A business is deemed a failure when it cannot generate enough cash flow to cover its operating expenses and interest. Many firms find themselves in a situation when they are unable to continue any longer. Such firms feel the need to sell their assets to repay whatever liabilities they have, and then close down the business forever. There can be another type of business failure in which a firm’s products are doing well in the market, but the firm’s cash flow is not sufficient to cover current operating expenses and interest. Such firms need to be reorganized so that they can become efficient all over again.
There are two types of business bankruptcy Chapters that such firms can use – Chapter 7, Chapter 11,
Chapter 7 Bankruptcy – Liquidation
A business may file for protection under Chapter 7 when it is convinced that there is no future and that it can only repay (or part repay) its liabilities by selling its assets. Chapter 7 is also termed as liquidation. Businesses that have a mountain of debts to service, a product line that has no future, and assets that are depreciating or getting impacted by obsolescence, typically file for bankruptcy under Chapter 7. Also, if the business is dependent on the owners’ skills, which is not delivering the results, then the firm may file for bankruptcy under this Chapter because you cannot reorganize skills.
Sole proprietorships, corporations, and partnerships can file for bankruptcy under Chapter 7. Once the claim is filed, the court appoints a case trustee who first determines the assets that can be sold, and then sells these, and distributes the proceeds among the creditors. A sole proprietorship will receive a discharge when the bankruptcy is completed. A discharge means that the sole proprietor has no more debts, and can start his financial life all over again. Partnerships and Corporations do not receive a discharge – these are liquidated under Chapter 7.
Chapter 11 Bankruptcy – Reorganization
Chapter 11 Bankruptcy is for businesses that have a viable product line, sufficient assets, and intellectual capital. If such firms continue doing business, they can repay their liabilities over the long term. These firms can file for bankruptcy under Chapter 11, which can help these firms reorganize their business, survive for a better tomorrow, and also pay off their liabilities.
Once Chapter 11 Bankruptcy is filed, the court appoints a case trustee who checks the reorganization plan filed by the firm, shares it with the creditors, and takes their approval (creditors vote for the plan). Once the reorganization plan is approved the business has to execute it. Any variance from the plan leads to its failure.
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