This post aims to provide a high-level overview of the three main types of bankruptcy cases: Chapter 7, 11, and 13.
Chapter 7 – the “liquidation” model
In every Chapter 7 case, a trustee is appointed. The job of the trustee is to liquidate the assets of the bankruptcy estate. So, if there is personal property to sell, i.e., furniture or equipment, the trustee will hire liquidators (auctioneers, etc.). Similarly, if there are lawsuits to pursue, or accounts receivable to collect, the trustee will pursue the same. The objective is to turn the physical property into cash. Once the assets are liquidated, the trustee pays the creditors according to a priority scheme that is set forth in the Bankruptcy Code. A Chapter 7 is available for individuals and business entities (LLC’s, corporations, etc.). However, only an “individual” receives a discharge in a Chapter 7 case. A discharge is a formal release of the debt obligations. In its simplest form, the Trustee liquidates and winds up the Debtor’s estate, and the Debtor is relieved of its pre-bankruptcy debt obligations.
Chapter 11 – the “reorganization” model
Like a Chapter 7, Chapter 11 is available for both individuals and entities. The general rule is that there is no Trustee appointed in the Chapter 11 case. Rather, the Debtor and its management team continues to operate during the Chapter 11 case.
The Debtor files for bankruptcy protection in order to secure some “breathing room” to create a “plan” of how it will repay its creditors over time. Some plans contemplate the sale of a portion of the Debtor’s property. Some plans contemplate the infusion of cash from a new investor. And other plans propose to pay creditors from future revenues of the operating business. The key is that the creditors must receive at least as much as they would receive if the case were liquidated under Chapter 7. If the plan is approved by the creditors and the Bankruptcy Court, the Debtor emerges from Bankruptcy as a “reorganized” debtor. The old debts (pre-bankruptcy) are paid according to the “plan” and the new debts (post-bankruptcy) are paid in the ordinary course. The big picture concept behind this reorganization model is that the business is more valuable if it is allowed to keep running (as a going concern) and pays its creditors over time, rather than completely shutting it down, like you would in a liquidation model.
Chapter 13 – “wage earners” reorganization
Chapter 13 is a hybrid, with some of the characteristics of a Chapter 7 and some from a Chapter 11. However, Chapter 13 is only available for individuals with “regular income”, i.e., a job that pays over a predictable time (weekly, bi-weekly, monthly, etc.) Unlike Chapter 7 or Chapter 11, this model also has a debt cap, i.e., $1,184,200 for secured debts and $394,725 for unsecured debts. The Debtor proposes a very simple “plan” to pay back its creditors over time from the Debtor’s “theoretical” disposable income, i.e., the amount that is leftover when you subtract monthly expenses from monthly income. This amount is then paid to a Chapter 13 Trustee, who distributes it, pro rata, to the Debtor’s creditors over time.
Contemplating bankruptcy can be challenging. Bankruptcy may not be the best solution in each case. Often, we find that there may be alternatives to filing a bankruptcy case. If you have any questions about these models, please feel free to give us a call.