Corporate bankruptcy is unfortunately dominating coronavirus headlines. Executives are requesting bailouts to maintain jobs (looking at you airlines) and politicians butt heads over whose responsibility it is to keep business doors open. But what happens when a company goes bankrupt? Do employees always lose their jobs?
This article walks through the two different types of bankruptcies and what the actual implications are for each type of bankruptcy.
Overview
There are two types of bankruptcy filings that a company can pursue when they are in financial distress, and that’s what determines the implications. When a company files for Chapter 7, this is the most thought of type of bankruptcy because a company will be forced to liquidate (sell everything) and close up shop. However, when a company files for Chapter 11, the company is allowed to restructure its debts and attempt to become profitable again.
Chapter 7 Bankruptcy
When a company files Chapter 7 bankruptcy, this requires an appointed trustee to liquidate all of the companies assets and use those profits to pay down as much of the outstanding debt as possible (as determined by a judge). It’s referred to as a “liquidation bankruptcy.” After the liquidation event, the doors are shuttered because the company is required to stop operating, employees are laid off and shareholders lose virtually all equity in the business.
This is most often what comes to mind when people think of bankruptcy. Companies who file for Chapter 7 have accumulated so much debt that it cripples the business to the point of no return.
Chapter 11 Bankruptcy
When a company files Chapter 11 bankruptcy, they do not have to close their doors, but instead, are allowed to re-organize and attempt to become profitable. The management team will continue to run the business, however, all major decisions must be approved by the court. It’s not uncommon that, if a company survives Chapter 11, not only do they continue operating and maintain jobs, but they often come out even stronger on the other side because they were able to rid themselves of crippling debt that otherwise would have forced them under.
The real losers in this situation are the shareholders – equity owners tend to lose all value in the held stock. This often disproportionately affects the executive team of the company who often holds a large amount of their net worth in their company’s stock.
Understanding the differences between Chapter 7 and Chapter 11 will lead to much more productive conversations, especially when it comes to bail out packages. We’ve heard a lot this year about bailout packages, and lots of arguments back and forth about what industry should receive bailouts vs. not.
When you hear executives claim that jobs will be lost and companies will disappear – pause and think, will this company actually go away entirely? Or will the management team lose a significant amount of their net worth and the company come out stronger? Or maybe something in between?
Personal Bankruptcy
Just like corporations, individuals can also declare bankruptcy. Given the economic challenges many people are enduring throughout this difficult time, this last resort may serve as a relief from insurmountable debts. Individuals are most likely to declare Chapter 7 or Chapter 13 bankruptcy, but others do exist in more unique circumstances. There are also relief programs that state and federal entities offer that may apply to individuals dependent on their situation. Before filing for bankruptcy, individuals should consult a lawyer specializing in bankruptcy law.
Check out additional topics to make personal finance SLIGHTLY EDUCATIONAL on our Personal Finance page.
