Chapter 7 vs Chapter 11: Types of Small Business Bankruptcy

Chapter 7 vs Chapter 11: Types of Small Business Bankruptcy

If you own a small business that is struggling with overwhelming debt, declaring bankruptcy may seem like the only option. The two main types of bankruptcy available for small businesses are Chapter 7 and Chapter 11. Both can provide relief but in very different ways. This article will explain the key differences between Chapter 7 and Chapter 11 bankruptcy so you can determine which path is right for your situation.

What is Chapter 7 Bankruptcy?

Chapter 7 bankruptcy is sometimes referred to as “liquidation” bankruptcy. This type of bankruptcy essentially means closing down your business and using the proceeds from selling its assets to pay off as much debt as possible. Here are some key things to know about Chapter 7 bankruptcy:

• All business operations must cease – Once you file for Chapter 7 bankruptcy, your business has to stop operating entirely. You will sell off any assets the business owns and use that money to repay creditors.
• Assets are sold by a trustee – The bankruptcy court appoints a trustee to oversee the liquidation process. They will handle selling your business assets and distributing the proceeds.
• Some assets may be exempt – You may be able to exempt certain assets from liquidation, such as equipment you need for a job or a vehicle up to a certain value. State exemption laws determine what can be protected.
• Remaining debts are discharged – After liquidating assets and paying creditors, most remaining debts are discharged, meaning you are no longer legally obligated to pay them back. There are exceptions like taxes and alimony.
• Creditors cannot pursue you for discharged debts – Discharged debts are wiped clean. Creditors cannot try to collect on them through lawsuits or other means.

Chapter 7 bankruptcy offers the benefit of a fresh start since your business debts are eliminated. However, you must be prepared to shut down all business operations. For some small businesses, Chapter 7 is the most viable option if the company is too far in debt to recover.

What is Chapter 11 Bankruptcy?

Chapter 11 bankruptcy allows a business to reorganize and restructure its debts while continuing to operate. The goal is to emerge with a manageable debt load. Here are some key things to know about Chapter 11 bankruptcy:

• Business can continue operating – Filing Chapter 11 does not require shutting down. You can continue running your business as usual during the bankruptcy.
• Court oversight – The bankruptcy court and an appointed trustee oversee the entire Chapter 11 process.
• Creditors must approve reorganization plan – You will work with your creditors to develop a reorganization plan detailing how debts will be repaid. Creditors must approve the plan.
• Repayment plan timelines – Repayment plans are often spread over 3-5 years. The plan must show the business can cash flow the new debt payments.
• Creditors may take losses – Creditors may agree to take losses by accepting less than the full amount owed to help the business recover.

The goal of Chapter 11 is to rehabilitate the business and restore it to profitability. It can allow you to keep running a business you have worked hard to build while resolving overwhelming debts. However, the process is complex and court-supervised.

Key Differences Between Chapter 7 and Chapter 11

When deciding between Chapter 7 and Chapter 11 bankruptcy for your small business, there are some major differences to keep in mind:

• Liquidation vs. Reorganization – With Chapter 7, you must liquidate while Chapter 11 allows you to reorganize debts and continue operating.
• Court Oversight – Chapter 11 involves heavy court oversight of the reorganization, while Chapter 7 trustees handle liquidation.
• Creditor Approval – Chapter 11 requires creditor approval of repayment plans, while Chapter 7 creditors have no say.
• Time Commitment – Chapter 11 involves a lengthy, complex process often lasting years. Chapter 7 liquidation is typically faster.
• Cost – The court fees, legal fees, and trustee fees make Chapter 11 very expensive compared to Chapter 7.
• Debt Discharge – Chapter 7 discharges many debts entirely, while Chapter 11 discharges debts according to the repayment plan.

As you can see, Chapter 7 liquidation vs. Chapter 11 reorganization offer very different paths. Chapter 7 essentially closes up shop and wipes the slate clean. Chapter 11 requires negotiating with creditors and following court orders to repay debts over time. Which option makes more sense depends entirely on your business situation.

Is Chapter 7 or Chapter 11 Better for Small Businesses?

There is no one-size-fits-all answer to whether Chapter 7 or Chapter 11 bankruptcy is better for small businesses. The choice depends on your specific circumstances and goals. Here are some factors to consider:

• How viable is your business? – If your business model is no longer profitable, Chapter 7 liquidation may be the only realistic option. If it can be turned around, Chapter 11 may work.
• How severe are your debts? – Businesses with massive debts they could never repay even with a 5-year repayment plan may need Chapter 7.
• Are creditors willing to negotiate? – Chapter 11 only works if creditors agree to take losses and negotiate repayment terms.
• Do you have the time and money for Chapter 11? – The complex reorganization process takes years and significant legal fees.
• Do you want to save the business? – Chapter 11 allows you to restructure debts while keeping the business alive.

Be realistic about your situation when deciding between the two bankruptcy options. Meeting with an experienced small business bankruptcy attorney can help you determine if Chapter 7 or Chapter 11 offers the best path forward.

What Happens After Filing for Chapter 7 or Chapter 11?

The bankruptcy process does not end once you file for Chapter 7 or Chapter 11. Here is what happens next:

After Filing Chapter 7

• The court appoints a trustee to oversee liquidating your business assets.
• You must provide the trustee with extensive financial records and paperwork about your business.
• The trustee sells off assets and distributes proceeds to creditors.
• You may have to appear in court to answer trustee questions under oath.
• Remaining discharged debts are wiped away after about 3-6 months.
• You receive a discharge order from the court eliminating the discharged debts.

After Filing Chapter 11

• The court appoints a trustee to monitor your business operations throughout bankruptcy.
• You continue running your business as the trustee oversees finances.
• You must develop a reorganization plan showing how you will repay debts.
• Creditors vote on whether to approve your repayment plan.
• If approved, you make payments over 3-5 years until debts are repaid.
• After completion, you receive a discharge order eliminating remaining debts.

