In general, businesses facing financial problems have the same options in bankruptcy as individuals: the discharge of debt in exchange for the sale of assets pursuant to Chapter 7; and the negotiation of new payment arrangements under Chapter 11.
Chapter 7 Business Bankruptcy Filings
A Chapter 7 filing by a business allows the company to essentially liquidate its assets. Unlike personal Chapter 7 filings, businesses may not claim exemptions on property to be sold. Furthermore, it does not technically discharge the debt. If the company was set up as a sole proprietorship or partnership, you may still be legally responsible if the sale does not pay creditors off in full. However, if the company was set up as a limited liability company or a corporation, the liquidation of assets has the effect of discharging the debt, as members or shareholders are shielded from personal liability.
Chapter 11 Bankruptcy Petitions
A Chapter 11 is the business version of a Chapter 13 debtor reorganization. Most business bankruptcy filings take the form of a Chapter 11.
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Once you file a Chapter 11 petition, the creditors of your company must cease all efforts outside of the bankruptcy process to collect any debt from you. Typically, as the debtor, you must then propose a plan of reorganization, wherein you outline how you will repay your creditors over a period of time. The plan of reorganization is designed to allow you to stay in business while you turn things around. The bankruptcy court will oversee the reorganization, and has the discretion to grant partial or complete relief from most debts and contracts.
In the Chapter 11 process, the debtor initially has the exclusive right to propose a plan of reorganization. Customarily, though, if a certain period of time passes and a plan has not been approved, creditors may propose repayment arrangements. Ultimately, the court must approve the plan, based on specific criteria, and the creditors must approve the plan.
If the court does not confirm the reorganization plan, the following may occur:
- The court may convert the case to a liquidation under Chapter 7, and the creditors are paid from the liquidation proceeds in accordance with statutory priorities.
- If it is in the best interests of the creditors and the business, the case may be dismissed, resulting in a return to the status quo prior to filing for bankruptcy.
- If the company reverts to the status quo, creditors resort to non-bankruptcy law to satisfy their debt claims.
When a company’s debts exceed its assets, at the completion of bankruptcy, the creditors may end up with ownership of the newly reorganized company in hopes that eventual financial success will compensate for their losses. The rights and interests of the company’s owners are terminated, leaving them with nothing.
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