A Chapter 7 corporate bankruptcy is a federal court-sanctioned and supervised procedure in which a court-appointed trustee takes over the corporation's finances and debts. In this type of bankruptcy, the trustee liquidates, or sells, the corporation's assets and distributes the proceeds to the corporation's creditors. Sole proprietorships and partnerships cannot file for Chapter 7 corporate bankruptcy.
While a corporation can voluntarily file for Chapter 7 bankruptcy, its creditors can also force the business to involuntarily enter Chapter 7. Unlike Chapter 7 bankruptcy for individuals, however, a corporate Chapter 7 petitioner does not receive a discharge of its debts. Technically, these debts survive dissolution of the business. Once a petition is filed, the trustee manages dissolution of the business, selling the business's assets and distributing funds to the creditors in accordance with priority of their claims. During the pendency of the case "the automatic stay" prohibits the debtor's creditors from pursuing debt collection.
Three Types of Claims
There are three types of claims in a corporate Chapter 7 bankruptcy case: priority, secured, and unsecured. The claims that receive payment first are the priority claims, those involving the costs of the bankruptcy proceeding itself. Next, secured claimholders receive payment. A secured claim is one that is "secured" by property, or collateral. Often, this is a mortgage holder such as a bank or a corporate bondholder. Next to be paid are the unsecured creditors who have extended credit without collateral, such as vendors and some bondholders. Lastly, the stockholders, or owners of the company, are paid if there are sufficient funds remaining after the other types of claims have been paid.
When is Chapter 7 Corporate Bankruptcy a Good Idea?
A business may decide to petition for Chapter 7 bankruptcy when business debt is overwhelming and reorganization of the business is not feasible. The appointment of a bankruptcy trustee is an economical way to wind up a business because of the low cost involved. Using a bankruptcy trustee to do so proactively limits allegations that the corporate officers did not properly liquidate the business. A Chapter 7 bankruptcy may also discourage creditors from seizing assets that are personally guaranteed by corporate officers and limit creditor suits. Allowing a trustee to dissolve the business also frees up the corporate officers to seek other employment.
When is Chapter 7 Corporate Bankruptcy Not a Good Idea?
A business may seek other ways to service debt other than a Chapter 7 bankruptcy when there are few assets to liquidate, the bankruptcy proceeding itself is costly and the business wishes to avoid scrutiny of its prior business dealings. There is nothing in the law that requires an insolvent business to file bankruptcy. Thus, dissolution of the business under state law may be an adequate solution.
Chapter 7 bankruptcy is a viable option for a corporation that wishes to wind up a failing business operation and liquidate business assets to pay its creditors. Court expenses associated with the bankruptcy proceeding are paid first. Creditor claims supported by collateral are paid secondly, and then unsecured creditor claims. Least likely to be paid are the stockholders, or owners, of the corporation. As an alternative, failing businesses also have the option of simply dissolving the business pursuant to state law.