Business bankruptcy laws give a struggling company four main federal options: Chapter 7 to shut down and sell off assets, Chapter 11 to reorganize while continuing to operate, Chapter 12 for family farms and commercial fishing operations, and Chapter 13 for sole proprietors. Which chapter fits depends on the type of entity, how much it owes, and whether the business has a realistic path back to profitability. The rules are federal, so they work the same in every state.
Chapter 7: Liquidation
Chapter 7 ends the business. A court-appointed trustee takes control of the company’s assets, sells them, and distributes the proceeds to creditors in the order set by federal law.1United States Courts. Chapter 7 – Bankruptcy Basics There is no plan to keep the doors open. Operations stop, and the entity winds down.
One point catches many owners off guard: corporations and LLCs do not receive a discharge in Chapter 7. The entity simply dissolves. Any debts the liquidation proceeds do not cover technically remain on the books, though there is nothing left to collect from. That matters when an owner has personally guaranteed the company’s obligations. Those guarantees survive the business bankruptcy and stay the owner’s personal problem, which is why guaranteed debts often push owners into a separate personal filing.
Chapter 11: Reorganization
Chapter 11 keeps the business running while it restructures what it owes. The company can negotiate lower interest rates, extend repayment timelines, or reduce balances, all subject to court approval and creditor input.2United States Courts. Chapter 7 – Bankruptcy Basics – Section: Alternatives to Chapter 7 The goal is survival.
How a Plan Gets Approved
Drafting a plan is not enough. The bankruptcy court applies several tests before confirming it. Every class of creditors whose rights are altered must either accept the plan or receive at least as much as they would have received in a Chapter 7 liquidation — the “best interests” test. At least one impaired class must vote in favor, and that vote cannot come only from company insiders.3Office of the Law Revision Counsel. 11 U.S. Code 1129 – Confirmation of Plan The court must also find the plan feasible and unlikely to lead to another bankruptcy.
When a class refuses to accept, the debtor can still push the plan through a “cramdown.” The court can impose the plan on dissenters if it does not discriminate unfairly and is fair and equitable, which triggers the absolute priority rule: higher-priority creditors get paid in full before lower-priority creditors or equity holders receive anything. Once confirmed, the plan discharges most pre-petition debts and binds every party, including creditors who voted no.4Office of the Law Revision Counsel. 11 USC 1141 – Effect of Confirmation For corporate debtors, discharge does not reach debts arising from fraud against the government or taxes tied to fraudulent returns.
Subchapter V for Smaller Companies
Subchapter V is a streamlined version of Chapter 11 built for smaller businesses. It uses shorter deadlines, gives more flexibility in creditor negotiations, and eliminates the U.S. Trustee quarterly fees that regular Chapter 11 debtors pay. Eligibility requires total debts of no more than $3,024,725, after a temporary increase to $7.5 million expired in June 2024.5United States Department of Justice. Subchapter V Small Business Reorganizations Legislation to permanently restore the higher limit was introduced in early 2026 but has not been enacted.
When Reorganization Doesn’t Work
A Chapter 11 case can convert to Chapter 7. The debtor can usually request conversion voluntarily, and any creditor or interested party can ask the court to convert the case “for cause.” Cause includes continuing losses, mismanagement of the estate, unauthorized use of assets, or failure to comply with court orders.
Chapter 12 and Chapter 13: Specialized Repayment
Chapter 12 is reserved for family farmers and commercial fishing operations, whose seasonal cash flow makes standard timelines unworkable. Eligible farmers can carry up to $12,562,250 in total debt; fishermen face a $2,568,000 cap.6United States Courts. Chapter 12 – Bankruptcy Basics Both use a three-to-five-year repayment plan matched to their income patterns.
