What are the differences between chapter 7 and chapter 11 bankruptcy?

By Investopedia Staff AAA
A:

Chapter 7 bankruptcy is sometimes also called liquidation bankruptcy. Firms experiencing this form of bankruptcy are past the stage of reorganization and must sell off any un-exempt assets to pay creditors. In chapter 7, the creditors collect their debts according to how they loaned out the money to the firm (also referred to as the "absolute priority"). A trustee is appointed, who ensures that any assets that are secured are sold and that the proceeds are paid to the specific creditors.

For example, secured debt would be loans issued by banks or institutions based upon the value of a specific asset. Whatever assets and residual cash remain after all secured creditors are paid are pooled together to be paid to any outstanding creditors with unsecured loans: e.g. bondholders and preferred shareholders.

Chapter 11 bankruptcy can also be called rehabilitation bankruptcy. It's much more involved than chapter 7 as it allows the firm the opportunity to reorganize its debt and to try to re-emerge as a healthy organization. What this means is that the firm will contact its creditors in an attempt to change the terms on loans such as the interest rate and dollar value of payments. Like its cousin, chapter 11 requires that a trustee be appointed; however, rather than selling off all assets to pay back creditors, the trustee supervises the assets of the debtor and allows business to continue. It's important to note that debt is not absolved in chapter 11: the restructuring only changes the terms of the debt, and the firm must continue to pay it back through future earnings.

If a company is successful in chapter 11, it will typically be expected to continue operating in an efficient manner with its newly structured debt. If it is not successful, then it will file for chapter 7 and liquidate. In both instances, common shareholders will most likely see little (if any) return on their investments.

To learn more about bankruptcy, check out the articles An Overview Of Corporate Bankruptcy and Z Marks The End.

RELATED FAQS

  1. How can I become a venture capitalist?

    Find out what it takes to become a venture capitalist, and read about some of the primary attributes private equity firms ...
  2. How is venture capital regulated by the government?

    Learn about some of the ways in which the U.S. government and the Securities and Exchange Commission regulate venture capital.
  3. How do ridesharing companies like Uber make money?

    Discover the services a transportation company such as Uber provides and how the premiere ridesharing company operates and ...
  4. What are the benefits and drawbacks of owning preferred stock and common stock?

    Owning a share of a company can be accomplished through the purchase of common or preferred stock, but there are benefits ...
RELATED TERMS
  1. Donation-based Crowd Funding

    Donation-based crowdfunding is a way to source money for a project ...
  2. Estimated Recovery Value (ERV)

    The projected value of an asset that can be recovered in the ...
  3. Recovery Rate

    The extent to which principal and accrued interest on a debt ...
  4. Provisional Patent Application

    A short-term means of protecting an invention that requires less ...
  5. Bankruptcy Court

    What is bankruptcy court?
  6. Franchise disclosure document

    A Franchise Disclosure Document (FDD) is a legal document presented ...

You May Also Like

Related Articles
  1. Entrepreneurship

    How Steve Jobs Changed The World

  2. Investing

    A Look at the 5 Richest People in the ...

  3. Investing News

    The 5 Wealthiest People in Mexico

  4. Entrepreneurship

    The Most Successful App Companies

  5. Investing Basics

    Undervalued Franchises: The Best Choice?

Trading Center