Chapter 7 vs. Chapter 11: What's the Difference?

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Empty Pockets, Heavy Hearts: Coping with Bankruptcy

Here is a hard and difficult truth that many MBA programs are unlikely to share: Many of you, perhaps most of you, will at some point be involved with a business that runs out of money and can't pay its debts. (This is probably a good time to mention that your $14.95 tuition is non-refundable.) But fear not, young capitalist. If you can't pay your bills on time, you may feel bankrupt but you're merely insolvent. You're not actually bankrupt until you legally declare you can't pay your creditors, or until your creditors file a bankruptcy petition against you. At this point, a court's going to start helping you figure out how to pay your debts.

There are six types of bankruptcy in the U.S. Bankruptcy Code, but the kinds most often associated with businesses are Chapter 7 and Chapter 11. (They are lengthy chapters in a very sad book.) Pick which sentence best describes your situation:

"Ack! This business was a horrendous idea!"

Chapter 7 bankruptcy dictates how liquidation works in bankruptcy proceedings. Let's say your floundering business is in the hole to its creditors, so you petition for Chapter 7 bankruptcy. Your business ceases operations, and the court appoints a bankruptcy trustee who then starts selling off your assets and divvying up the proceeds among your creditors. You really should have seen this coming when you opened a make-your-own sundae bar in northern Minnesota.

If you own stock in a Chapter 7 company, we've got some bad news: It's usually worthless. At least you have your health.

"We can still make money...we've just managed our debts poorly."

In the case of Chapter 11 bankruptcies, your business doesn't seem completely irredeemable, and it's probably more valuable if you keep it in one piece rather than selling off all of its individual assets. Thus, Chapter 11 provides for reorganization rather than liquidation.You'll stay in business, and the court can void some of your debts. Of course, you will have to come up with a plan for reorganization that your creditors must approve, and you'll pay them back according to this plan. You can keep managing your company, but the court has to approve your major decisions. If your reorganization plan works and the company returns to profitability, you'll be able to breathe several sighs of relief. But if the plan fails, your assets are probably going to get liquidated.

If you own stock in a Chapter 11 company, it may still have some value.The stock is probably going to be pulled off of its exchange, but it can still be traded over the counter. According to the SEC, however; most reorganization plans tend to cancel all existing shares, so you could be left with nothing. Even ifthe company rises from the financial ashes, the new owners will usually be its creditors, not the pre-bankruptcy stockholders. On the plus side, though, you'll definitely have a boring financial story to tell at cocktail parties.