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When a corporation faces severe financial challenges that cause its inability to repay debt obligations, filing for protection under corporate bankruptcy law is a common occurrence. Filing for bankruptcy protection allows the company to complete one of two tasks: restructure the corporation in order to become debt free and eventually profitable, or completely dissolve business operations and liquidate all the assets it owns. What happens after a decision to file bankruptcy depends on what type of bankruptcy protection a corporation is seeking.

Chapter 7 Bankruptcy

When a corporation files Chapter 7 bankruptcy protection in court, the company is required to cease all business operations as the end result is full liquidation. Corporations opt to file Chapter 7 when they determine that the continuation of the business under a reorganization is not going to result in a profitable company. Once the corporation has filed for Chapter 7, a bankruptcy trustee is appointed through the bankruptcy court. The trustee then manages the liquidation of assets to creditors, bondholders and shareholders.

In this process, the bankruptcy trustee sells all corporate assets and uses the proceeds to repay administrative and legal expenses first, followed by creditor accounts. For debt obligations that are secured by collateral, called secured debt, the trustee returns those physical assets to the appropriate creditor to fulfill the debt. If collateral is not sufficient to cover secured debt, the remaining creditors are pooled with unsecured creditors and bondholders, each of which are in line to receive proceeds from the corporation's remaining assets. Individuals who own common stock are at the bottom of the list of creditors to receive proceeds during a Chapter 7 bankruptcy. Once all assets are liquidated, the business is dissolved.

Chapter 11 Bankruptcy

Corporations that determine a reorganization of the business may result in a return to profitability opt to file Chapter 11 bankruptcy protection. Under Chapter 11, corporations are allowed to continue business operations, but the bankruptcy court retains control over significant business decisions. Corporations may also continue to trade company bonds and stocks throughout the bankruptcy process, but are required to report the filing with the SEC within 15 days.

Once Chapter 11 bankruptcy is filed, the federal court appoints one or more committees that are tasked with representing and working with creditors and shareholders of the corporation to develop a fair reorganization. The corporation, along with committee members, creates a reorganization plan that must be confirmed by the bankruptcy court and agreed upon by all creditors, bondholders and stockholders.

Within a reorganization plan, the corporation is absolved of its responsibility for a portion of its debt obligations so that the company can return to a place of profitability. Creditors are paid in similar order to Chapter 7 proceedings, starting with secured creditors and employees, followed by bondholders, preferred shareholders and stockholders. Once the reorganization plan is deemed complete by the court, the corporation emerges from Chapter 11 bankruptcy and is able to continue with operations in order to create a profit.

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