Corporate Finance Tutorials
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In 2002, Worldcom filed for one of the largest bankruptcy ever. Worldcom had $41 billion of Debt while it filed for Chapter 11 Bankruptcy. Do you know that there are primarily five diverse types drawn by Bankruptcy Code of the United States. A respective bankruptcy type is recognized by the Code’s chapter that defines the code.
In this article, we look at these 5 types of Bankruptcies –
- Chapter 7 Bankruptcy: Liquidation
- Chapter 9 Bankruptcy: Adjustment of Municipality Debts
- Chapter 11 Bankruptcy: Restructuring
- Chapter 12 Bankruptcy: A Family Farmer Debt Adjustment with Regular Income
- Chapter 13 Bankruptcy: Modification of an Individual’s Debts as per Regular Income
Chapter 7 Bankruptcy: Liquidation
Chapter 7 Bankruptcy is also referred to as “complete bankruptcy,” or “straight bankruptcy,” or “liquidation,” which is believed to be the most frequent form of bankruptcy being filed among persons. Chapter 7 basically enables the defaulter to start fresh.
Under the successful reporting of Chapter 7 case, a representative gathers the nonexempt assets of the debtor, which are later converted to cash, subsequently, cash distributions are started to all the creditors as per the bankruptcy law.
In several cases of Chapter 7, the debtor gets a release discharging the individual from personal obligation for some known dischargeable debts. One must consider filing for a Chapter 7 while there exists no expectation of any successful debt repayments by the debtor, there exist no cosigners in the case, or else court act by creditors become pending. Further, companies that demand liquidation of their assets while discontinuing their business could even file for bankruptcy under Chapter 7.
Any individual considering to file Chapter 7 must have the knowledge of fact that he/she is susceptible to lose their property while filing for bankruptcy under Chapter 7. Any direct bankruptcy case may not include suggesting a settlement plan, such as that needed while filing for bankruptcy under Chapter 13, however as an alternative needs the bankruptcy representative to collect and send the nonexempt assets of the debtor. The creditors would receive distributions in accordance with the Bankruptcy Code while selling the assets of the debtor.
Chapter 7 Bankruptcy – Eligibility:
Nearly anyone is eligible for filing a bankruptcy petition under Bankruptcy Chapter 7 including, partnerships, corporations, couples, and individuals. Chapter 7 enables relief irrespective of the debt amount or if the debtor stands solvent or bankrupt.
A person might not file for Chapter 7, else a different chapter, if over the past 180 days a previous bankruptcy case was discarded driven by the willful failure of debtor to remain present in the court else obey the court else the debtor willingly withdrew the earlier petition post creditors demanded aid from the court to successfully recover property on which they have ownership.
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The release of debts isn’t present for partnerships or corporations under Chapter 7. This Chapter just allows individuals to discharge their debts. In addition, after having filed for Chapter 7, one isn’t qualified to again file the case for about six years.
Chapter 7 Bankruptcy Example
Acclaim Entertainment, an originally American video game development company that was founded in 1987 after few years of operations filed for a Chapter 7 case on September 1, 2004 in New York.
Therefore, the company was asked to pay off all their debt that exceeded USD$100 million by liquidating each of its valuable assets and settle the payment for all its creditors.
Also, have a look at Liquidation Value
Chapter 9 Bankruptcy: Adjustment of Municipality Debts
Just a municipality, for example school districts, municipal utilities, taxing districts, counties, villages, towns and cities might file for Bankruptcy Chapter 9. Under this chapter, the municipality is believed to reorder and suggest a strategy of reimbursement, alike the Chapter 11 Bankruptcy case.
Chapter 9 Bankruptcy – Eligibility:
Just a “Municipality” could file for getting respite under Bankruptcy Chapter 9. “Municipality” refers to a governmental sector or public support or any State’s instrumentality. Its definition is wide enough to comprise of public enhancement districts, school districts, townships, counties and cities. Municipality even comprises of revenue-generating groups that deliver services which needs to be paid by the users instead of through usual taxes, for example gas authorities, highway authorities, and bridge authorities.
