How Does Chapter 7 Bankruptcy Work?

Written by Economic Development Jobs on June 30, 2018. Posted in Contract interpretation, Judge thomas e. scott, Mediator

Bankruptcy court is where individuals or entities go when they no longer have the assets to pay off their debts, or at least cannot do so in a timely way. When it comes to businesses, there are two options for walking into bankruptcy court: Chapter 11 and Chapter 7. Chapter 7 bankruptcy is by far the more common and involves liquidating the company, while Chapter 11 is primarily a form of reorganization.

Bankruptcy Court: Who is Involved?

When a company is unable to pay back creditors and things cannot be worked out, bankruptcy court is where everything will be settled. In a Chapter 7 case, a ruling judge presides over the bankruptcy court, while a representative from the Department of Justice also attends to keep things moving. There is also another trustee appointed to oversee the business’ liquidation. The company that files in bankruptcy court is the debtor, and there can be many creditors who are owed money. Typically, creditors are considered secured, priority, or unsecured. Secured creditors such as banks are paid off first as company assets are liquidated, while unsecured creditors, such as suppliers, may or may not ever see a dime. Priority creditors are usually company employees or government entities owed tax, and they fall somewhere in between.

How Does Chapter 7 Get Started?

The debtor company has to file in bankruptcy court. They file a petition for bankruptcy and give a list of all their creditors. As soon as they do, they must stop functioning as a company. All keys to offices, warehouses, company vehicles, or any other property are handed over the trustee. The trustee takes over operations in a very limited way, primarily to get it ready for an orderly liquidation and to look for any potential lawsuits. The trustee also looks for any assets the owner may have tried to hide and transfers them back to the company to be used in paying creditors.

What Happens Next?

Within 15 days of the filing, the debtor company must also file a Schedules and Statement of Financial Affairs. This filing shows the complete financial state of the company as of the day of filing, as well as historical operations. It also lists everything that has been paid to company owners and other insiders within the last year. Then the principal of the company is interviewed by the trustee, under oath. This interview takes place at the Office of the U.S. Trustee and is free for anyone to attend. All creditors are free to ask questions. This is the start of an investigation that typically takes a few months. During that time, the trustee looks for any evidence of impropriety, and, assuming nothing is found, a final report gets filed.

How do Creditors Get Paid?

All creditors file a proof of claim about the amount they think they should get, and in almost all cases creditors get back only a small fraction of that amount. The trustee will look over these filings, and if he or she belivies the creditor is not due so much an objection is filed and the judge decides the proper amount of the claim. All assets are reduced to cash through the sale of buildings and other real property, as well as the prosecution of any lawsuits. In a typical case, most unsecured creditors will receive nothing, and if they were paid by the company before the filing, they may be sued by the trustee to recover that money so it can be given to secured creditors and priority creditors.

Bankruptcy court and bankruptcy filings can be long and arduous. There are typically many creditors claiming assets, and there may be inappropriate or even criminal behavior on the part of owners attempting to protect or even enhance their personal assets. Most creditors know little about bankruptcy law and are wise to get a legal help in prosecuting any claims.

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