Sole proprietors — where the owner and the business are legally the same person — usually file under Chapter 13 rather than Chapter 11. Chapter 13 lets the owner keep assets and pay a trustee out of future income over three to five years. Eligibility requires unsecured debts under $526,700 and secured debts under $1,580,125.7United States Courts. Chapter 13 – Bankruptcy Basics
The Automatic Stay
Filing any bankruptcy petition triggers an automatic stay that immediately freezes almost all collection activity against the business and its property. Creditors cannot file or continue lawsuits, foreclose, repossess equipment, or seize bank accounts for pre-filing debts.8Office of the Law Revision Counsel. 11 U.S. Code 362 – Automatic Stay No separate hearing is needed. The stay prevents a scramble among creditors and gives the case room to run.
The stay has built-in exceptions. Criminal proceedings against the debtor continue. Government agencies keep their police and regulatory authority, so environmental enforcement and workplace safety investigations do not pause. Tax audits and the issuance of tax deficiency notices also proceed normally. A creditor can ask the court to lift the stay on specific property by showing the debtor has no equity in it or that the property is not necessary for reorganization.
Who Gets Paid First
Creditors are not treated equally. Federal law sets a strict payment order, and it matters whether you are running the bankrupt business or owed money by one. The priorities run roughly like this:
- Domestic support obligations — alimony and child support come first.
- Administrative expenses — trustee fees, attorney fees, and post-petition operating costs of the bankruptcy itself.
- Gap-period claims — in involuntary cases, ordinary-course debts incurred between the filing and the order for relief.
- Employee wages — up to $17,150 per worker for wages, salaries, commissions, and accrued leave earned within 180 days before the filing or the business closing, whichever came first.
- Employee benefit plan contributions — unpaid contributions to health, retirement, and similar plans, also capped at $17,150 per employee.
- Certain tax claims — income taxes, employment taxes, and other specified obligations owed to government units.
After priority claims are satisfied, secured creditors collect from the specific collateral backing their loans. General unsecured creditors get whatever is left, which is often pennies on the dollar or nothing. Shareholders and other equity holders stand last and rarely recover anything.9Office of the Law Revision Counsel. 11 USC 507 – Priorities
Trustees, Debtors in Possession, and New Financing
In Chapter 7, the U.S. Trustee Program appoints a private trustee who takes control of the company’s assets, liquidates them, and distributes the proceeds by the priority ladder.10United States Department of Justice. U.S. Trustee Program – Private Trustee Information The trustee is neutral. No single creditor should be favored over the others.
Chapter 11 is different. Existing management typically stays in place as a “debtor in possession” and continues running the business day to day. That authority comes with a duty. The debtor in possession owes a fiduciary obligation to creditors, not to shareholders, and every decision has to protect the value of the estate for the people owed money. The court requires periodic financial reporting and must approve significant transactions like asset sales or new financing.
Reorganizing companies often need fresh capital, and the Bankruptcy Code provides a framework for getting it. A debtor in possession can take on ordinary-course unsecured credit without court approval. Anything beyond that — unusual unsecured borrowing, loans secured by estate property, or priority financing — requires a court hearing.11Office of the Law Revision Counsel. 11 USC 364 – Obtaining Credit The system works as an escalating ladder. If unsecured lenders will not come to the table, the court can authorize borrowing with priority over other administrative expenses, or secured by liens on unencumbered property. In extreme cases, the court can approve “priming liens” that jump ahead of existing secured creditors, but only if those creditors receive adequate protection. The debtor bears the burden of showing that less aggressive options failed.
Payments the Trustee Can Claw Back
Trustees have the power to unwind certain payments and transfers the business made before filing. This is one of the most consequential features of business bankruptcy and often surprises creditors.
A trustee can recover payments made to creditors within 90 days before the bankruptcy filing if those payments gave one creditor more than it would have received in a Chapter 7 liquidation. The logic is simple. Once a company is sliding toward bankruptcy, it should not be picking favorites.12Office of the Law Revision Counsel. 11 USC 547 – Preferences For insiders like officers, directors, and affiliated entities, the lookback runs a full year.
