Chapter 7 Business Liquidations


 Overview of a Business Liquidation Bankruptcy

The Bankruptcy Code allows a business entity, such as a corporation or a limited liability company, to file a petition for a Chapter 7 bankruptcy liquidation. In this type of bankruptcy, the entity itself, as opposed to its owners, enters bankruptcy protection.

A business bankruptcy is distinct from an ordinary, non-bankruptcy business wind-down, where a business does not seek court protection from creditors but instead closes its doors, sells or transfers its assets, satisfies all creditor demands, and returns any surplus capital to its owners. A business bankruptcy accomplishes many of these goals but is typically triggered by a pressing need, such as a pending foreclosure, a creditor lawsuit or a need to immediately close the business. A business bankruptcy may be filed by either the business’s owners (a voluntary petition) or by the business’s creditors/third-parties (an involuntary petition).

Upon filing a business bankruptcy, the entity’s owners immediately close the business and turn over possession of all assets to a court-appointed trustee, who will liquidate assets, pay creditors, and return any surplus funds from the liquidation to the business’s equity owners, if available.

Effects of Filing a Chapter 7 Petition

Upon the filing of a Chapter 7 petition, the operations, assets, and liabilities of the business are immediately subject to the control and oversight of the Bankruptcy Court. All business operations by non-court personnel must immediately cease. The Bankruptcy Court will appoint a Chapter 7 bankruptcy trustee to take possession of the business, wind up its business affairs if necessary, and liquidate assets to satisfy claims. The business’s owners and management must cooperate with the bankruptcy trustee to ensure that all assets, records, and any other relevant information are turned over to the trustee.

It is worth noting that a Chapter 7 petition will only involve the debts of the debtor entity – it will not extinguish any guarantor liability of claims against individual third-parties, such as the owners or managers of a liquidating business. If such claims cannot be resolved out of court, such third-parties may need to consider filing their own bankruptcy petitions.

The Automatic Stay

Upon the filing of a Chapter 7 bankruptcy petition, federal law (11 U.S.C. § 362) proscribes that all creditor rights and remedies, administrative actions, or related collection actions are immediately stayed. The stay is essentially an automatic injunction, meaning that it comes into existence by the filing of the bankruptcy petition – no further court action is needed to create or give notice of the stay. The automatic stay is intended to protect the Debtor and its property from all collection efforts, creditor harassment, foreclosure actions, and seizures of property in order to preserve the status quo pending an adjudication of the case.

The automatic stay remains in effect for the duration of the case unless it is modified or terminated by order of the Bankruptcy Court. A party in interest may request leave from the bankruptcy court to take certain actions, such as foreclose on secured property or seek to collect insurance proceeds if the movant demonstrates good cause to the Bankruptcy Court. Any creditor action in violation of the automatic stay is void and may result in the assessment of penalties against the violating creditor.

Trustee’s Liquidation of Assets

As mentioned above, the Trustee will collect all assets of the business – including inventory, equipment, other tangible and intangible property, rights, and/or entitlements – and liquidate any such property to satisfy creditor claims filed in the case in order of their priority. The Bankruptcy Code considers the entity’s owners, the “equity security holders,” as the lowest priority group. Thus, only if all claims of creditors are satisfied in full, any remaining assets will be distributed to the owners.

Closing the Case

Because a business entity is not entitled to a Chapter 7 discharge, after investigating all claims and distributing property, if appropriate, the Trustee will file a final report. This final report will detail the assets, if any, collected and any claims paid. Thereafter, the bankruptcy court will close the case – meaning that the business is defunct, its assets liquidated, and the bankruptcy case complete.