In the US, business bankruptcy occurs when a business no longer has enough cash flow or access to credit to pay its debts or cover operating expenses. Filing for business bankruptcy provides legal protection to companies in financial trouble and creates a reasonable path to repay debt. Business bankruptcies are filed publicly, and are one of the only official indicators of business distress. There are different kinds of business bankruptcy, commonly referred to by their chapter in the US Code:
Chapter 7: Liquidation
A business entity can file for Chapter 7 bankruptcy — liquidation — when they’re no longer able to pay off debts. It’s used to liquidate assets and repay creditors. Chapter 7 requires LLCs and corporations to sell all business assets and close the business.
For sole proprietors, it requires a bankruptcy trustee be appointed to sell all non-exempt assets to pay creditors. Afterwards, the sole proprietor’s debts are cleared and the business can stay open.
Chapter 11: Reorganization (for Larger Debt Filings)
Chapter 11 bankruptcy lets larger companies reorganize debt and stay in operation. A company in Chapter 11 bankruptcy is called a “debtor-in-possession,” and must negotiate with their creditors to develop a reorganization plan. For most businesses, this plan outlines how the company will restructure and pay for existing debt over time, including selling assets as applicable. A bankruptcy court judge must review and approve the plan.
This path is complicated and expensive, so Chapter 11 isn’t typically an option for smaller businesses and sole proprietors.
Chapter 12: Reorganization (for Family Farmers and Fisherman)
Chapter 12 bankruptcy is similar to Chapter 13, but it’s designed just for family farmers and fishermen. It provides more flexibility in making payments over a period of three or five years, due to the seasonality of most farming and fishing businesses.
Chapter 13: Reorganization (for Individuals)
This type of business bankruptcy is designed for individual wage-earners and sole proprietors who have regular income. It helps individuals create a plan to restructure and pay back debt over a course of up to five years, depending on monthly income.
In the US, Chapter 7, 11, and 13 bankruptcy are the most common.
The total number of bankruptcies has decreased almost every year since 2010 — and that includes the years 2020 and 2021, despite challenges of the COVID-19 pandemic. Chapter 11 filings increased by almost 30% in 2020 — the highest level since 2012 — but decreased again in 2021. And bankruptcy filings by publicly traded companies in 2020 reached their highest levels since 2010.
The US Department of Justice publishes bankruptcy court records data. Other organizations, like the American Bankruptcy Institute, provide additional analysis and reporting by reviewing the data published by district courts. Gathering business bankruptcy data presents challenges; each district court files bankruptcy data individually. For accurate business bankruptcy data, organizations need to regularly review and incorporate new filings.
Creditors use business bankruptcy data to identify existing risk in their lending portfolio. But what about future bankruptcy risk?
Solutions exist to help financial institutions anticipate business bankruptcies by monitoring financial health indicators in near real-time. That way, creditors know when a business is in financial trouble - before a public bankruptcy notice.