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How does Chapter 7 reorganization work?

  • July 24, 2020

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A Chapter 7 bankruptcy allows a business owner to get out from under a lot of debt and in most cases, the assets are sold and the business closes.  When businesses file under Chapter 7 there is usually no other alternative but it does allow the owner to move on to other things. 

There are different kinds of bankruptcies that can be filed, and there are two main ones for businesses. Chapter 11 is one that allows the business to reorganize its debts in a way that they can be paid off, and the business continues and may end up doing fine.  Chapter seven is often called a "liquidation" bankruptcy. This happens when the company is beyond a point where a reorganization might help.

Under a Chapter 7 bankruptcy, most unsecured debt is written off. The business's property is sold off to pay secured debts. Unsecured debt is debt that is not attached to any collateral, such as a personal loan or a credit card. Secured debt is where there is collateral, such as a car or other assets, guaranteeing the loan.

In bankruptcy, a trustee is appointed by the court. The trustee is an administrator who oversees the selling of the property to get secured debts paid. This person takes care of paying off creditors after the assets are sold. After the assets are sold, and that money runs out while paying creditors, the trustee, and the court discharge the rest of the debt.

Most of the time it is individuals who file for Chapter 7 relief from debt but it may also be a partnership or some other type of business. The court takes a look at the type of debt, however, and may not allow chapter 7 to move forward if the debt the person has is more commercial debt than legitimate business expenses.

Since the process will eliminate debt, the court will want to make sure there is no abuse. A presumption of abuse will be made if the debtor's monthly income is above $12,850 or more than 25 percent of the amount of unsecured debt. The debtor will have to show special circumstances to justify a Chapter 7 if the income is too high.  When it is too high the case may be converted to a Chapter 11 or 13 bankruptcy. The case will only be allowed to go forward once the presumption of abuse is removed

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A case may not be filed if the debtor had a previous filing in the last 180 days or had a case dismissed because the debtor failed to appear in court or he failed to follow orders of the court. People must also undergo credit counseling in order to file this type of bankruptcy.

When a case is filed, the debtor must provide the court with a lot of information, including:

  • A list of assets and liabilities
  • Statement of income and expenses
  • a general financial statement.
  • a list of contracts and current leases
  • Tax return for the most recent year
  • Tax returns for any years filed after the case began.

People with a lot of commercial debt will have additional requirements, including proof of having received credit counseling.

There are some fees involved that must be paid when the bankruptcy is filed. A payment plan may be made, and there are cases where the court waives the fees if they absolutely cannot be paid.

Once the case is filed, the debtor must then submit more information.

  • A list of all creditors and how much is owed
  • Source and amount of income
  • List of all property owned
  • List of living expenses.

Married people must also provide this information about their spouse, whether that spouse is involved or not. Some property is exempt. States may have different rules as to what exempt property is.

Filing this type of bankruptcy stops most collection actions, but only for a short time. While the case is going on creditors may not initiate lawsuits, garnish wages, and are not supposed to even call demanding payment.

From that point, the trustee will meet with the creditors. The debtor must attend the meeting and answer all questions creditors have. After this meeting, the trustee will advise the court as to whether abuse should be presumed and the case dismissed, or whether the case should go forward.

The court could dismiss the case, convert it to another type of bankruptcy, or move forward with the liquidation of the business's assets to pay off the debts.

From there the assets of the business are sold, and creditors with secured debts are paid off. The rest of the debt, usually the unsecured debt, is written off and the debtor gets a fresh start. 

There are many exceptions and a Chapter 7 bankruptcy can be revoked by the court. Contact a bankruptcy attorney to learn more about your options if your business is drowning in debt.