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Bankruptcy - What Happens in Chapter 7?

By Pamela Jones et al.

What happens if a company ends up in Chapter 7 bankruptcy? Here's the overview from Cornell University School of Law's Legal Information Institute:

Bankruptcy law provides for the development of a plan that allows a debtor, who is unable to pay his creditors, to resolve his debts through the division of his assets among his creditors. This supervised division also allows the interests of all creditors to be treated with some measure of equality. Certain bankruptcy proceedings allow a debtor to stay in business and use revenue generated to resolve his or her debts. An additional purpose of bankruptcy law is to allow certain debtors to free themselves (to be discharged) of the financial obligations they have accumulated, after their assets are distributed, even if their debts have not been paid in full....

There are two basic types of Bankruptcy proceedings. A filing under Chapter 7 is called liquidation. It is the most common type of bankruptcy proceeding. Liquidation involves the appointment of a trustee who collects the non-exempt property of the debtor, sells it and distributes the proceeds to the creditors. Bankruptcy proceedings under Chapters 11, 12, and 13 involve the rehabilitation of the debtor to allow him or her to use future earnings to pay off creditors.

It sounds so simple, when they put it like that. But we've seen how very complex it can end up, in watching SCO in bankruptcy court. But they've been in Chapter 11, where the point is rehab. Catch the point that Chapter 7 is called liquidation? That's the point of it. So if the court grants the motions by the U.S. Trustee's Office, IBM and Novell to send SCO to Chapter 7, then what happens?

Someone has to oversee the liquidation, and in Chapter 7, that means the court has to appoint a trustee, who takes the steering wheel away from the executives and becomes the designated driver. He or she can even run the business for a limited time, while the liquidation is ongoing. So he distributes whatever there is left, following the rules of distribution, and then the slate is wiped clean, and the bankrupt owes no more. In the case of a company, as opposed to an individual, it also means it exists no more. Of course, with SCO, nothing is that simple, and because of the litigation, there has to be some way to get that all worked through and decided. But it's the trustee who decides what to do, not the current executives.

Full post as published by Groklaw on May 29, 2009 (boomark / email).