Bankruptcy Filings: Chapter 11 Reorganization vs. Chapter 7 Liquidation

Posted by Aaron Juckett, CPA, CPC, QPA, QKA on Sun, Dec 14, 2008
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Whether it be stories about the bankruptcy filings of the Tribune Company and the Antioch Company that we have discussed on this Blog, or the constant media attention on the Big 3 automakers, there appears to be questions about the differences between a Chapter 11 reorganization and a Chapter 7 liquidation:

When a business is unable to service its debt or pay its creditors, the business or its creditors can file with a federal bankruptcy court for protection under either chapter 7 or chapter 11. In chapter 7, the business ceases operations and a trustee sells all of its assets and distributes the proceeds to its creditors. In chapter 11, in most instances the debtor remains in control of its business operations as a "debtor in possession", and is subject to the oversight and jurisdiction of the court.
The court can grant complete or partial relief from most of the company's debts and its contracts. Sometimes, if the business's debts exceed its assets, then at the completion of bankruptcy the company's owners all end up without anything; all their rights and interests are ended and the company's creditors are left with ownership of the newly reorganized company.

When many people think of bankruptcy, they think of a Chapter 7 liquidation filing. However, all three of the cases that I mentioned above have filed or are exploring for a Chapter 11 reorganization filing. The Wikipedia page addresses the rationale behind a chapter 11 filing:

In enacting chapter 11 of the Bankruptcy code, Congress concluded that it is sometimes the case that the value of a business is greater if sold or reorganized as a going concern than the value of the sum of its parts if the business's assets were to be sold off individually. It follows that it may be more economically efficient to allow a troubled company to continue running, cancel some of its debts, and give ownership of the newly reorganized company to the creditors whose debts were canceled. Alternatively, the business can be sold as a going concern with the net proceeds of the sale distributed to creditors ratably in accordance with statutory priorities. In this way, jobs may be saved, the (previously mismanaged) engine of profitability which is the business is maintained (presumably under better management) rather than being dismantled, and, as a proponent of a chapter 11 plan is required to demonstrate as a precursor to plan confirmation, the business's creditors end up with more money than they would in a chapter 7 liquidation.

The U.S. Courts website has information pages on Chapter 11 Reorganization Under the Bankruptcy Code and Chapter 7 Liquidation Under the Bankruptcy Code


Aaron Juckett, CPA, CPC, QPA, QKA
Written by Aaron Juckett, CPA, CPC, QPA, QKA

Aaron is President and Founder of ESOP Partners and provides implementation, administration, and consulting services to hundreds of companies. He is a member of The ESOP Association (TEA) and the National Center for Employee Ownership (NCEO).

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