by Jeff Smoot

Most corporate bankruptcy filings are under Chapter 11, the “reorganization” chapter of the Bankruptcy Code. However, corporations can and sometimes do file under Chapter 7. A Chapter 7 “liquidation” case is usually filed by individual debtors, who can claim certain property as exempt (e.g., homestead, motor vehicle, household goods and furnishings, pension fund), which they can keep even if that leaves nothing for creditors. And individual Chapter 7 debtors receive a discharge, prohibiting their pre-bankruptcy creditors from taking any action to enforce any otherwise dischargeable debt after the case is completed. A Chapter 7 trustee is appointed to take possession of and sell all non-exempt assets for the benefit of creditors. Creditors are paid from sale proceeds based on their priority (e.g., secured, unsecured, equity), with unsecured creditors paid on a pro-rata basis based on the amount of funds available and the amount of each allowed claim. If sufficient assets are recovered and liquidated by the trustee to pay all unsecured creditors in full, any surplus funds may be available for the debtors, although in most Chapter 7 cases there is not enough to pay unsecured creditors more than a few cents on the dollar, if anything.

The process is basically the same for a corporation filing Chapter 7. Once the case is filed, the company ceases its business operations and a trustee is appointed to liquidate its remaining assets. However, unlike an individual debtor, a corporation cannot claim exemptions; all of its assets are available for creditors. Also, a corporation cannot receive a discharge; if it has anything left that was not administered in the bankruptcy case, creditors can still enforce their rights against it after the case is closed.

Essentially, a Chapter 7 filing has the same result as a corporate dissolution under state law (the usual way of winding up a defunct corporation), but with the benefit of having the process overseen by a disinterested trustee. In most cases, it makes more sense for a corporation that is hopelessly in debt and unable to continue in business to simply close the doors, notify creditors, wind up the corporation’s affairs, and be done with it. However, filing a corporation into Chapter 7 may be appropriate and beneficial under a number of circumstances, including:

• Where a creditor is taking action to levy on or lien assets of the corporation that could be used to pay other creditors or, especially, debts that the corporate officers have personally guaranteed or would be personally liable to pay such as wages or trust fund taxes.

• When a bankruptcy filing would discourage or prevent a creditor from filing an action naming corporate officers personally, or cut off potential future claims that might include individual officer liability such as unpaid wage claims.

• Where the corporation's officers and directors are concerned that creditors or shareholdlers may allege that they did not properly liquidate the company if they did it themsleves.

• Where the corporation has an asset such as an account receivable that is recoverable but the corporation does not have adequate funds to pursue collection. A bankruptcy trustee may be in a much better position to recover an asset using the trustee's strong-arm powers under the Bankruptcy Code than an insolvent corporation.

• Any other situation where it makes sense for a bankruptcy trustee to liquidate the remaining assets of the corporation and distribute them to creditors.

Although the appointment of a bankruptcy trustee may seem like an economical way to wind up a business, filing a corporation into Chapter 7 just to avoid the burden and expense of winding up the company can be viewed as an abuse of the bankruptcy process, leading to dismissal of the case. Bankruptcy trustees are not required to assume the duty of winding up a shell company with no assets. As a general rule, if there are few or no recoverable assets for the trustee to administer and a Chapter 7 filing would be solely for the convenience of the officers and shareholders, then it is inappropriate to file the company into Chapter 7. In such circumstances, the corporation should be dissolved under state law.

It may also be a bad idea to file a corporate Chapter 7 if the company does not want its information made public. A debtor filing Chapter 7 is required to make full disclosure of its assets, debts and financial transactions, and bankruptcy filings are public records. In any case where the company might have information it does not want shareholders, the SEC, law enforcement, or the news media to see, a quiet, private corporate dissolution under state law would be the preferred option.

Also be aware that corporate officers and shareholders have a duty to cooperate with the trustee in his or her investigation and recovery of assets, even if the trustee is attempting to recover assets or transfers from them, such as loan repayments made shortly before filing, draws taken while the company was undercapitalized, or other unauthorized transfers of funds or assets. Turning over the company to a trustee could lead to unexpected results for officers who have mismanaged company assets. A thorough review of the company’s financial transactions by an experienced bankruptcy attorney is advisable prior to committing to a bankruptcy filing under any chapter.

A corporation filing Chapter 7 must be active and in good standing, make a formal resolution approving the bankruptcy filing, and be represented by an attorney. A dissolved corporation lacks capacity to file bankruptcy, and a bankruptcy filing without a corporate resolution would be unauthorized and subject to dismissal.

If your corporation is having financial difficulty and needs advice on how to proceed, whether through dissolution under state law or in bankruptcy, you should consult with a bankruptcy or corporate dissolution attorney.

This article is for informational purposes only, and should not be relied upon as legal advice. No attorney-client relationship is created or intended by publication of this article. If you desire legal advice or representation regarding the issues discussed in this article, please contact Highpoint Law Group PLLC.

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