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Can Nonprofits File Bankruptcy? is rarely discussed in the philanthropic community. Regardless, filing for federal bankruptcy relief is not uncommon and is a way to resolve the status of a nonprofit in serious financial difficulties. As with individuals and for-profit businesses, sometimes this drastic remedy is necessary.
Can Nonprofits File Bankruptcy? The Answer is YES!
Bankruptcy can become an option for a variety of reasons – some avoidable and others the result of outside, unexpected forces like a serious economic recession or sudden dry-up in government funding.
Nonprofits have an aversion to using bankruptcy as a tool. While nonprofit organizations constitute 30 percent of all corporations, they represent only 1 percent of corporate bankruptcy cases. I suspect the gap is indicative of their morality rather than their durability. Nonprofits are so anxious about reputation that they prefer risking liquidation to admitting financial distress.
“Nonprofits can benefit from the bankruptcy process, either by restructuring debts and continuing to operate, or by providing a method to transfer valuable assets to another entity which can continue to make use of them.” There are, however, restrictions that apply in case of a nonprofit entity “transferring its property.
Section 541(f) of the Bankruptcy Code provides that a “nonprofit entity can transfer property only to the same extent it could if no bankruptcy had been filed.”
These issues can include, for instance, “analysis of legal or donor restrictions on the transfer of property owned by a nonprofit.” In certain industries, like healthcare, there are additional statutory obstacles, or there may be non-transferable licenses, or contracts with government or insurance companies.
Nonprofits File Bankruptcy…Here’s An Example
The Tumbleweed Center for Youth Development had been in operation for some 45 years. It had been serving “hundreds of homeless people ages 12-25 each year with resource centers, emergency and transitional housing, life counseling and other programs,” as well as “services for youth refugees and unaccompanied minors from outside the U.S.”
By December 2016, though, the directors made the decision to file for bankruptcy. The group “was having severe cash flow difficulties and what became insurmountable debt.” Earlier in the year, there had several key resignations: the CEO and not one, but two, CFOs. “New interim leadership determined that the organization was ‘grossly overspending.’”
What made the difference in terms – primarily – of the needy client population that about to be deprived of critical services was that a “handful of private foundations donated hundreds of thousands of dollars as the bankruptcy was declared to allow for an orderly transition even while programs continued to function.”
Under the court proceedings, all of the programs will be transferred to other nonprofits over several months as Tumbleweed liquidates assets to pay off its debts.
With this assistance from the charitable community as well as good planning, this important service-provider was “able to close up without the pain and chaos that often surrounds an abrupt shutdown.”
Chapter 7 vs. Chapter 11
Filing for bankruptcy under Chapter 7 protection is often the first legal step businesses take to liquidate a business they can’t save. This type of bankruptcy, available for individuals as well as businesses, helps rid the person or company of debts with no further legal problems. For businesses, this also requires going completely out of business.
A Chapter 11 bankruptcy filing puts debt payments on hold while the company tries to reorganize. The filing business must submit a reorganization plan to a bankruptcy judge assigned to the case. The judge appoints a creditor’s committee, made up of those the business owes money to, to hear their side of things.
Creditors can accept the company’s plan, submit their own plan, make suggestions to the company’s plan or reject it and ask the judge to liquidate the business.
If the judge approves the company’s reorganization plan (with or without modifications), creditors can’t force the company to pay its debts while it reorganizes. In some cases, the plan offers to pay creditors a partial payment of their debt. In other cases, payments might be put on hold until the company is back on its feet.
Courts may allow companies to proceed with Chapter 11 bankruptcy in order to protect jobs that might be lost, avoid problems their closure might create for other businesses or help creditors eventually get their loans repaid.
Operating While in Chapter 11
If your nonprofit operates while under Chapter 11 bankruptcy protection, it will have to provide regular reports to the bankruptcy judge and the creditor’s committee. If you do not meet your obligations under your approved bankruptcy plan, you might have to get your plan modified and approved by court, or be shut down.
You should also be aware of any restrictions put on nonprofits in a Chapter 11 bankruptcy, warns For Purpose Law Group. One example is a nonprofit’s limited right to transfer property during a bankruptcy.
Managing your Public Relations
If word gets out about your nonprofit bankruptcy, donors might no longer give you money, fearing it will go to pay off debts. Not only will your donors be nervous, but your vendors, suppliers and employees might also be less interested in working with and for you.
Once you file for and receive Chapter 11 bankruptcy protection, it’s important that you let key stakeholders know what your nonprofit insolvency means. Make sure you explain what a Chapter 11 bankruptcy is, what your plans are for getting out of your predicament, and share the timeline for when you hope to be out of bankruptcy and back on a firm financial footing.
Sometimes, a bankruptcy decision does not mean that closure is the end result. There are options, under certain circumstances, that include reorganization and eventual continuation of operations.
Can Nonprofits File Bankruptcy? was first posted at INSIDE CHARITY
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