The Bankruptcy Code’s section 109(c) identifies four extra eligibility requests for Chapter 9 Bankruptcy:
- Any organization or governmental officer or the municipality must be authorized by the State law to become a debtor.
- The municipality need to be bankrupt, as per the section 101(32) (c) of 11 U.S.C.
- The municipality need to express a desire for implementing a strategy for debt adjustments; and
- The municipality need to do either of the following:
- Attain the creditors contract for holding as a minimum a significant number of each class claims that any debtor aims to damage under a strategy for a specific case filed under Chapter 9;
- Failing to capture the contract of creditors that hold a minimum of the number of claims of every class that debtor intends to damage through a strategy while negotiating positively with creditors.
- Unsuccessful negotiation with creditors owing to such negotiations standing unviable; or
- Rationally believing that any creditor might try to get a preference.
Chapter 9 Bankruptcy Example
A tiny health care district in Northern California filed for Chapter 9 petition on October 17, 2010 illustrating the situation as to be having over 200 creditors as well as overall liabilities in the range of $10 million to $50 million.
The latest audited financial documents of 2010 indicate that the district possess $11.7 million worth of remaining bonds including, the 1996 $2.5 million worth of insured revenue bonds, the 2009 $4.9 million worth of insured revenue bonds as well as $4.3 million worth of broad obligation bonds introduced in 2001.
Chapter 11 Bankruptcy: Restructuring
Chapter 11 Bankruptcy is mainly applicable to commercial companies that prefer continuing with their business operations though reimbursing creditors by acting upon a court-permitted restructuring plan.
The Chapter 11 plan allows the debtor with a right to apply for a restructuring plan in 120 days post the court’s relief order has been released. Debtors are obligated to provide a revelation statement to creditors that enables the latter to assess the plan, though will the plan get approved is eventually decision of the Court.
Further, the debtor is believed to have several options under Bankruptcy Chapter 11 for forcing the business towards delivering profitability. These possibilities comprise plummeting debts by reimbursing a part of them whereas settling others, settling troublesome leases and agreements, and redeveloping the business operations. Upon complete strategy implementation, the debtor typically witnesses an integration period and arises with a minimized debt load as well as a highly profitable and reorganized business.
Chapter 11 Bankruptcy – Eligibility:
Businesses and individuals may similarly file under Bankruptcy Chapter 11. Though, Chapter 11 is principally implemented in case of business debt. Most of the time companies file for Bankruptcy under Chapter 11 when their overall debts surpass the Chapter 13limits. For filing a bankruptcy under Chapter 13, the party must be obliged to pay under $269,250 in unsecured, liquidated and non-contingent debts, while below $807,750 in secured, liquidated and non-contingent debts. A debtor is barred from filing a case under Chapter 11, else any different chapter, under few conditions such as during the past 180 days a previous bankruptcy appeal was terminated because of the debtor’s deliberate disappointment for appearing in front of the court else obey the court orders otherwise the debtor willingly terminated the earlier case once creditors demanded respite from the court for recovering property on which they demanded justice.
Chapter 11 Bankruptcy Example
Enron filed for Chapter 11 bankruptcy when it employed 21,000 people and had a revenue of $111 billion!.
Chapter 12 Bankruptcy: A Family Farmer Debt Adjustment with Regular Income
The Bankruptcy Chapter 12 allows debt respite to family farmers having consistent yearly income. Bankruptcy Chapter 12 appears hugely like Bankruptcy Chapter 13 since both these bankruptcy choices enable the borrower to suggest a strategy of debt reimbursement over the period of say three to five years, coupled with a trustee being allocated to overlook the complete bankruptcy process while disbursing the payments received to all the creditors once the case finishes successfully. Chapter 12 enables a family farmer to stay with their operations on the farm whereas the strategy is being continued.
