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Difference between Chapter 7 and Chapter 11 bankruptcy: Yahoo U

The retail apocalypse struck again this week with Pier 1 Imports (PIR) announcing massive store closures and rumors spread that the company could be headed for bankruptcy. Pier 1 is shutting nearly half of its 942 stores and Bloomberg reported that the retailer drafted a bankruptcy plan and presented ideas for a smaller version of the retailer to some creditors. 

Companies filing for bankruptcy often turn to two options: Chapter 7 and Chapter 11.

In Chapter 7 bankruptcy, most assets are liquidated. Outstanding leases get cut off and in some cases the loan balance will be discharged (although the underlying asset like a company car or office space will have to be surrendered). A trustee would be appointed to liquidate other assets like trademarks and intellectual property. Cash raised from those sales are then paid out to the lenders. In many cases, Chapter 7 results in full liquidation of the company.

But what if a company wants to clear some of the debts but wants to leave assets, at least some of it, to have maybe one more shot at a comeback? They could choose Chapter 11 bankruptcy, or “reorganization.”

In a re-org, the company would submit a debt repayment plan to the bankruptcy court. This plan includes ways to pay down all the debts that are due. The plan has to include steps the company is willing to take to pay back creditors. In Chapter 11, an executive’s personal assets are not at risk, although the value of any stock held would obviously be affected.

But Chapter 11 is a two way street with creditors. Creditors can disapprove of a re-organization plan, and in some cases can actually convert the Chapter 11 to a Chapter 7.

According to the U.S. Court system, there were over 773,000 bankruptcy cases filed in the U.S. in 2018. This figure also includes personal bankruptcy cases, not just companies.  The majority, 61%, filed for Chapter 7. Only 1% of the cases were Chapter 11 bankruptcies.

Climbing out of Chapter 11 is a tough task to pull off, but there have been success stories in the past. In 1996, Marvel climbed out of Chapter 11. And then there's also all the major airline carriers: United Arlines filed for Chapter 11 in 2002, Delta in 2005, and American Airlines in 2011. 

Note: This story originally stated that companies filing for Chapter 7 would have their outstanding debt discharged. The story was amended on January 13 to clarify that in some cases, principal loan balances can be discharged.

Brian Cheung is a reporter at Yahoo Finance. Valentina Caval is a producer with Yahoo Finance’s On the Move.

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