When economic challenges become insurmountable, businesses often find themselves at a crossroads, considering bankruptcy as a way to manage their debts and potentially restructure (Chapter 11) or liquidate their assets (Chapter 7). Two prominent options available under the United States Bankruptcy Code for businesses are Chapter 7 and Chapter 11 bankruptcy. As a seasoned bankruptcy attorney, I've had the privilege of guiding countless businesses through these turbulent waters. In this comprehensive guide, we will delve into the nuances and distinctions between Chapter 7 and Chapter 11 bankruptcy for businesses so business owners can make an educated decision about where their business is headed.
Chapter 7 Bankruptcy: The Liquidation Option
Chapter 7 bankruptcy, often referred to as "liquidation bankruptcy," is an option primarily geared towards businesses that have reached a point where there is no viable path to recovery. Here are some key aspects of Chapter 7 bankruptcy:
- Liquidation of Assets: One of the primary objectives of Chapter 7 is the liquidation of a business's non-exempt assets to repay its creditors. This means that the business ceases operations, and the appointed trustee sells off the company's assets to distribute the proceeds among creditors according to a predetermined priority.
- Speed and Simplicity: Chapter 7 is generally a faster and more straightforward process compared to Chapter 11. This can be advantageous for businesses that want to quickly wind down operations and move on from their financial troubles.
- End of Business: A significant drawback of Chapter 7 is that it typically spells the end of the business. Once the assets are sold and creditors paid, the business entity is usually dissolved.
- Personal Liability: Business owners may still be personally liable for certain debts, depending on the business structure and the circumstances surrounding the debts. Therefore, it is important for business owners to understand their personal liability when it comes to business debt.
Chapter 11 Bankruptcy: The Reorganization Option
Chapter 11 bankruptcy is often chosen by businesses that believe they can recover from their financial difficulties with a bit of breathing room and a chance to reorganize. It offers a more flexible approach than Chapter 7:
- Continuation of Business: One of the primary advantages of Chapter 11 is that it allows the business to continue operating while it develops a plan for paying back the debt it owes. This "breathing room" can be essential for businesses that are operating profitably and have a viable future.
- Debt Restructuring: Under Chapter 11, businesses can propose a plan to restructure their debts, potentially reducing the amount owed, lowering interest rates, and extending payment terms.
- Asset Retention: Chapter 11 allows the business to retain or voluntarily surrender its assets, including intellectual property, equipment, and real estate, which can be pivotal for companies looking to downsize and shed assets that may be costing the unnecessary expenditures.
- Management Control: There is no appointment of a trustee at the beginning of the case so business owners maintain control over the day-to-day operations of the company as long as the company operates within certain parameters set by the Court and Office of the U.S. Trustee.
- Complex Process: Chapter 11 is a more complex and costly process compared to Chapter 7. It requires a reorganization plan that must be approved by creditors and the court.
Comparing Chapter 7 and Chapter 11 – Which is Better for Your Business?
As a business owner, the toughest decision will be deciding whether the company should be dissolved (Chapter 7) because it is no longer a viable company or deciding to keep the company open (Chapter 11) in an effort to keep a viable company from dissolving.
When choosing whether the best option for your business is a Chapter 7 or Chapter 11 – here are some things to consider:
- Financial Health: Chapter 7 is typically chosen when a business is financially distressed beyond recovery, while Chapter 11 is for businesses that see a path to financial stability with a reorganization plan. Although all business owners want to keep their businesses operating, this will be based on the profitability of the business. If the business is losing money month over month – Chapter 11 will not be an option.
- Business Continuation: Chapter 7 usually results in the cessation of business operations, whereas Chapter 11 allows the business to continue operating so long as the business remains profitable and can demonstrate future profitability.
- Asset Liquidation: Chapter 7 involves the liquidation of assets to pay creditors, whereas Chapter 11 aims to retain assets and restructure debts.
- Time Frame: Chapter 7 is generally quicker, often taking several months, whereas Chapter 11 can take years to complete depending on the complexity of the case.
- Trustee Control: In Chapter 7, the trustee controls the asset distribution, while Chapter 11 allows business owners more control over the process.
- Cost: Chapter 11 is more expensive due to its complexity, legal fees, and the need to develop and propose a reorganization plan.
- Chance of Business Survival: Chapter 11 offers a higher likelihood of business survival, making it preferable for businesses with a strong potential for recovery. However, whether the business will survive in a Chapter 11 will largely depend on the profitability of the business.
The following websites offer valuable resources regarding the differences between Chapter 7 and Chapter 11 for your business:
- Bloomberg Law - https://pro.bloomberglaw.com/brief/chapter-7-vs-chapter-11-bankruptcy/
- of Justice - https://www.justice.gov/ust/bankruptcy-fact-sheets/overview-bankruptcy-chapters
- Forbes - https://www.forbes.com/advisor/debt-relief/types-of-bankruptcies/
- Investopedia - https://www.investopedia.com/ask/answers/differences-between-chapter-7-and-chapter-11/
Conclusion
Choosing between Chapter 7 and Chapter 11 bankruptcy is a critical decision for any struggling business. As a bankruptcy attorney, my role is to carefully evaluate the unique circumstances of each client and guide them toward the most appropriate path. While Chapter 7 offers a clean slate through liquidation, Chapter 11 provides an opportunity for businesses to restructure and potentially emerge stronger. However, the choice ultimately depends on the business's financial health. Understanding these key differences, businesses can make informed decisions to navigate the complexities of bankruptcy and, with the right strategy, find a path to financial stability and success once more.
Accordingly, it is important to seek professional guidance and understand the potential consequences before filing for your business. If you or your business need bankruptcy guidance, and need someone to explain how bankruptcy works and how bankruptcy can affect you or your business, we are well qualified as a full-service law firm for people in this county and other New Jersey counties: Passaic County, Hudson County, Essex County, Bergen County, Morris County, Union County, and Sussex County. Call us today at 973-554-9827 or toll free 973-696-8391.
