What does a company in the USA need to do to be declared in bankruptcy and what are the consequences?

Companies who have major financial problems can file for bankruptcy to recoup some of their losses or find a way to get back on their feet. They can file either Chapter 7 or Chapter 11 bankruptcy, depending on their situation and objective.

How do these bankruptcy proceedings work?

What is Chapter 7 bankruptcy?

Chapter 7 bankruptcy, also known as “liquidation” bankruptcy, is a process designed to help businesses that are overwhelmed with debt.

Its primary goal is to provide a fresh financial start to debtors by discharging most of their unsecured debts. While some assets may be liquidated, many debtors find that they can retain most of their essential property due to exemptions. The debtor is relieved from the obligation to pay the discharged debts.

However, the company may also face significant consequences, including the loss of non-exempt assets. These assets are liquidated, meaning they are sold by a court-appointed trustee. The proceeds from the sale are then used to repay creditors as fully as possible.

To go through Chapter 7 bankruptcy, the company must first file a petition with the bankruptcy court, along with detailed lists of assets and liabilities, current income and expenses, a statement of financial affairs, and other necessary information.

Upon filing, an automatic stay goes into effect, which stops most collection actions against the debtor, including lawsuits and phone calls from creditors. A bankruptcy trustee is then appointed to administer the case and oversee their liquidation.

The trustee identifies and sells non-exempt assets to raise funds to pay creditors. However, many personal assets are exempt under federal or state law, meaning the debtor may keep them.

The proceeds from the sale of assets are distributed to creditors according to the priorities established in the Bankruptcy Code.

What is Chapter 11 bankruptcy?

Chapter 11 bankruptcy is the preferred option for corporations, partnerships, and sole proprietors who believe they have a viable opportunity to get back on their feet financially.

Chapter 11 was designated as the chapter for business reorganization when the Bankruptcy Code was enacted in 1978. The restructuring of a debtor’s assets and liabilities allows a business to continue operating and pay creditors over time while addressing the financial challenges they face.

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Chapter 11: Most expensive form of bankruptcy

Chapter 11 bankruptcy is a legal process that is commonly used by businesses, both large and small, to overcome money difficulties and work towards financial stability. While it offers opportunities for rehabilitation, it is a complex and resource-intensive process that requires careful planning and negotiation.

Because of its complexity and expense, reorganization bankruptcy is usually the last resort of a company after exploring other alternatives. Although Chapter 11 usually involves a corporation or partnership, people in business or individuals can also seek its relief.

A number of companies that were on the brink of failure and filed for bankruptcy have managed to bounce back, including General Motors, Marvel Entertainment, and Texaco.

How does Chapter 11 bankruptcy work?

The process begins when a business voluntarily files for Chapter 11 bankruptcy by submitting a petition to the bankruptcy court. The petition may also be an involuntary one, filed by creditors that meet certain requirements. Once the petition is filed, an automatic stay goes into effect. This stay prohibits creditors from taking any action to collect debts, including lawsuits, repossessions, or foreclosures.

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Crafting a reorganization plan and disclosure statement

The business, with input from creditors, must develop a reorganization plan. This plan outlines how the company will address its financial problems, including how it will restructure its debts, renegotiate contracts, and continue its operations. If the debtor is unable to propose a plan, the creditors may submit one of their own.

Creditors then have the opportunity to vote on the plan. If approved, it is submitted to the bankruptcy court for confirmation. The court reviews the plan to ensure it meets legal requirements and is fair and equitable.

Plan implementation and ‘business as usual’

Once the court confirms the plan, the business begins implementing it. This may involve restructuring debt, selling assets, renegotiating contracts, or other measures outlined in the plan. The debtor, considered a “debtor in possession” continues to run the business.

The company will need the permission of the courts to take certain actions such as selling assets, borrowing new money, signing rental contracts, and ceasing or expanding operations.

Coming out of Chapter 11 bankruptcy

If the debtor is successful in implementing the reorganization plan, the business emerges from Chapter 11 bankruptcy. It continues its operations under the new financial structure outlined in the plan.

The business is often subject to ongoing monitoring and compliance to make sure it sticks to the terms of the reorganization plan. The bankruptcy court may retain jurisdiction over the case during this period.