Chapter 11 is a procedure for businesses and individuals with sophisticated financial situations. Sometimes companies and individuals are losing money and they’re losing value in their assets and that’s at the expense of creditors. When that happens a bankruptcy court will say, no you don’t have the right to continue to reorganize at the expense of creditors. We’re going to take that right away, we’re going to put you into a Chapter 7 case and we’re going to liquidate your assets for the benefit of creditors. Now usually for a business the conversion of a case to Chapter 7 is a death sentence because it means that their operations will have to close, that their assets will be liquidated and the company will have to close its doors. For an individual sometimes it’s the best possible thing because that means that the individual’s post-bankruptcy earnings will now be all of theirs. They won’t have to account for them to the bankruptcy court and in a lot of ways the struggle is over. But sometimes giving up that struggle is the best possible thing because it enables you to just get a fresh start. How does the court know if you’re losing money? Every month a Chapter 11 debtor needs to file reports of their income and their expenses and a running balance sheet for the last month. The court can look and see if you’re losing money because your income is not as high as your expenses. Usually you’ve got a few months after filing a Chapter 11 case to make your case, as it were, and to prove that you can be profitable in the long run. But if it turns out that month after month you’re losing money, the bankruptcy court will shut that Chapter 11 case down and convert it to a Chapter 7 case. Another reason why a Chapter 11 case is converted to Chapter 7 is if the debtor is committing fraud or gross mismanagement of their business operations. That’s a tough standard for the creditor to prove but frequently bankruptcy debtors are scared, they’re afraid to lose control of their assets, they’re afraid of what the bankruptcy court will do if they fully expose all of their assets and all of their income and so they make mistakes in judgment and when that happens, bankruptcy court won’t hesitate – they will convert a Chapter 11 case to Chapter 7.
Why do Chapter 11 cases get converted to Chapter 7?
Ronald J. Drescher has been practicing since 1986 in the areas of business transactions, commercial litigation, loan documentation, bankruptcy, creditors’ rights, and out-of-court workouts. His experience also includes corporate reorganizations, insolvency, business and tax planning.