90 Second Lesson: Why Would a Debtor Choose to Liquidate Under Chapter 11?

Question: A reader asks, “I read about a company that filed Chapter 11 recently with a plan to sell all assets and go out of business. Why wouldn’t it file Chapter 7?”

Answer: While it is true that the title of Chapter 7 is “Liquidation” and the title of Chapter 11 is “Reorganization,” these names are deceiving.

When a Chapter 7 bankruptcy is filed, the business (the “debtor”) almost always stops operating. The Chapter 7 trustee takes over control of the debtor’s assets (its “estate”) and liquidates them for the benefit of creditors.

Many times, however, a business is worth far more if it can be sold as a going concern. That requires the business to continue operating in bankruptcy, and that can be achieved in a Chapter 11 bankruptcy, in which the debtor becomes a Debtor-in-Possession (DIP) (rather than a trustee being appointed).

The DIP may have negotiated a sale with a purchaser prior to bankruptcy but the buyer wanted the free and clear protections under 363(f). Filing Chapter 11 would allow the DIP and the purchaser to complete the sale free and clear if the provisions of section 363(f) are met.

The debtor may want to sell the business as a going concern. To certain purchasers, a going concern business will be worth more than a business that has stopped operating. Because the DIP retains control in Chapter 11, the business can keep operating as it had been prior to the bankruptcy, thus preserving its going concern value.

In short, the debtor in its business judgment may find that liquidation under Chapter 11 provides more benefits than liquidation under Chapter 7.

[Editor’s Note: This 90 Second Lesson is part of our irregular series in which we answer readers’ questions. If you have a question, submit it to [email protected] and we will try to answer it.
To learn more about this and related topics, you may want to attend the following webinars: The Nuts and Bolts of a 363 Motion and Help, My Business Is in Trouble.]