Bankruptcy Overview: Chapter 7 & Chapter 11
In the context of commercial real estate, bankruptcy refers to a legal status that a business entity may enter when it is unable to repay its outstanding debts. The primary purpose of bankruptcy is to provide a structured and fair process for the resolution of financial difficulties, ensuring that creditors are treated equitably and that the debtor has an opportunity for a fresh start.
There are several types of bankruptcy, but the two most common ones for businesses are Chapter 7 and Chapter 11.
Chapter 7 Bankruptcy
- In a Chapter 7 bankruptcy, the business ceases operations, and a trustee is appointed to liquidate the company’s assets.
- The proceeds from the liquidation are used to pay off creditors in a specific order of priority established by bankruptcy law.
- Once the assets are liquidated, the remaining eligible debts are typically discharged, meaning the debtor is no longer legally obligated to repay them.
Chapter 11 Bankruptcy
- Chapter 11 bankruptcy allows a business to continue its operations while reorganizing its debts and financial structure.
- The debtor (business) proposes a plan of reorganization outlining how it intends to repay creditors over time, often by renegotiating contracts, leases, and reducing debt.
- Creditors vote on the proposed plan, and if the court approves it, the business continues operating under new terms.
- Chapter 11 bankruptcy is often more complex and time-consuming than Chapter 7 but provides the opportunity for the business to emerge from bankruptcy as a going concern.
Aspects of Bankruptcy as it pertains to Commercial Real Estate
Automatic Stay: When a bankruptcy petition is filed, an automatic stay is imposed, preventing creditors from pursuing or continuing legal actions to collect debts. This gives the debtor breathing room to formulate a plan.
Impact on Real Estate Leases: In a Chapter 7 bankruptcy, leases may be terminated, and the property may be sold. In Chapter 11, the debtor may choose to assume or reject leases as part of its reorganization strategy.
Secured vs. Unsecured Creditors: Secured creditors have a claim on specific collateral (such as real estate), while unsecured creditors do not. The treatment of these creditors varies in bankruptcy proceedings.
Cramdown: In Chapter 11, a debtor may attempt to “cram down” a plan over the objections of certain classes of creditors. This involves getting court approval for a plan even if not all classes of creditors agree.
It’s essential to note that bankruptcy laws can be intricate, and the specifics may vary depending on jurisdiction. Real estate professionals and stakeholders should seek legal advice to navigate the complexities of bankruptcy.
Disclaimer: The information provided in this post is intended for general informational purposes only and should not be construed as legal advice. This content is not exhaustive, and laws regarding bankruptcy and commercial real estate may vary by jurisdiction. Readers are advised to consult with qualified legal professionals for advice tailored to their specific circumstances.
