Chapter 7 -- A Last Resort
Chapter 7 of the Bankruptcy Code is often a last resort for individuals or companies with financial problems that they cannot solve. Under Chapter 7, a Trustee is appointed to administer the assets of the debtor. The Trustee sells the assets in order to pay creditors. For individuals, some assets are exempt, and those are retained by the debtor.
Chapter 7 allows individual debtors to have their debts discharged so that they will be able to obtain a “fresh start.” The quid pro quo for the discharge is that the debtor be honest about his or her assets and liabilities. This allows creditors to have an accurate picture of the assets and liabilities, and makes it possible for the Trustee to do his job. For companies, Chapter 7 is a relatively inexpensive means of winding up the company’s affairs, especially when the company does not have many assets of value. Chapter 7 can be easier than a state law dissolution principally because in a Chapter 7, all assets are turned over to the Trustee, and it is the Trustee’s job to sell the assets and pay creditors. In a state law dissolution, that burden falls on the company.
Chapter 7 can also be a last resort for debtors who first file Chapter 11 in the hopes of reorganizing and continuing in business. If a debtor in Chapter 11 is unable to confirm a Plan of Reorganization, the bankruptcy judge will often convert the case to Chapter 7 resulting in the company’s liquidation. Thus, one of the risks of Chapter 11 is that if the debtor cannot get enough creditors to agree to its Plan of Reorganization, then all of the assets may be liquidated by a Chapter 7 Trustee.
Although Chapter 7 inevitably means that the company or individual will not be reorganizing, it is sometimes favored by creditors who are otherwise suspicious of the debtor’s activities. This is because the Trustee (a party unrelated to the debtor) is placed in control of the debtor’s assets. In contrast, in Chapter 11, absent extraordinary circumstances, there is no Trustee appointed. Sometimes the oversight from a neutral third party is necessary to give creditors confidence that the bankruptcy process will allow the debtor’s assets to be fairly distributed to the debtor’s legitimate creditors.
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