Chapter 7 Bankruptcy and Liquidation Issues

• Author: By Michael Conway and Michelle Shriro
• Pages: 209-232

209

For companies and individuals carrying a large debt load with no pos-

sibility of restructuring, Chapter 7 of the Bankruptcy Code1 provides an

individual or a business protection from creditors as well as a forum

to conduct an orderly liquidation. Chapter 7 may be appropriate for

many reasons such as in the case of a franchisee or franchisor which

has a money losing business and there is no possibility of turning the

business around and/or restructuring debts. In other cases, the busi-

ness operations may already be shut down and the owners may desire

to have an orderly liquidation of the business assets. Alternatively, the

franchisee company may be in expensive litigation with a party such

as its franchisor and lacks the funds to continue the litigation. Some

Chapter 11 debtors in a pending bankruptcy case may determine for

business or legal reasons that a reorganization is no longer possible

and seek to convert the case to a Chapter 7 liquidation. An individual

with signicant debts such as a guaranty of the franchise agreement

may also consider Chapter 7 if such individual desires to obtain a fresh

start by discharging his or her debts and does not have an ability or

the resources to pay such debts in a plan or otherwise.

I. GENERAL PRINCIPLES OF A CHAPTER 7

BANKRUPTCY—DISCLOSURE

The framework of Chapter 7 allows either a company or an individual

to le a bankruptcy case which serves as a forum and a process for

the orderly liquidation of a debtor’s debts. An individual can obtain

1. The sections of the Bankruptcy Code that specically pertain to Chapter 7 can be

found in 11 U.S.C. §§ 701–27.

Chapter 7 BankruptCy

and Liquidation issues

By Michael Conway and Michelle Shriro

10

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210 Chapter 10

a “fresh start” by discharging his or her debts (subject to certain exceptions).

Once the bankruptcy petition is led, companies and individuals get the benet

of the automatic stay2 which has the effect of staying all collection activities by

creditors and stopping all litigation from continuing.

Disclosure of assets and liabilities by the debtor company or individual is a cen-

tral principle of Chapter 7. In both individual and corporate cases, Chapter 7 debt-

ors are required to complete detailed Schedules and Statement of Financial Affairs,

in which the debtor lists all assets it owns and all liabilities it owes.3 The Sched-

ules and Statement of Financial Affairs are signed under oath and led with the

bankruptcy court. In both individual and corporate cases, the corporate debtor

representative or the individual debtor are required to attend a creditors’ meet-

ing (commonly called a section 341 creditors’ meeting after the governing Bank-

ruptcy Code section), in which the corporate representative or individual debtor

is required to testify and to answer questions under oath about their assets and

liabilities.4 Failure to complete the Schedules and Statement of Financial Affairs

truthfully, correctly, and specically in situations when all assets are not disclosed,

could have serious consequences for the debtor entity or the person signing the

Schedules on behalf of the corporate entity. This includes criminal implications or

in the case of an individual, the potential loss of an individual’s discharge.5

A Chapter 7 trustee is automatically appointed to administer the remaining

assets of the debtor company or individual.6 Creditors who are owed money

by the debtor company receive notice of the bankruptcy ling and should le

claims in the bankruptcy case, provided there are assets in the case.7 The Chap-

ter 7 trustee will pay the claims on a pro rata basis in accordance with the prior-

ity scheme established by the Bankruptcy Code. Often, a creditor will assume,

typically based on prior experiences, that it is not worth the time to get involved

in the Chapter 7 claims process. However, at a minimum, since the cost of ling

a claim is typically low, it is generally worth the cost of ling a claim in Chapter

7 cases in which there are assets. In addition to ling the claim, in the case of

an individual, a creditor can seek to have its debt declared non dischargeable.8

Finally, there are numerous non monetary remedies a franchisor may need to

seek, including relief from the automatic stay to terminate its franchise agree-

ment or deidentify the premises.

Prior to a section 341 meeting of creditors, an analysis should be made con-

cerning whether a different Chapter 7 trustee with more experience in the type

of assets being liquidated might be of value. Specically, the Bankruptcy Code

2. 11 U.S.C. § 362(a).

3. 11 U.S.C. § 521.

4. 11 U.S.C. § 341.

5. 18 U.S.C. § 157; 11 U.S.C. §§ 727(a)(2)(3)(4) & (5).

6. 11 U.S.C. § 701(a).

7. The distinction between “asset” and “no asset” cases is discussed later in this chapter.

8. 11 U.S.C. § 523.

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