Chapter 11, or corporate reorganization, is what most companies use when filing for bankruptcy. Chapter 7 is sought if the company requires complete liquidation.
Chapter 11 is a form of rehabilitative bankruptcy for businesses. The primary feature of Chapter 11 is its provision for reorganization. Corporations and partnerships in dire financial straits generally seek Chapter 11 protection; however, sole proprietorships may also be eligible for Chapter 11 relief.
Under Chapter 11, the debtor usually proposes a plan of reorganization to stay in business while a bankruptcy court oversees the reorganization of the company's contractual and debt obligations. The court may grant complete or partial relief from most of the company's debts and contracts, allowing the company to start anew.
Debtors in Chapter 11 have the exclusive right to propose a plan of corporate reorganization for a period of time. When the time has elapsed, creditors also may propose plans. The proposed plans of either debtors or creditors must satisfy a number of criteria in order to be confirmed by the bankruptcy court. Among other things, creditors must vote to approve the plan of reorganization.
If the court does not confirm the reorganization plan, the following may occur:
When a company's debts exceed its assets, at the completion of bankruptcy, the creditors may end up with ownership of the newly reorganized company in hopes that eventual financial success will compensate for their losses. The rights and interests of the company’s owners are terminated, leaving them with nothing.
Although most businesses that file for bankruptcy use Chapter 11, others file for a Chapter 7 proceeding. An organization that files for Chapter 7 bankruptcy is asking the court to have its non-exempt assets liquidated. Creditors may force a company to file for Chapter 7.
Businesses filing for Chapter 7 bankruptcy essentially go through the same process that an individual filing for Chapter 7 does. A trustee sells off the organization’s assets for cash then pays off administrative expenses and any secured creditors. Unless there is excess cash after paying off all secured and unsecured creditors, the company’s shareholders will lose their investments. Unlike consumer debt, business debt is not discharged under Chapter 7 proceedings.