharge means nothing to share.
  • Insider transfers — repayment of owner loans, compensation above reasonable value, distributions while insolvent — are the easiest recoveries a trustee obtains, and they can support a denial of discharge for an individual.
  • Trust fund taxes carry personal liability for responsible persons and are not dischargeable.
  • Successor liability on an asset purchase from a distressed seller arises under de facto merger, mere continuation, and fraudulent-transfer theories, with expanded doctrines in product liability and environmental contexts. A § 363 sale order is the cleanest protection available to a buyer.
  • Post-petition financing and DIP roll-ups implicate the same fairness questions and require notice and an opportunity to object.

Resources

Stage 12 — After the case

  • For a reorganized debtor: make the plan payments, understand what constitutes default and whether notice and cure apply, and modify only as § 1193 permits.
  • For a creditor: track distributions, confirm the discharge's scope, and pursue any nondischargeable claim or nondebtor obligor.
  • For everyone: revise the credit policy. Perfect security interests immediately, do not change payment terms during a customer's decline, keep shipping where it is safe, obtain guaranties from solvent affiliates, and consider credit insurance for concentrated exposure.
  • For a judgment that survives: docket it where the debtor holds property, renew it before it expires, and monitor for assets.

Resources

Cross-border and special contexts

Foreign proceedings. Where a debtor has operations or creditors abroad, Chapter 15 provides for recognition of a foreign proceeding, relief in aid of it, and cooperation between courts. Recognition of a foreign main proceeding brings the automatic stay; recognition of a nonmain proceeding brings discretionary relief. A U.S. creditor of a foreign debtor should watch for a recognition petition, because it changes where and how the claim must be asserted.

Regulated debtors. Banks and insurance companies are ineligible for bankruptcy and are resolved through federal or state receivership regimes with their own priority schemes. Healthcare businesses face a patient care ombudsman and specific rules on the disposal of patient records. Businesses holding licenses — liquor, cannabis, gaming, transportation — face regulators whose consent is required for any transfer, and whose timeline is independent of the court's.

Landlords and lessors. A nonresidential real property lease must be assumed or rejected within a statutory period, and the landlord's claim for rejection damages is capped by 11 U.S.C. § 502(b)(6). Equipment lessors should determine early whether the transaction is a true lease or a disguised security interest, because the treatment differs completely.

Employees. Wage and benefit claims within the statutory look-back receive priority up to a per-employee cap, and post-petition wages are administrative expenses. A reduction in force during a case still triggers WARN Act obligations, with the resulting claims entitled to priority in part.

Insurance. Policies are property of the estate; the proceeds may or may not be, depending on who is entitled to them. A D&O policy's Side A coverage is frequently the only source of recovery for a claim against directors of an insolvent company, and the insured-versus-insured exclusion's carve-out for a trustee's claims is the provision that determines whether that source exists.

Master resource index

Articles

Guides

Checklists

Related toolkits

External and primary sources

  • Bankruptcy Code: 11 U.S.C. § 362 (automatic stay); § 363 (use, sale, and cash collateral); § 365 (executory contracts); § 502 and § 503 (claims and administrative expenses); § 506; § 507 (priorities); § 523 and § 727
  • Avoidance: § 544; § 546; § 547; § 548; § 550; § 553
  • Subchapter V: §§ 1181–1195
  • Uniform Voidable Transactions Act as adopted; UCC § 9-610 and § 9-626

This toolkit is educational and not legal advice. Local rules, United States Trustee guidelines, debt limits, and state law alternatives vary substantially, and several deadlines discussed here cannot be extended. Consult qualified bankruptcy counsel before filing or on receipt of a bankruptcy notice.