What Are the Main Types of Corporate Bankruptcy?

Depending on Filing, a Company May Be Able to Continue Operations

Part 2 of 3
There are two main forms of corporate bankruptcy: Chapter 11 and Chapter 7.

Which form of bankruptcy a company chooses may determine the fate of stockholders and bond owners.

Ultimately, the end of a bankruptcy process, regardless of whether it is Chapter 11 or Chapter 7, may not make any difference to investors.

Let’s take a brief look at both types of filings.

Chapter 11

Chapter 11 bankruptcy is the first choice of most companies.

Under Chapter 11, a company can develop a reorganization plan and continue operating.

Existing debts and contracts, including contracts with unions, are renegotiated.

The company, under the guidance of a trustee appointed by the federal bankruptcy court, works out a plan to settle its obligations.

While in bankruptcy, the company is protected for creditors by the court, preventing creditors from disrupting the operations of the company.

However, creditors and stockholders must approve the reorganization plan. The bankruptcy judge has the authority to accept the plan even if the creditors and stockholders reject it.

Once the reorganization is complete, the company can come out from under the protection of the bankruptcy court and resume normal operations.

A Chapter 11 filing assumes there is a possibility the company can emerge from the process as a viable operating company.

Chapter 7

Companies that either fail in their Chapter 11 reorganization or have no hope of resuming as a viable business may file a Chapter 7 bankruptcy.

Chapter 7 reorganization is a complete liquidation of all company assets.

The proceeds are used to pay off creditors in a specific order:

  • Secured creditors – These are creditors whose loans are backed by some form of collateral, such as land, factories, machinery and so on. Banks or other lenders that finance tangible assets make up this group.
  • Unsecured creditors – These are creditors that have lent money to the company without specific collateral. Banks that provide lines of credit or short-term loans fall into this group along with bondholders.
  • Stockholders – Stockholders are the owners of the company. They would receive a proportionate share of any money left after the creditors are paid. This usually means the stockholder gets nothing because the assets are much less valuable than the debts.
The bankruptcy court will see that the assets are sold for the highest possible price and distribute the proceeds according to the schedule above.

If you own stock in a company that goes into Chapter 7 bankruptcy, the odds are extremely high (practically 100 percent) that your stock will be worthless.

Part 1: What is corporate bankruptcy?

Part 2: The two major forms of corporate bankruptcy.

Part 3: What happens to stockholders and bond owners?