What Happens When a Business Files for Bankruptcy?

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The effect a bankruptcy filing will have on your business depends, in part, on the chapter of bankruptcy your company files. Because the federal bankruptcy code designates certain chapters of bankruptcy for certain types of businesses, the effect a bankruptcy filing will have on your company also depends on the type of business in which you hold a stake.


A business files for bankruptcy by filing a bankruptcy petition. The company must also file bankruptcy schedules. These detail the company's assets and liabilities, income and expenses, a statement of its financial affairs, and executory contracts and leases. After the business files the bankruptcy petition, an automatic stay takes effect. At this time, the company's creditors must cease all efforts to collect on debts. The U.S. Trustee Program appoints a local bankruptcy trustee to administer the bankruptcy case, and the trustee oversees payments to the creditors.

Personal Bankruptcy

A business organized as a sole proprietorship functions as an extension of the owner. Therefore, a sole proprietor would file personal bankruptcy under Chapter 7. In this case, after the U.S. Trustee Program appoints the bankruptcy trustee, the trustee gathers all of the business owner's property and sells all non-exempt property. The trustee uses the cash from the sale to pay the company's creditors. At the end of the bankruptcy process, the bankruptcy court discharges the business owner's remaining debts. A sole proprietor may also file for Chapter 13 bankruptcy. In a Chapter 13 case, the debtor will keep all of his property and make monthly payments to a bankruptcy trustee, who will distribute payment to each of the sole proprietor's creditors.

Business Bankruptcy

A business organized as a partnership, limited liability company or corporation functions as an entity separate from its owners. Therefore, one of these companies can't file for personal bankruptcy. A partnership, LLC or corporation can file for Chapter 7, but it won't receive a discharge of its debts. As in personal bankruptcy, a bankruptcy trustee takes possession of the company's property and sells it to raise cash to pay creditors. Under Chapter 7 bankruptcy, the partnership or corporation ceases to exist.

Chapter 11

When a business opens a Chapter 11 case by filing a bankruptcy petition, an automatic stay takes effect. In exchange for this protection, the company must disclose its financial situation by filing a written disclosure statement and a plan for reorganization with the court. The disclosure statement must include information about the company's assets, liabilities and business affairs. This information allows its creditors to make informed decisions about the proposed reorganization plan. The company's creditors must approve the disclosure statement. After this, the bankruptcy court will hold a confirmation hearing for the reorganization plan. If the court confirms the plan, either the debtor in possession or a bankruptcy trustee will run the business to generate money for the benefit of the creditors.

Read More: How to Convert Chapter 11 Bankruptcy to Chapter 7

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