What it means
Chapter 7 is the straight liquidation chapter of the US Bankruptcy Code. A trustee takes control of everything the debtor owns that is not legally protected, converts it to cash, and distributes the proceeds according to a fixed priority order.
For a company, filing under Chapter 7 normally means the doors close, staff are let go and the legal entity is wound up. It matters commercially because it sets the floor for what any creditor can expect.
When a customer or supplier goes into Chapter 7, the practical question is not whether you will be paid in full, but where your claim sits in the queue and how much cash the trustee raises from a forced sale. Forced sales rarely fetch the values shown on a balance sheet, which is why unsecured recoveries are often in the low tens of cents on the dollar or less.
The priority order is the heart of the chapter. Secured creditors are paid from the proceeds of whatever specific asset secures their loan, then administrative costs including the trustee's fees, then statutory priority claims such as certain unpaid wages and taxes, then general unsecured creditors, and finally, in the rare cases where anything is left, shareholders.
The nuance to remember is the relationship with Chapter 11. A company that files under Chapter 11 hoping to reorganise can convert to Chapter 7 if the plan fails, and creditors will often compare the two: if the business is worth more sold piece by piece than kept running, liquidation is the rational outcome.
For individuals, Chapter 7 also delivers a discharge, releasing them from most remaining personal debts.
In practice
Real-world examples.
Example
A 40-year-old family printing firm loses its two biggest contracts, cannot cover payroll and files for Chapter 7. The trustee auctions the machinery, collects outstanding invoices and pays secured lenders in full, while trade suppliers eventually receive around 20 cents on the dollar.
Example
A venture-backed software start-up runs out of cash with no buyer for the business. Because its main asset is intellectual property rather than equipment, the trustee sells the code and trademarks to a competitor for $1,500,000, which after costs covers priority wage claims and leaves a small distribution for unsecured creditors.
Example
A restaurant group first files under Chapter 11 hoping to shed leases, but fails to agree a plan with its landlords. The case converts to Chapter 7, the kitchen equipment is sold at auction, and gift card holders join the general unsecured queue behind the secured lender.
Think of it
“Chapter 7 is liquidation bankruptcy-selling assets to eliminate debt.
Formula
Calculation
The core calculation is the liquidation waterfall, which distributes proceeds strictly by priority:
Distribution to Unsecured Creditors = Liquidation Proceeds - Administrative Costs - Secured Claims - Priority Claims
Worked example. A printing business ceases trading and files for Chapter 7. The trustee sells its presses, vehicles, stock and receivables for gross proceeds of $8,000,000.
Trustee fees, legal costs and other administrative expenses take $800,000, leaving $8,000,000 - $800,000 = $7,200,000. The bank's loan of $4,000,000, secured on the presses, is paid next, leaving $7,200,000 - $4,000,000 = $3,200,000. Priority claims for unpaid wages and taxes come to $700,000, leaving $3,200,000 - $700,000 = $2,500,000.
General unsecured claims total $10,000,000, so the recovery rate is $2,500,000 / $10,000,000 = 0.25, or 25%. A paper supplier owed $120,000 receives $120,000 x 0.25 = $30,000, and the shareholders receive nothing at all.Case study
Seen in the real world.
The following is a fictional, illustrative case. Kettleside Furniture Works manufactured flat-pack furniture for three national retailers. When two of them switched to overseas suppliers within the same year, revenue fell by 60% and the company could not service $6,000,000 of bank debt secured on its factory equipment.
Management explored a Chapter 11 reorganisation but concluded that without customers there was no business to reorganise, so the fictional company filed under Chapter 7 instead. The trustee sold the factory equipment for $4,500,000 and the remaining stock and receivables for $2,000,000, a total of $6,500,000. After $650,000 of administrative costs and full repayment of the $6,000,000 secured loan, nothing was left even for priority claims, let alone the $9,000,000 owed to timber suppliers and hauliers.
The illustrative lesson for those suppliers was uncomfortable: several had extended credit for years without ever checking whether the customer's assets were already pledged to a bank. Two of them subsequently introduced credit limits and personal guarantees for customers with heavily secured balance sheets.
Watch out
Common mistakes.
- Treating Chapter 7 and Chapter 11 as interchangeable, when one liquidates the business and the other tries to keep it running.
- Valuing your likely recovery using the debtor's balance sheet, when forced liquidation values are typically far below book value.
- Ignoring whether a customer's assets are already pledged to a secured lender, which often determines whether unsecured suppliers get anything at all.
Questions
People also ask.
Who decides what gets sold in Chapter 7?
A court-appointed trustee takes control of the estate, sells non-exempt assets and distributes proceeds, and the previous management no longer runs the business.
Can a company reopen after Chapter 7?
Generally no, because the entity is wound up and its assets are sold, although a buyer may purchase the assets or brand from the trustee and start a new business with them.
Do employees get paid in a Chapter 7 case?
Certain unpaid wages earned shortly before the filing receive statutory priority up to a capped amount per employee, ranking ahead of general unsecured creditors but behind secured lenders and administrative costs.
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