Chapter 7 vs. Chapter 11: Small Business Bankruptcy

Chapter 7 vs. Chapter 11: Small Business Bankruptcy

If the debt burden you are is facing is insurmountable, you may be considering bankruptcy for your small business.  This may be the right course of action, especially if your personal assets are at risk. Which type of bankruptcy, Chapter 7 vs. Chapter 11, is right?

Chapter 11 Bankruptcy

Chapter 11 bankruptcy, sometimes referred to as rehabilitation bankruptcy, allows companies to reorganize their debt and hopefully re-emerge as viable, profitable organizations. Doing so means creditors are contacted to see if terms of loans can be re-negotiated and paid off with future earnings. A trustee is appointed to oversee the rehabilitation process and track all assets. If a company can’t efficiently continue operations after filing for Chapter 11 bankruptcy, its next step is Chapter 7 bankruptcy. This requires the sales of assets to pay off creditors, and means the company ceases operations.

Chapter 7 Bankruptcy

Firms that are past the stage of reorganization can file for chapter 7 bankruptcy, which is the most common form of bankruptcy. Often referred to as liquidation bankruptcy, Chapter 7 bankruptcy means that the organization sells its assets to pay off debtors.  It ceases operations, and a trustee is appointed. It is the responsibility of the trustee to administer absolute priority, which ensures creditors are paid first, followed by shareholders. Secured debt, such as loans issued by banks or financial institutions, takes the highest priority.

Time Considerations

Chapter 7 bankruptcy filings are relatively short. From the time of the filing until discharge—the order that wipes out the debt—a Chapter 7 bankruptcy usually takes anywhere from three (3) to six (6) months. Chapter 11 filings take much longer due to their complexity. Because the organization is continuing its operations, monthly reports regarding income and expenses must be filed with the court. It’s not uncommon for repayment plans under a Chapter 11 bankruptcy to take over five (5) years.

Do I Have Other Options?

For organizations wishing to avoid a commercial bankruptcy filing and the stigma attached, there are two options to consider:

  • Out-of-Court Workouts Organizations can sometimes re-negotiate their creditor debt without court proceedings. Creditors might agree to this if they feel a company’s bankruptcy filing could prevent them from recovering the entire amount of the debt owed them. However, getting all debtors to agree to this is difficult. If any don’t agree to an out-of-court agreement, it could jeopardize a company’s attempt to avoid a bankruptcy filing.
  • An Assignment for Benefit of Creditors Used to save time and money, an assignment for benefit of creditors is a liquidation, but under state, not federal, law. The company selects an assignee, which liquidates assets and distributes the proceeds to all creditors who have filed claims against the company. It’s not considered an actual bankruptcy, which can sidestep the stigma that often accompanies a bankruptcy filing.

There are many issues to consider when contemplating bankruptcy for your small business. There are court and filing fees, and it’s important to note that the trustee is paid, as well. In fact, they’re paid on a commission basis. The more they have to liquidate, the more they’re paid.

You should always consult an attorney if you’re considering Chapter 7 or Chapter 11 bankruptcy for your small business. The attorneys at Bennett Weston LaJone & Turner, P.C. will work with you to determine your best options.

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