Aon | Financial Services Group
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Chapter 7 is the most common type of bankruptcy in the United States for both individual and business debtors. The main purpose of a Chapter 7 bankruptcy is to “liquidate the debtor’s assets in order to satisfy the debtor’s creditors”.1
After a debtor files a petition for Chapter 7, an injunction called the “automatic stay” takes effect, preventing certain creditors from acting upon the debtor company’s assets. The stay allows for an orderly distribution of assets to creditors by avoiding a “race to the courthouse”.2 The court will appoint a Chapter 7 trustee, who is tasked with collecting and selling debtor property, distributing the proceeds to creditors and closing the estate.3 The allocation of sale proceeds is governed by the priority of creditors’ rights, with the holders of the lowest risk / lowest upside assets first in line to collect from the estate.4 Proceeds first go to creditors holding the most senior secured debt, followed by junior debt holders. Creditors that hold equity (i.e., shareholders) are typically last, if anything remains. As there is no repayment plan, once assets are fully liquidated and the debtor is discharged by the court, the bankruptcy process is concluded.
The Chapter 7 process is preferred for individual debtors and small businesses as it is simple and inexpensive. These same features, however, makes it less attractive to other debtor entities, such as public corporations. Liquating in this way reduces the likelihood of creditors receiving “top dollar” from sales proceeds as the trustee may lack the industry knowledge and contacts that would find the best buyers for the debtor’s assets.
Aon is not a law firm or accounting firm and does not provide legal, financial or tax advice. Any commentary provided is based solely on Aon’s experience as insurance practitioners. We recommend that you consult with your own legal, financial and/or tax advisors on any commentary provided by Aon. The information contained in this document and the statements expressed are of a general nature and are not intended to address the circumstances of any particular individual or entity.