By: Maureen Weidman
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Business owners are faced with a multitude of decisions that need to be made every day. Many of these decisions are to be expected. Some of them aren’t. Sometimes, the weight of business debt can make business owners feel like they are staring down an endless dark tunnel. Unfortunately, business owners around the world are often faced with one of the hardest decisions of all: deciding whether to file bankruptcy.
This Post is aimed at teaching readers about bankruptcy and outlining the major differences between the 2 types of bankruptcy available for businesses: Chapter 7 and Chapter 11. With any luck, business owners will feel more comfortable about their options after reading this Post, and will feel less like they are lost in that dark tunnel of uncertainty.
What Is Chapter 7 Bankruptcy?
Chapter 7 bankruptcy is a form of liquidation bankruptcy that is available to both individuals and businesses under the Bankruptcy Code. In liquidation bankruptcy, the debtor must put all assets into an estate. The estate is then managed by a trustee who sells the assets and distributes the proceeds to the creditors.
Most people are familiar with Chapter 7 bankruptcy in the individual context, where an individual debtor puts assets into the estate (leaving out certain exempt items like a homestead) and the rest is liquidated and distributed to creditors. Afterwards, the debtor receives a discharge and begins a “fresh start” free from debt.
Chapter 7 does not have the same end result for businesses. For businesses, there is no “fresh start” after Chapter 7 bankruptcy because businesses cannot receive a discharge from Chapter 7. Like in the individual context, the debtor puts all of the business assets into an estate and a trustee manages the estate by selling the assets and distributing the proceeds to the creditors. Meanwhile, the business owner has a passive role in a Chapter 7 bankruptcy.
Because Chapter 7 is the point of no return for business owners, many choose to avoid it for as long as possible. However, there is no shame in deciding that Chapter 7 is the best decision for your business. Many hopeful business owners begin in Chapter 11 and end up in Chapter 7 after multiple unsuccessful attempts to restart their businesses. If you have doubts that you will be able to reorganize, you may save yourself future time and anguish by filing Chapter 7. Click here for information about Chapter 7 for businesses.
How Is Chapter 11 Bankruptcy Different?
Chapter 11 bankruptcy and Chapter 7 bankruptcy have similarities, but their outcomes for businesses are like night and day. Chapter 11 bankruptcy is not liquidation, but reorganization.
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Reorganization in the Chapter 11 context is just what it sounds like: the business gets a new lease at life under the shelter of Chapter 11 bankruptcy. One of the first protections that any debtor receives in bankruptcy is the protection of the automatic stay. Pursuant to the automatic stay, all collection proceedings must stop. This means that everything from harassing phone calls to foreclosure proceedings will come to an abrupt end.
Although the automatic stay applies in Chapter 7 as well, it is less meaningful there, since the business is effectively dying when it files for Chapter 7. In Chapter 11, the automatic stay provides some solace to business owners as they formulate plans to reorganize.
The comfort from the automatic stay is somewhat short-lived because Chapter 11 involves a great deal of work. Like in Chapter 7 bankruptcy, the business assets are transferred to an estate. Unlike in Chapter 7, in Chapter 11, the business itself is the trustee. In the Bankruptcy Code, the business is referred to as the “debtor in possession.” The debtor in possession has all the rights and powers of a trustee. This is helpful for business owners who care a great deal about their business and wish to maintain control over it.
There are several hurdles that business owners should be aware of before filing Chapter 11. One of the first challenges that business owners will have to face in Chapter 11 is creating a plan of repayment and getting that plan confirmed. In Chapter 11, the unsecured creditors must approve of the plan before it is confirmed. Also, in order for any business to succeed, it must have financing. Obtaining financing can be tricky even for stable businesses, let alone businesses that are already experiencing financial difficulties. This is why the Bankruptcy Code creates incentives to help Chapter 11 businesses get the financing they need to regroup. Click here to learn more about chapter 11 and financing.
How Do I Choose?
Choosing whether to file Chapter 7 or Chapter 11 bankruptcy may be one of the most difficult decisions a business owner can make. We have discussed some of the differences between the 2, but there are a few other considerations.
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Chapter 7 bankruptcy is much shorter. On average, a debtor stays in Chapter 7 for about 6 months. To the contrary, Chapter 11 can take years to accomplish. Even then, the success rate of Chapter 11 is rather dismal, some scholars have estimated as little as 10%. Many businesses attempt to reorganize under Chapter 11, and when they fail, are forced into Chapter 7.
Statistics like these beg the question why any business owner would ever file Chapter 11. However, there are success stories. For major airlines, filing Chapter 11 bankruptcy may even be considered a right of passage. Ultimately, business owners must consider the consequences of both Chapter 7 and 11 and decide whether they are willing to put in the effort necessary to succeed in Chapter 11. As always, if you are considering filing bankruptcy, be sure to consult an attorney to see what options are best for you and your business.
Sources
1. See http://www.creditslips.org/creditslips/2015/04/why-has-chapter-11-failed-as-a-reorganizing-chapter-.html.
2. See 11 U.S.C. § 701, et seq.
3. See 11 U.S.C. § 1101, et seq.
4. See Michele M. Arnopol, Why Have Chapter 11 Bankruptcies Failed So Miserably: A Reappraisal of Congressional Attempts to Protect a Corporatin’s Net Operating Losses after Banktruptcy, 68 NOTRE DAME L. REV. 133, 134 n. 6 (2014).
Maureen,
This is a very interesting post. It was very well structured and easy to read. As a business owner, I would definitely want to know this information. I like the fact that you mentioned the low success rate there are for Chapter 11 bankruptcy because I feel that most business owners care about their business so much that they will do whatever they can to save it. When an owner sees that Chapter 11 gives them a chance to save it I am sure they would jump at that opportunity. The low success rate, however, will warn some of them and have them file Chapter 7 bankruptcy. This was overall a very informative post.
Hey Maureen!
This is a great topic because I think a lot of people are not even aware that there are two different types of bankruptcy! I think you do a great job of making that distinction and also separating the facts. The calculations as to success rates are also very helpful to the business owner who is trying to make an informed decision as to which chapter to file under. All in all I think is very helpful and portable guide to a fairly complicated topic.
Great work!
Maureen,
Great post. I love they way you organized the content — making a somewhat complicated subject far easier to understand. Furthermore, it almost seemed as if you were actually guiding me through the process of deciding which type of bankruptcy to file. I’m guessing this was your intention. I have yet to take a Bankruptcy course, so I have very little knowledge of what the actual process entails. However, this was a great overview! Fantastic job.
– Cameron