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Bankruptcy law in the United States is extensive and complex. Recent updates to the Bankruptcy Code and economic turmoil in the United States only further muddy the water. With so much uncertainty, Withum’s experts are invaluable resources when it comes to understanding and navigating the bankruptcy process.
Understanding which type of bankruptcy is best for your company is difficult to do alone. When businesses file for bankruptcy, they often choose to file under Chapter 7 or Chapter 11. The Small Business Reorganization Act and the CARES Act have now created Chapter 11 Subchapter V Bankruptcy, which became effective in February 2020, as an option to aid small businesses.
There are discerning differences between the three most common types of business bankruptcy – Chapter 7, Chapter 11 and Chapter 11 Subchapter V. Understanding those differences can help you determine what type might be the best fit for your business.
Chapter 7
Chapter 11
Chapter 11 Subchapter V

Chapter 7 Bankruptcy

Chapter 7 Bankruptcy ends in liquidation. It is a reasonably quick process concluding in the filer’s discharge (individuals), meaning their debt, and their business no longer exists.

Process

To file for Chapter 7 Bankruptcy, the debtor must file a petition that outlines their assets and liabilities with the bankruptcy court. Once a debtor files a petition with the court, the US Trustee Program— a branch of the Department of Justice — appoints a trustee who will be in charge of overseeing the case once approved by the bankruptcy court. The trustee then examines the debtor’s assets, begins to convert them into cash, and seeks to identify any available avoidance actions. Finally, the trustee oversees payment to the creditors based on the priorities outlined in the bankruptcy code.

Due to the long and expensive nature of traditional Chapter 11 Bankruptcy, many small businesses that pursue Chapter 11 reorganization, unfortunately, fall to liquidation under Chapter 7 in the process.

Chapter 11 Bankruptcy

Chapter 11 Bankruptcy ends in a company’s reorganization. It is typically a lengthy, tedious and costly process that is usually reserved for big businesses.

Process

Pre-filing actions for Chapter 11 are extensive and require due diligence in compiling a company’s financial records. Once the debtor files a petition — that outlines their assets and liabilities, like Chapter 7 — the office of the United States Trustee works with the business’s unsecured creditors to form the creditor’s committee. This committee, with their own financial advisors, accountants and attorneys, oversee the bankruptcy process on behalf of the unsecured creditors. This committee also provides input and evaluates any proposed reorganization plans presented by the debtor.

In addition to the quarterly trustee fees and their own financial and legal advisor fees, the debtor must cover the creditor committee’s legal and financial advisor fees. These fees, in conjunction with the timeline of the bankruptcy, drive up the cost of the process.

One of the means to reorganize is to sell business assets in whole or part, known as a 363 Sale. This section of the bankruptcy code allows a business to sell the business and or its assets in an auction process under the court’s supervision. The benefit of the 363 Sale is that the buyer acquires the assets free and clear of all liens.

Post-sale, there will inevitably be residual assets as well as potential claims to be pursued.  Plans will typically call for a Liquidating Trust to receive and liquidate these items, with the proceeds paid to certain classes of creditors. Typically the Unsecured Creditors committee serves as the oversight committee for the Trust as the unsecured creditors are generally the beneficiaries of the proceeds.

Debtors then follow their approved reorganization plan to emerge from bankruptcy. This plan can last for several years.

Chapter 11 Subchapter V Bankruptcy

Subchapter V, a provision to Chapter 11 of the Bankruptcy Code, was introduced in early 2020 as part of the Small Business Reorganization Act and later modified by the CARES Act in an effort to provide relief for small businesses. Subchapter V modifies some of the requirements of Chapter 11 to make reorganization and emergence more accessible, less costly, and faster for small businesses to reorganize.

Process

Qualification for a Subchapter V filing is limited to business with debt of less than $7.5 million. Subchapter V diverges from Chapter 11 in that it eliminates the creditor’s committee and requires no quarterly trustee fees, among other rules and regulations. In addition to fewer fees, the subchapter also streamlines the bankruptcy process by providing a 90-day deadline for debtors to file a plan.

Withum’s Insolvency, Bankruptcy and Receivership Services Team is ready to assist any party involved in a bankruptcy, from debtors facing financial difficulties to creditors who have customers who have or may potentially file, Creditors committees in need to financial advisory and Trustees. Our talented team of professionals utilize their diverse experience in Insolvency and Industry knowledge to guide our clients to positive conclusions.

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