One of the biggest misconceptions about bankruptcy is that a corporation, limited liability company or other business entity is eligible for a Chapter 7 bankruptcy discharge. It is not, and thus, business entities cannot wipe out their debts and keep some or all of their assets in a Chapter 7 liquidation. Pursuant to 11 U.S.C. § 727, Chapter 7 discharges are only available to eligible individuals. If a corporate entity wants to obtain a discharge of its pre-petition debts, a non-liquidating Chapter 11 will allow it to achieve that goal, but the cost is significantly higher. In a Chapter 11 reorganization, most pre-petition debts are generally discharged upon confirmation of a Chapter 11 plan pursuant to 11 U.S.C. § 1141(d)(1). And with the advent of Subchapter V (a type of Chapter 11 case enacted as the Small Business Reorganization Act in August 2019), businesses with less than $7.5 Million in debt are generally eligible to receive a discharge through a more streamlined and generally less costly process.
A business generally files a Chapter 7 bankruptcy to provide for an orderly wind-up of its affairs if there is no likelihood of a successful reorganization, and it is often considered a way to bring closure to a corporate entity’s existence. Unlike individual Chapter 7 cases, businesses are not entitled to any exemptions (such as homestead, retirement accounts, insurance policies or annuities, vehicles, or other tangible or intangible property) under State or Federal law, and a Chapter 7 trustee is appointed in each case to investigate the Debtor’s pre-petition financial affairs, marshal the Debtor’s assets, pursue litigation claims, and otherwise collect monies due to the Debtor for distribution to those creditors that file proofs of claim in accordance with the priority scheme outlined in Section 502 of the Bankruptcy Code.
While corporate Chapter 7 bankruptcies can be useful to bring closure and wind-up a business, business owners should be mindful that the Chapter 7 trustee has the power and duty to investigate the Debtor’s pre-petition financial affairs, which includes the power to avoid and recover certain transfers, including fraudulent conveyances and preferential transfers (often referred to as “clawbacks”), which could make the business owner and/or the owner’s friends and family members that might have received transfers from the Debtor, litigation targets.
However, there are scenarios where filing a corporate Chapter 7 bankruptcy may be warranted. For example, if the Debtor’s principal has personally guaranteed corporate obligations but is unable to effectuate an orderly liquidation of the Debtor’s assets, or if it is likely that the Chapter 7 trustee can more efficiently liquidate and monetize corporate assets, and there are no (or limited) potential avoidance claims against the Debtor’s principals or insiders.
Thus, it is important that any business owner thinking about a corporate bankruptcy filing consult with competent counsel to gain a full understanding of the risks and benefits of a bankruptcy filing, be it a Chapter 7 or Chapter 11.
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About Scott Brown
Scott N. Brown is a Chambers USA ranked partner of the firm and panel Chapter 7 bankruptcy Trustee. Scott is considered a thought leader in the industry and has been practicing in the bankruptcy/insolvency field for 20 years. Scott concentrates his practice on court-appointed fiduciary representation, creditor’s rights, complex bankruptcy litigation, and business reorganization. Click here to learn more.