Most owners do not walk into a bankruptcy conversation by choice, and by the time the word comes up, they’re used to bad news. There is no magic spell that can make the bills go away. When a business owes more than it can pay, federal bankruptcy law offers two main paths: Chapter 7 and Chapter 11. The term “liquidation” refers to the shutdown of a company. This means that the company will stop all its operations and sell off all of its assets. That is Chapter 7. Chapter 11 is reorganization. The goal of reorganization is to give the business time to develop a plan to continue operating. Which one fits your company will depend on various factors. Knowing the facts about these two bankruptcy options can help you make a more informed decision.
As the name suggests, Chapter 7 is all about the end of the road for your business. It is meant for companies that have no realistic way back. In a Chapter 7, the trustee takes control of the assets of the bankrupt entity, sells off the assets, and distributes the proceeds to the creditors according to a set order of priority. Once the assets are sold and the creditors paid, the business entity is usually dissolved. Your business is dead, and the process is usually over quickly. Compared with Chapter 11 it is also simpler, which suits an owner who wants to wind things down and move on.
One thing owners often get wrong is assuming that closing the company closes the book on the debt. Depending on how the business is structured and the circumstances behind each debt, the owners could still be on the hook. So liquidation is a big decision and not one you should take lightly. It’s your call, of course, but make sure you understand all the risks involved.
Chapter 11 Reorganization
Many bankrupt business owners are worried that if they declare bankruptcy they are required to shut down their business. That is true of Chapter 7, but not of Chapter 11. A Chapter 11 case can give your business a second chance to survive. If your goal is to stay in business, you need to consider Chapter 11. In a Chapter 11, a business reorganizes its debts and continues operating. The goal of Chapter 11 is for the business to be given the time and opportunity to pay its debts. The Chapter 11 is more of a pause button, allowing the company and the owner to make a plan for staying in business and paying creditors. That breathing room matters most for a company that is operating profitably and has a viable future.
The plan is where the relief comes from. It can propose to reduce the amount you actually pay and spread it out over time. A reorganization can also help modify interest rates and restructure the loan payments. By stretching the repayment dates, it gives the company breathing room. For an owner who has been investing personal money into the struggling business for years, this can be liberating. A reorganization can actually give the business flexibility to keep what it needs and shed the rest. The company can keep its equipment, real estate and intellectual property, or it can voluntarily give back the assets that it doesn’t need. For a company trying to downsize, it helps you keep what you need while reducing your costs.
The difference between the two is that in Chapter 11, you get to control your business, and for the most part, you can plan and direct how it operates. No trustee is appointed at the start of the case. During a Chapter 11 reorganization filing, the owner of the business remains in control of the company, provided it operates within the parameters set by the court and the Office of the U.S. Trustee. The company remains in operation and continues to provide its products and services to its customers.
The catch is that Chapter 11 is more complex and more costly. The plan for a Chapter 11 reorganization takes a little while to work out, since it must be acceptable to both the business and its creditors, and your reorganization plan will need the court’s approval before you can put it into effect. A Chapter 7 case is often finished in several months, while a Chapter 11 case, depending on its complexity, can drag on for years. In addition, the fees tacked on to a Chapter 11 can be much higher, because of the legal work and the effort of developing and proposing the plan.
Preserving the Business or Ending It
Your choice between Chapter 11 and Chapter 7 is a tricky question to answer. The reality is that Chapter 7 bankruptcy or Chapter 11 bankruptcy involves both mathematical and emotional factors. Every owner wants to keep the doors open, but the math has to come first, and the math is profitability. The first thing you must assess is sales, or revenue, versus expenses to determine the bottom line profit margin. Does your company have a positive, or negative, bottom line profit margin? Chapter 11 can help you reorganize those business debts and loans, but doesn’t make a business more profitable. If a company is losing money then it is not profitable, and if it is losing money month over month, Chapter 11 will not be an option. In the end, whether a business survives a Chapter 11 will mostly depend on whether it can remain profitable and can make its payments on loans and creditors. Is your business model workable? If yes, a Chapter 11 is an option. If not, you might not have a choice.
Generally speaking, the two chapters have very different mandates. The goals of Chapter 7 are much simpler and more straightforward. It is for a business in distress beyond recovery. The trustee takes possession of all of the debtor’s non-exempt assets and sells them off, and the trustee, not the owner, controls the distribution. Basically if you go bankrupt and file under Chapter 7, that’s the end of your company. It is quicker and cheaper. By comparison, a Chapter 11 is for those businesses that look towards reorganizing, or restructuring. Instead, the focus is for the debtor to continue operating while restructuring its existing debts. It is an opportunity to actually reorganize your debts and actually continue to run your business and continue to be viable. It takes longer and costs more, but it gives the business a far better chance of surviving.
Both paths are tough, but they bring different kinds of hope. Chapter 7 offers a clean slate through liquidation, and Chapter 11 offers a chance to restructure and perhaps come out stronger. There’s no one-size-fits-all answer. What’s right for your business depends on your unique circumstances. The answer isn’t always clear. You will have to decide between preserving the business or ending it, and that decision should rest on an honest look at the company’s financial health. That is why an owner needs a trusted advisor to help them make an informed decision by balancing opportunity and risk.
