Personal Vs. Corporate Bankruptcy

Similar to an LLC, when corporations liquidate under chapter 7 of the U.S. bankruptcy law, it includes only the business assets. The owner is totally exempt from personal liability in regards to any corporate debt, excluding the loss of value of any shares. Creditors are repaid from the proceeds of liquidation. Before equity receives anything, debts must be paid in full.

Chapter 11 of the U.S. bankruptcy law states that all assets are kept by any organization that reorganizes and continues operation, while most creditors receive partial payment. Investment decisions become less efficient in reorganization because equity over-invests in risky projects

In corporate bankruptcy the goal is to obtain enough repayment to creditors that lenders will continue to lend, at least to other borrowers. Inefficient investment decisions made by equity managers in prioritizing decisions, limit the company’s return. Filtering failure is a result of inefficient bankruptcy decisions. Both of these factors are influential to creditors, which may cause them to raise interest rates or reduce the amounts they are willing to lend, depending on whether the company’s return is lowered by inefficient decisions.

Sometimes a corporation is financially solvent, yet strategically defaults on their debt. When the firm is successful, owners repay. They default if the firm fails, with filtering failure and inefficient liquidation.

Slavery is no longer used as a penalty for personal bankruptcy, so individuals can only reorganize, even though it is most commonly referred to as liquidation. When individuals claim bankruptcy, their personal assets are liquidated in order to repay any debt and their assets are divided among the creditors. There is a limit to the amount of assets that debtors must use to repay. Debtors can keep a certain amount of financial wealth and post bankruptcy earnings. “Fresh start” refers to 100% exemptions for post-bankruptcy earnings, limiting the debtor’s obligation to repay. Most unsecured debts are discharged. In personal bankruptcy, debtors can get partial consumptions insurance. Prior to filing for personal bankruptcy, debtors can convert non-exempt assets as bank accounts into home equity. Wealth for debtors who are homeowners are protected by high homestead exemptions.