The months or years following your bankruptcy filing will require a lot of court appearances and coordination with trustees and creditors. Hiring an attorney familiar with the process is highly recommended to guide you through the complex legal procedures.

What Debts Can Be Discharged in Chapter 7 and Chapter 11?

One major advantage of both Chapter 7 and Chapter 11 is the ability to discharge certain debts. This means you are no longer legally obligated to repay them. Here are some guidelines on what business debts can potentially be discharged in each type of bankruptcy:

Debts Dischargeable in Chapter 7

• Credit card debt
• Medical bills
• Personal loans
• Past-due utility bills
• Business loans from individuals
• Accounts payable
• Civil judgments
• Breach of contract debts

Debts Dischargeable in Chapter 11

• The same debts as Chapter 7
• Business loans from financial institutions
• Secured debts like mortgages and car loans
• Lease agreements

There are certain debts that cannot be discharged in either type of bankruptcy, including recent taxes, alimony/child support, and student loans. An attorney can advise you on which debts may be eligible for discharge.

What Are the Pros and Cons of Chapter 7 vs. Chapter 11?

Weighing the advantages and drawbacks of each bankruptcy chapter can help decide which route to take:

Pros of Chapter 7

• Faster process with less court oversight
• Less expensive legal fees and court costs
• Stops all collection activities from creditors
• Discharges many unsecured debts entirely
• Allows a fresh start after liquidating business

Cons of Chapter 7

• Requires liquidating all business assets
• Could lose assets exempt from liquidation
• Damages business credit and personal credit rating
• May still owe taxes and other nondischargeable debts

Pros of Chapter 11

• Allows you to reorganize and continue operating business
• Creditors may agree to take partial repayment
• Get time to restructure debts into manageable payments
• Avoid liquidating valuable business assets

Cons of Chapter 11

• Complex, lengthy process with ongoing court oversight
• Very expensive legal and professional fees
• Creditors must approve repayment plan or liquidation may still result
• Ongoing business disruption during bankruptcy
• Risk of not completing payments and converting to Chapter 7

Looking at the pros and cons together allows you to see which set of trade-offs makes the most sense for your small business situation.

How to Decide Between Chapter 7 and Chapter 11

With the major differences between Chapter 7 and Chapter 11 bankruptcy explained, here are some tips on deciding which route to take for your small business:

• Consult an attorney – Hire a business bankruptcy lawyer to objectively assess your situation and provide legal guidance.
• Understand your goals – Are you looking for a fresh start or trying to save the business? This can steer your decision.
• Review finances thoroughly – Look at your income, expenses, assets, liabilities and creditors’ willingness to negotiate.
• Consider time and cost trade-offs – Chapter 11 takes longer and costs more but may save your business.
• Know the risks – Chapter 11 carries risks like liquidating if you can’t complete the repayment plan.
• Look beyond bankruptcy – Explore other options like negotiating with creditors before deciding to file.

The choice between Chapter 7 and Chapter 11 will have major implications for your business. Weigh your options carefully and seek legal advice to make the best decision you can.

Alternatives to Chapter 7 and Chapter 11 Bankruptcy

While Chapter 7 and Chapter 11 are the main types of bankruptcy for businesses, they are not the only options. Here are a few alternatives to consider:

• Chapter 13 – Allows individuals and sole proprietors to reorganize debts into a 3-5 year repayment plan. Only available to businesses with regular income and less than $419,275 in debt.
• Assignment for the Benefit of Creditors – You assign your assets to a third party trustee to liquidate and pay creditors. Does not provide same debt discharge as bankruptcy.
• Company Voluntary Arrangement – Make a proposal to creditors to accept reduced payments over 3-5 years. Requires 75% creditor approval.
• Creditors’ Voluntary Liquidation – Shareholders vote to voluntarily liquidate company assets to repay creditors. Directors oversee the process.
• Debt Consolidation – Consolidate multiple debts into a single new loan with lower interest rate to reduce monthly payments.
• Debt Settlements – Negotiating directly with creditors to agree on lump sum payments lower than amount owed.

While bankruptcy provides strong legal protection, the alternatives may allow you to resolve debts without having to formally declare bankruptcy. Discuss all options thoroughly with your attorney.

The Bankruptcy Decision Process

Making the decision between Chapter 7, Chapter 11 or bankruptcy alternatives involves several steps:

1. Review your financial situation in detail – cashflow, debts, assets, etc.
2. Research how bankruptcy would impact your specific circumstances.
3. Consult with an attorney experienced in small business bankruptcy.
4. Consider how bankruptcy aligns with your business goals.
5. Compare the costs, benefits and risks of all options.
6. Determine if alternatives like debt negotiation may work.
7. Decide if reorganization or liquidation better meets your needs.

Rushing into bankruptcy without exploring all the implications is risky. Take time to understand the complex legal and financial considerations before moving forward.

How to Rebuild After Small Business Bankruptcy

Recovering from a bankruptcy filing takes time for small business owners. Here are some tips to rebuild your business:

• Monitor your credit – Review credit reports and rebuild credit slowly over time.
• Keep detailed financial records – Careful recordkeeping helps demonstrate rehabilitation.
• Consider an alternative business structure – Forming an LLC or corporation can limit future liability.
• Shop for financing – Look for lenders willing to work with rebuilt credit like the SBA.
• Focus on profitability – Keep costs low and aim for steady, sustainable revenue.
• Be upfront with suppliers – Clearly communicate your situation so they understand the risks.

While the bankruptcy process is difficult, many businesses successfully recover. With patience and hard work, you can rebuild your company’s financial health.