Bankruptcy is a legal procedure that assists a financially troubled business in dealing with its financial problems. There are two main types of business bankruptcies: Chapter 7, which results in a liquidation of all assets; and Chapter 11, which may result in reorganization or liquidation. Under both of these types of bankruptcies, the business must disclose all of its assets, debts, income, expenses and other financial information. The filing of a bankruptcy proceeding automatically stops creditors from taking any action against the business outside of the Bankruptcy Courts.

In a Chapter 7 liquidation proceeding, a Trustee is appointed by the Court to oversee the sale of the assets and distribution of the proceeds to creditors. At the conclusion of a Chapter 7 bankruptcy proceeding, the debtor is discharged from general, unsecured debts, which are not collateralized by a lien or mortgage. This means that the business no longer legally owes these debts. Secured debts, those which are collateralized by a lien or mortgage, and some taxes, may receive different treatment depending on the circumstances.

Chapter 11 business reorganizations work differently than liquidation proceedings. In a typical business reorganization, the business proposes a plan that provides for the whole or partial repayment of its debts over time. The proposed plan is circulated to all creditors and those creditors whose claims are impaired under the terms of the plan, have the right to vote in favor or against approval of the plan. The Court will review the plan to be sure that it is fair and legal for each class of creditors. The Court will also review the debtor’s income and expenses to see if it can reasonably expect to complete the plan, i.e., if the plan is feasible.

Generally, in business reorganization, the Court does not appoint a Trustee to oversee the business or the implementation of this reorganization plan. Rather, once the Chapter 11 petition is filed, the business becomes a “debtor-in-possession” and has a fiduciary duty to maximize the value of the estate for the benefit of all creditors. This means that the business owner usually remains in control of the business during the reorganization process. However, monthly operating reports must be filed to keep the Court and creditors informed of how the business is doing. The business owner is also obligated to operate the business in a manner that will provide the most value to creditors, to operate the business in accordance with the provisions of the Bankruptcy Code, and to file and abide by a reorganization plan. Unlike a liquidation, a successful confirmed Chapter 11 plan may allow the owners to retain their equity interest in the company and continue to operate the business.

Business bankruptcy is a complicated process. If your business is in financial difficulty, discuss your legal rights and responsibilities with an attorney.

Information is current as of 5/2023.