The bankruptcy code is a rather complex federal law. The bankruptcy process has its own system, in the sense that it has a bankruptcy court and bankruptcy judges that are separate from other federal courts and federal judges. The most important bankruptcy provision for businesses is Chapter 11, which helps businesses reorganize their debts.
Although bankruptcy law is mostly federal law, state law does come into play, particularly in determining which assets can remain exempt from creditors. States vary widely on what can remain exempt, which means that some states are better than others for those who want to declare bankruptcy.
The first step for someone interested in filing for bankruptcy is to talk to a bankruptcy attorney about the choices that someone filing for bankruptcy will have to make, such as the best place to declare bankruptcy, for those who have a choice. The following discussion provides an overview of the bankruptcy laws applicable to businesses. If you're interested in the bankruptcy laws applicable to individuals, see
Chapter 11. The purpose of Chapter 11 is to allow businesses to continue in operation while the court works with the debtor business and its creditors to reorganize the debts. The process begins when the debtor business files a petition with the bankruptcy court, which lists its creditors. In Chapter 11 cases trustees are usually not appointed, except in extreme cases.
Once the petition is filed, the court notifies the creditors listed in the petition that a bankruptcy petition has been filed. The filing stays all further collection efforts by the creditors, which means that they cannot attempt to contact the business to collect debts as long as the case remains active. Their only recourse to collect debts at this point is through the court.
In bankruptcies involving larger businesses with lots of creditors, the court will usually appoint a committee to represent the debtors. In some cases, committees will be appointed to represent different types of creditors where their interests might be different, such as a separate committee for unsecured creditors.
The next step is for the debtor business to prepare and file a plan for debt reorganization with the court. The plan sets out the debtor's view of how the debts will be repaid and how the business will return to profitability. The creditors, of course, will typically want to file their own plan and have that one approved by the court. Within the first 120 days after the petition is filed, the debtor has the exclusive right to file a plan. After 120 days, the debtor and creditors can file plans.
The plan must designate all classes of claims, it must indicate which claims are not being impaired under the plan and which claims are being impaired, and it must treat all within a class similarly.
Once the debtor submits a plan, the court will hold a confirmation hearing, at which time all creditors are entitled to vote on it, except those who contractual arrangements with the debtor are unaltered by the plan. All classes of creditors must approve the plan by majority vote. If the creditors approve the plan, the next step is for the court to approve it. The court has the right to reject the plan under certain circumstances, such as where it believes that the demands made on the debtor by the plan will cause the business to fail. Usually, though, if the creditors approve the plan, the court will too.
After confirmation, the reorganization plan becomes the contractual arrangement between the debtor and its creditors as long as it remains in effect. Confirmation also discharges all debts that arose prior to the plan.
Chapter 7. Chapter 7 is a bankruptcy option for businesses that want to liquidate their assets and go out of business. Businesses don't normally use Chapter 7 - it's usually for individuals - because the value of the business is usually greater than the value of the tangible assets that could be sold, and it wouldn't make financial sense to liquidate. But businesses do use Chapter where there is no hope for continuing in operation and their only assets are their tangible assets.
Chapter 7 is similar to Chapter 11 in the sense that it begins with the filing of a petition that stays further creditor actions. It's different in the sense that the court appoints a trustee, who takes possession of the creditor's assets and sells them to the highest bidder.
Other considerations. Any business considering bankruptcy should be aware of laws that could get them in trouble for things it did prior to filing for bankruptcy. The temptation for many who are considering bankruptcy is to pay off certain favored creditors, such as family members, before the petition is filed. For example, if a business has $2,000 in cash, and it owes $10,000 to the owner's brother and $10,000 to a bank, some business owners will give the $2,000 to the brother before filing the petition.
The law gives the court the right to invalidate transfers made within 90 days of filing the petition, or one year if a family member or close friend is involved, if the court determines that the transfer gave that person a preference over other creditors. The law also gives the bankruptcy court the power to invalidate certain pre-filing sales that it deems were fraudulent, such as where assets were sold for below-market prices prior to filing for bankruptcy. The same filing deadlines apply in that situation as applied to preferences.
Involuntary bankruptcy. Under certain conditions, creditors can force a business into Chapter 7 or Chapter 11 bankruptcy. Thus, the decision to file for bankruptcy protection is not always completely in the debtor's hands.