Chapter 12 Bankruptcy – Eligibility:
- Consistent Annual Income
This Bankruptcy Code illustrates that just a family fisherman or family farmer having “consistent annual income” might file for Bankruptcy chapter 12 to get some respite. This condition is required in order to make sure that the yearly income of debtors become adequately regular and stable for allowing the debtors to successfully pay under chapter 12 strategy. However, chapter 12 allows for conditions in which fishermen or family farmers have income generally periodic in nature. The debtors filing petition for relief under chapter 12 get free of cost help or respite.
- “Family Fishermen” and “Family Farmers”
This Bankruptcy Code puts “family fishermen” and “family farmers” in two key categories: (i) one person or one person with the spouse and (ii) a partnership or corporation. Fishermen or farmers belonging to the first category need to satisfy all the subsequent four conditions on the date when the case is filed for relief qualification under Bankruptcy Chapter 12:
- A single person or a couple must be involved in a profitable fishing activity or a farming activity.
- The overall debts including, unsecured and secured of any operation need not surpass $1,500,000 in the case of a profitable fishing activity or $3,237,000 in the case of a farming activity.
- In the case of a family fisherman, a minimum of 80% and in the case of a family farmer a minimum of 50%, of the overall debts that remain constant in amount (removing the debtor’s home debt) needs to be linked with the profitable fishing or farming operation.
- Over half of the consolidated income of any individual or any couple for the previous tax year (else, just for family farmers for both the 2nd as well as 3rd previous tax years) need to be achieved from the profitable fishing or farming activity.
Chapter 12 Bankruptcy Example
David, a family farmer who is continuing to farm his land since past 10 years in the state of Florida, US. Suddenly, due to the global downturn in the agricultural market the price of his crop production declined significantly that forced the farmer to go in a state of Bankruptcy as the overall cost of production continues to rise whereas, the farm output does not get the right price upon trading that has forced David to file for Chapter 12 to get some compensation. David reports total debt of his commercial farming operation to be nearly 2,250,000.
Since David complies with all the rules of Chapter 12 hence, he can successfully file a case under the section to get some compensation while continuing with his farming business profitably.
Chapter 13 Bankruptcy: Modification of an Individual’s Debts as per Regular Income
Chapter 13 Bankruptcy being made for persons who possess a steady income source and wishes to pay off all their debts, however at present is incapable of doing so. The Bankruptcy Chapter 13 might be desirable to the Chapter 7 since Chapter 13 typically lets the debtor hold on to a precious asset, for example, an individual’s house. The debtor is empowered to place and suggest a key strategy in front of the court under Bankruptcy Chapter 13. The strategy describes the way debtor would reimburse creditors with time over a period ranging from three to five years. Finally, the Court should later approve this strategy.
Suppose the Court accepts the strategy, the debtor would need to pay the creditors via a trustee. Hence, the debtor gets protected from all the actions taken by creditors that include actual agreement with that debtor for entire strategy’s life, wage garnishments, and lawsuits. Any outstanding debt would be discharged upon the successful plan completion.
Chapter 13 Bankruptcy – Eligibility:
- Businesses must have adequate disposable income (DPI) including, salary or regular wages, pension payments, social security gains, public gains (welfare payments) etc.
- Overall debt should not be extremely high.
- The Bankruptcy filing candidate must be currently on his/her income tax reporting.
Chapter 13 Bankruptcy Example
Josh, a book-seller and having an annual turnover of $1, 50,000 and regularly files for income tax on the annual basis. However, due to a sudden downturn in the economy, he witnesses significant losses due to continued declining sales as people start saving more and minimizes visiting the shop. Thereby, subsequently, Josh has a huge pile of debt nearly $1, 00,000 with no cash to repay the vendors and creditors.
Under this situation, since Josh is successfully meeting all the conditions of filing a Chapter 13 petition he subsequently decides to hire a lawyer and file a Chapter 13 Bankruptcy petition to get some financial respite.