When a troubled business is unable to pay its creditors, it may file (or be forced by its creditors to file) for bankruptcy in a federal court under Chapter 7. A Chapter 7 filing means that the business ceases operations unless those operations are continued by the Chapter 7 Trustee. A Chapter 7 trustee is appointed almost immediately, with broad powers to examine the business's financial affairs. The Trustee generally liquidates the assets and distributes the proceeds to the creditors.[2] This may or may not mean that all employees will lose their jobs. When a large company enters Chapter 7 bankruptcy, entire divisions of the company may be sold intact to other companies during the liquidation.
The investors who took the least amount of risk prior to the bankruptcy are generally paid first. For example, secured creditors will have taken less risk, because the credit that they will have extended is usually backed by collateral, such as assets of the debtor company. Secured creditors often know they will get paid first if the company declares bankruptcy.[3] Fully secured creditors, such as collateralizedbondholders or mortgage lenders, have a legally enforceable right to the collateral securing their loans or to the equivalent value, a right which generally cannot be defeated by bankruptcy. A creditor is fully secured if the value of the collateral for its loan to the debtor equals or exceeds the amount of the debt. For this reason, however, fully secured creditors are not entitled to participate in any distribution of liquidated assets that the bankruptcy trustee might make.
In a Chapter 7 case, a corporation or partnership does not receive a bankruptcy discharge. An individual can receive a Chapter 7 discharge (see 11 U.S.C.§ 727(a)(1)). Once all assets of the corporate or partnership debtor have been fully administered, the case is closed. The debts of the corporation or partnership theoretically continue to exist until applicable statutory periods of limitations expire.
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