What is bankruptcy?
- Balance sheet insolvency: liabilities exceed assets.
- Equity insolvency: inability to pay debts as they become due.
One does not have to be insolvent to voluntarily go bankrupt, but as a practical matter, bankruptcy is the federal procedure (Title 11 of the United States Code) that happens to insolvents. Bankruptcy filing can be voluntary or involuntary (forced):
- Voluntary: the debtor voluntarily files a bankruptcy petition and accompanying documentation, instituting a bankruptcy proceeding under Chapter 7, 9, 11, 12, or 13. (Under Chapter 9, the debtor must be a municipality; under Chapter 12, the debtor must be a family farmer–these 2 chapters are rare).
- Involuntary: creditor(s) may force the debtor into Chapter 7 or 11 if the debtor is generally not paying its debts as they become due. If the debtor has more than 11 creditors, then 3 creditors with aggregate unsecured claims of $14,425 must jointly file the involuntary petition. If the debtor has fewer than 12 creditors, then 1 creditor with an aggregate unsecured claim of $14,425 may file.
What are the purposes of filing bankruptcy?
- To avoid the piecemeal liquidation of a going concern by creditors. Often the value of a whole business exceeds the sum of its many parts.
- To fairly and equitably distribute the debtor’s assets among its creditors.
- To reorganize a company’s business, debts, leases, etc., thereby continuing to contribute jobs, and products or services to the community.
- In the case of individuals, to provide a fresh start free from the stresses and financial burdens of preexisting indebtedness.
- To take advantage of the automatic stay.
What are the most common chapters?
- Chapter 7: (Filing fee $306)–the liquidation chapter. All of the debtor’s property becomes part of the bankruptcy estate, and a Trustee is appointed to oversee and administer that estate. The Trustee’s duties include the collection and recovery of assets (see, for example, Preferences below), and then the distribution of the proceeds of those assets under the distribution rules provided by the Bankruptcy Code. Chapter 7 is commonly available to both individuals and businesses.
- Chapter 13: (Filing fee $281)–Only for individuals with regular income, but this includes sole proprietorship businesses. The individual retains all of his or her property in exchange for making payments out of disposable earnings to a Chapter 13 Trustee for a period of three to five years. The Trustee distributes the debtor’s payments under the debtor’s Chapter 13 plan, which must be approved by the Bankruptcy Court.
- Chapter 11: (Filing fee $1,046)–Mostly used by businesses that want to reorganize, but also used by individuals, especially those whose debts exceed the limits for Chapter 13 or who lack regular income. Unlike Chapter 7, the debtor remains in possession of its own property and runs its business in the ordinary course, subject to rules of the Bankruptcy Code and the Bankruptcy Court. The Chapter 11 debtor is called a Debtor-In-Possession (“DIP”). A successful Chapter 11 case results in the confirmation of a plan of reorganization pursuant to which the DIP’s prepetition creditors are paid pursuant to the plan’s terms. Upon confirmation of the Chapter 11 plan (or, in an individual case, upon completion of the plan), the debtor receives a discharge from its prepetition obligations.