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3 Types of Business Bankruptcy

3 Types of Business Bankruptcy What is Business Bankruptcy?

Business bankruptcy is a financial maneuver undertaken by businesses (corporations, companies, small business, and public/private organizations) to relieve them of financial struggles. When a business’ debt to equity ratio is skewed, meaning the corporation’s debts greatly exceed their profit, the company will evaluate the benefits of filing for bankruptcy.

Business bankruptcy offers a business the opportunity to essentially recreate their business model. If a corporation fails to repay their debt obligation, they may file for bankruptcy to either liquidate their assets or create a repayment plan through a government agency.

There are 3 distinct types of business bankruptcy—each form alleviates the debt obligation of a business either through liquidation of assets or the creation of a repayment plan. 

Types of Business Bankruptcy

Chapter 7 Bankruptcy: Chapter 7 Bankruptcy immediately liquidates the business’ assets. When the assets are liquidated they are essentially sold. The money accrued through the liquidation is then used to repay the company’s debt obligations.

When a company in debt files for Chapter 7 bankruptcy, a trustee is appointed to take charge of the business. At this time, the trustee will begin the process of liquidating the company’s assets.

Once the assets are liquidated, the creditor will be able to file a claim with the local court system to request repayment from the business or corporation in debt. The assets are then divided among the creditors and distributed based on the coordinating repayment obligation. In addition to the repayment of debts, a company filing for Chapter 7 bankruptcy is required to pay fees and costs associated with the use of a trustee.

Chapter 11 Bankruptcy: Chapter 11 bankruptcies were created to allow struggling businesses time to reorganize or restructure in order to revive the business. When a corporation or business files for Chapter 11 bankruptcy, it is generally allowed to continue business operations. However, they must be supervised by their local bankruptcy court and without interference from creditors.

The filing business must negotiate a repayment plan with the underlying creditors. Such plans typically develop monthly payments for the business to provide the creditors with partial payments. The repayment plan is agreed upon through mediation and administered by the local bankruptcy court. If one side feels that the repayment plan is unjust, an appeal process is available for both parties.

Chapter 13 Bankruptcy: Technically, businesses are not allowed to file for Chapter 13 bankruptcy. That being said, an individual employee can file for themselves, which will in turn cover all expenses they may personally owe due to a failed business venture. Typically sole proprietorships are the types of business that file this form of bankruptcy. In order to file for this form of bankruptcy, the court and creditors must pre-approve a repayment plan. The repayment plan allows creditors to collect debt while protecting the property of the debtor. The property is a form of collateralized debt in this form of bankruptcy.

In order to file, the applicant must prove a source of income as a means to meet the debt over a period of 3-5 years. This form of bankruptcy is viable for those individuals who, because of a failed business venture, are stricken with debt.

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