Business or Commercial Bankruptcy

Bankruptcy law refers to the laws which govern procedures wherein individuals and businesses can seek relief from financial debt in a civil court of law. The purpose of a bankruptcy proceeding is to allow an individual or business to deal with the debts that they have accumulated but cannot pay off.

In a typical bankruptcy proceeding, the court intervenes in the assets and property of a debtor (someone who owes others money) on behalf of a creditor (the person or business that is owed money). Creditors usually cannot collect debts until the bankruptcy proceedings are completed.

Types of Business Bankruptcy Proceedings

A bankruptcy filed by an individual person is referred to as a "consumer" or "personal" bankruptcy. Bankruptcy may also be filed by a business, since businesses are considered independent legal entities. In the case of a business, the proceedings are called "business" or "commercial" bankruptcy.

Businesses may elect to file bankruptcy in two ways, depending on their business needs. The first type is called Chapter 7 Bankruptcy, also known as "liquidation" bankruptcy. The second type is called Chapter 11 Bankruptcy, also called "business" or "reorganization" bankruptcy. The laws governing personal bankruptcy are different from those governing business bankruptcies. They may also vary from state to state, since each state has different tax laws.   

Filing under Chapter 7 Bankruptcy - "Liquidation" Proceedings

Filing under Chapter 7 or "liquidation" bankruptcy involves the sale of the business' property for the purposes of fulfilling debts. A business will usually choose to file under Chapter 7 if their debt is so great that they must resort to selling their assets or property in order to pay creditors.

Chapter 7 proceedings are initiated once the business submits a petition to the bankruptcy court. This petition is basically a listing or statement of all the property and assets that the business owns. It will also list the business' debts owed to various creditors, as well as the business' financial history. The court will use this petition in determining the distribution of properties and assets for debt payment.

A court will usually appoint a trustee, which is a third party in charge of administering the debtor's estate. Under Chapter 7, the court allows much of the debt to be "discharged", meaning that the debt is forgiven without the business having to pay the creditor for it. Some debts are non-dischargeable, which means that the trustee must divide some of the property in order to pay the debt. Examples of non-dischargeable debts are certain types of taxes, prior bankruptcy debts, and monies owed to the government.

Having debts discharged or forgiven is one of the main benefits of filing under Chapter 7 liquidation bankruptcy. Debt discharge allows some businesses to obtain a fresh start in their business after their debts are declared to be settled. However, usually after a Chapter 7 filing, the business will have to close down or cease operations, because they will likely not have any more funds or assets leftover after the court proceedings. 

Thus, an organization that has filed for bankruptcy under Chapter 7 will usually have to start all over again if they wish to resume their business operations.

Filing under Chapter 11 Bankruptcy- "Reorganization" Proceedings

Alternatively, a business can elect to file bankruptcy under Chapter 11 of the bankruptcy code. This is known as "reorganization" bankruptcy and is different in many respects from Chapter 7. It is usually filed when the business is not entirely swallowed up in debt and can solve some of its financial difficulties by restructuring the business.

Unlike a Chapter 7 filing, Chapter 11 usually requires that the business pay off its debts over a certain prescribed period of time. In other words, under Chapter 11, fewer debts are discharged and instead the business must eventually pay off the debt owed to the creditor.

The main feature of a Chapter 11 filing is that the business is allowed to restructure or reorganize its financial scheme in order to provide for more efficient operations. After filling its petition, the business is usually given 120 days to provide the court with a reorganization plan.

The reorganizing plan should explain how profits will be increased and expenditures will be decreased. For example, the business might choose to cut unnecessary expenditures or operations, such as removing part of a department. This is why Chapter 11 is also called "reorganization" bankruptcy. Usually if a company is "downsizing", they may be involved in a Chapter 11 proceeding.

An advantage of Chapter 11 bankruptcy is that, when the proceedings are over, the business is still usually intact and can continue its operations under the reorganizing plan they have submitted to the court.  However, they will still be obligated to repay the debt that has not been discharged, which may include all or most of its debts. The reorganization plan must also include how the company intends to repay its creditors.   

Advantages and Disadvantages of Chapter 7 vs. Chapter 11

A Chapter 7 filling has the following features and effects:

In comparison, Chapter 11 filling usually means:

The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA)

In 2005, Congress passed the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, also called "BAPCPA". This new law made several changes to both consumer and bankruptcy filing procedures.

In business bankruptcy cases, BAPCPA had its most significant effects in Chapter 11 reorganization proceedings. Small businesses are most affected by the new law, since BAPCPA imposed stricter compliance requirements for small businesses. The new law also changed the deadlines for filings, making them shorter than before.

If you are considering filing for bankruptcy under Chapter 11, consult with a lawyer who can help explain the details of BAPCPA to you.

Points to Consider

As you can see, filling for business bankruptcy does not necessarily mean that the organization is "going out of business". There are many options available to a business that has incurred financial debts and hardships.  If you are going to consult with a lawyer, here are some points to consider: