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How does Chapter 7 work for businesses?

Individual consumers experience financial challenges all the time. Many people think that businesses or companies are immune from such challenges because they have greater assets, as well as potentially greater access to financial resources. However, running a successful business is difficult and it is not at all uncommon for a business owner to find herself in the position where she is burdened by severe debt. In these cases, Chapter 7 bankruptcy could be a helpful solution.

When a business files for bankruptcy, it generally has the option of filing under Chapter 7 or Chapter 11. Even though individuals also have the option of filing for bankruptcy under Chapter 7, the process of filing under Chapter 7 for businesses is very different than when individual consumers file. Chapter 7 bankruptcy is often referred to as debt liquidation bankruptcy because filing under this chapter requires a business to liquidate its assets in order to use the process to repay its debt obligations. Because of the asset liquidation aspect of Chapter 7 for businesses, this type of bankruptcy effectively constitutes a winding down or termination of the business.

Although Chapter 7 can be an effective way for businesses to get out from under seriously burdensome debt, there are some important limitations in the debt relief provided to businesses filing for Chapter 7. Although individual consumers receive a discharge of all remaining debt after assets are sold and used to repay whatever debt possible, there is a discharge prohibition for businesses. This means that any debts that are no repaid during the liquidation and sale of the business's assets remain after the bankruptcy, and creditors can contine to seek repayment of those debts from the business or business owners. However, despite the fact that there is no legal discharge, this situation results in a "practical discharge" because there are no remaining assets for creditors to pursue for repayment after a business has ceased operation.

Because any leftover debt continues to remain after the business effectively ceases to exist as a legal entity, employees, officers, shareholders, affiliated companies or other people can continue to be held liable for remaining debts after a Chapter 7 bankruptcy is concluded in certain situations. Filing under Chapter 7 does nothing to eliminate this personal liability for business debts.

Source: The Journal of the DuPage County Bar Association, "Dissecting Chapter 7 Bankruptcy for Businesses," David M. Madden, 2009-2010

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