The trustee can also undo transfers made within two years before the filing where the business received less than fair value and was insolvent or undercapitalized at the time.13Office of the Law Revision Counsel. 11 U.S. Code 548 – Fraudulent Transfers and Obligations That covers things like selling equipment to a related company for a fraction of its worth or transferring real estate to a family member for a nominal price. Transfers made with actual intent to defraud creditors are voidable within the same two-year window.
Debts That Survive Bankruptcy
Not every obligation disappears. For individual debtors, including sole proprietors in Chapter 7 or Chapter 13, several categories are specifically excluded from discharge:
- Money obtained through false pretenses, false representations, or a materially false written financial statement the creditor relied on.
- Most recent tax debts, taxes where a return was never filed or was filed late, and taxes the debtor tried to evade.
- Debts arising from willful and malicious injury to another person or their property.
- Government fines and penalties that are not compensating for actual financial loss.
- Debts the business failed to list on its paperwork in time for the creditor to participate in the case.
A creditor who believes a particular debt falls into one of these categories has to file an adversary proceeding within 60 days after the first date set for the meeting of creditors.14Office of the Law Revision Counsel. Rule 4007 – Determining Whether a Debt Is Dischargeable Miss that deadline and the debt generally gets discharged with everything else.15Office of the Law Revision Counsel. 11 U.S. Code 523 – Exceptions to Discharge
When Creditors Force the Filing
Bankruptcy is not always the debtor’s choice. Creditors can push a business into Chapter 7 or Chapter 11 with an involuntary petition. If the business has 12 or more creditors, at least three must join the petition, and their combined undisputed claims must total at least $21,050 above the value of any collateral securing those claims. With fewer than 12 creditors, one creditor meeting that dollar threshold can file alone.16Office of the Law Revision Counsel. 11 USC 303 – Involuntary Cases
Involuntary petitions are relatively uncommon because the risk runs both ways. If the court dismisses the petition, the filing creditors can be ordered to pay the debtor’s attorney fees and damages, including punitive damages for a bad-faith filing.
Filing the Petition
A bankruptcy case formally begins when the petition is filed with the clerk of the bankruptcy court in the federal district where the business is headquartered or holds its principal assets. The court assigns a case number, designates a judge, and schedules the meeting of creditors — commonly called the “341 meeting.” This is not a courtroom hearing. A trustee runs the session, and the business’s representatives answer questions under oath about their financial disclosures and the assets in the estate.17United States Department of Justice. Section 341 Meeting of Creditors
The petition has to be filed with a detailed inventory of everything the business owns, from real estate and equipment to intangibles like trademarks. Every liability has to be identified: secured loans, unsecured trade debt, outstanding taxes. A statement of financial affairs covers recent payments and property transfers, giving the court and trustee a view into whether any pre-filing transactions deserve scrutiny. All of this goes on official forms available through the U.S. Courts website, including Schedule A/B for property and Schedule D for secured claims.18United States Courts. Bankruptcy Forms The business must also file copies of federal tax returns for the most recent tax years.19Internal Revenue Service. Declaring Bankruptcy
What It Costs
The court charges $338 to file a Chapter 7 petition and $1,738 for Chapter 11. Chapter 11 cases also carry ongoing U.S. Trustee quarterly fees based on disbursements. Beginning April 1, 2026, those fees range from $250 per quarter for cases disbursing under $62,625, up to $250,000 per quarter for cases disbursing roughly $27.8 million or more. Subchapter V cases are exempt. All payments are made electronically through the U.S. Trustee Program’s Pay.gov portal.20United States Department of Justice. Chapter 11 Quarterly Fees
Filing fees are a small piece of the total. Attorney fees vary with the complexity of the case, the chapter filed, and the size of the company. Hourly rates for experienced commercial bankruptcy attorneys commonly run from the low $400s to over $500 per hour. A straightforward small-business Chapter 7 might cost a few thousand dollars in legal fees, while a contested Chapter 11 for a mid-sized company can easily reach six figures. The court reviews all professional fees for reasonableness before they are paid from the estate.