Chapter 7 vs. Chapter 11: An Overview

In both Chapter 7 and Chapter 11 bankruptcy events, shareholders of the companies filing for bankruptcy will most likely see little, if any, return on their investments. However, there are some significant differences between these two filings.

Key Takeaways

  • Firms in a Chapter 7 bankruptcy are past the stage of reorganization and must sell off any un-exempt assets to pay creditors.
  • Chapter 11 bankruptcy can be called rehabilitation bankruptcy; it allows the firm the opportunity to reorganize its debt and to try to re-emerge as a healthy organization.
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Your Guide To Chapter 7 Bankruptcy

Chapter 7

Chapter 7 bankruptcy is sometimes 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 like bondholders and preferred shareholders. 

To qualify for chapter 7 relief, a debtor may be an individual, a partnership, or a corporation or other business entity. An individual cannot file under chapter 7 or any other chapter, however, if during the preceding 180 days a prior bankruptcy petition was dismissed due to the debtor's willful failure to appear before the court or comply with orders of the court, or the debtor voluntarily dismissed the previous case after creditors sought relief from the bankruptcy court to recover property upon which they hold liens.

Chapter 11

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 reemerge 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.

A chapter 11 case starts with a filing of a petition to the bankruptcy court where the debtor lives. A petition may be a voluntary petition, which is filed by the debtor, or it may be an involuntary petition, which is filed by creditors that meet certain requirements.

Special Considerations

Like Chapter 7, 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.