When a business prepares to file for bankruptcy, it needs to decide which specific chapter of the law to file under — Chapter 7, Chapter 11, or even in some cases Chapter 12 or 13. Businesses considering bankruptcy should carefully explore their options with the help of an experience bankruptcy lawyer.
Here are the four types of bankruptcies available to a business in serious financial trouble:
The purpose of Chapter 7 bankruptcy is to immediately liquidate the business debtor’s assets. When a debtor files for Chapter 7, a trustee is appointed to take charge of the business. At that time, the trustee begins the process of liquidating all assets. Once the trustee has recovered and liquidated all assets, then the creditors are able to file claims with the court requesting payment. The assets are then divided among the creditors, allowing also for trustee fees and costs.
Chapter 7 is for businesses that see no viable financial future in their business and are too far in debt to find a way out. At that point, there is no need for a restructuring plan, but just a way to get out of the business with minimal personal damage.
Chapter 11 bankruptcies are designed to allow a struggling business time to restructure or reorganize in order to revive the business. When a business files for Chapter 11 bankruptcy, it is typically allowed to continue operating — under the supervision of the bankruptcy court and without interference from creditors. The debtor will need to negotiate a reorganization plan with creditors, which usually provides them partial payment. Creditors or other parties can file a competing plan if they feel the proposed plan is not in their best interest.
A Chapter 11 filing is best for a business that is behind in debt payments, but which still has some amount of assets and regular income.
While businesses cannot technically file for Chapter 13 bankruptcy, an individual can file for themselves and cover all expenses they may personally owe due to a failed business venture. In some cases, sole proprietorships such as private practices are covered.
In a Chapter 13 filing, the court and creditors must approve a repayment plan that allows creditors to collect debt while protecting the property of the debtor. In order to file, a person must be able to show regular income as a means for meeting some of the debt load over a 3- to 5-year period. At the end of the period, and in the terms agreed upon by the court, additional unpaid debt will be discharged. (Exceptions apply for alimony, child support, school loans, and mortgages.)
Chapter 13 is a viable option only for those individuals who, due to a failed business, are overloaded with debt or have personal assets at risk.
Chapter 12 bankruptcy closely mirrors Chapter 13, except that it applies specifically to family farms. It is designed to allow the family to stay in the business of farming while reorganizing and paying off prior debts. It is preferable for farms over other bankruptcy options because it takes into account the unpredictability and seasonal nature of agriculture.
More from AllBusiness.com: