When a company files for bankruptcy, a federal court takes control of the process. The company either reorganizes its debts under Chapter 11 and keeps operating, or it liquidates under Chapter 7 and shuts down. The difference turns on one question: can the business produce enough value alive that creditors would rather keep it running than sell it for parts?
The answer is decided by a strict hierarchy of who gets paid. Secured lenders stand first in line, unsecured creditors stand behind them, and shareholders usually stand last, often with nothing. Every stage of the corporate bankruptcy process, from the first filing to the final distribution, is organized around that order. Readers following this should also see Corporate Newsletter Ideas That Get Employees to Actually Read.
The word itself carries a useful hint about its origin. According to The Free Dictionary, "happen" entered English from the Middle English "hap," meaning chance, which was borrowed from the Old Norse "happ." Bankruptcy law exists precisely because chance — bad luck, a failed product, a market turn — can sink even a well-run company, and the law provides an orderly alternative to a chaotic scramble for assets.
What is the difference between Chapter 11 and Chapter 7?
Chapter 11 is a reorganization. The company keeps operating, keeps its employees, and proposes a plan to repay creditors over time, often by renegotiating debts, closing unprofitable units, or selling some assets. An automatic stay takes effect the moment the case is filed: creditors cannot sue, seize collateral, or demand payment while the case runs. The company gets room to breathe.
Chapter 7 is a liquidation. A trustee is appointed to wind the business down, sell its assets, and distribute the proceeds to creditors in the legal order of priority. There is no plan and no future for the company itself. When the assets are gone and the money is distributed, the corporate entity is dissolved.
Companies sometimes file Chapter 11 hoping to reorganize and later convert to Chapter 7 when a workable plan proves impossible. The conversion is a formal step in the same case, and it marks the point where the court concludes that saving the business is no longer realistic.
Who gets paid first in a bankruptcy?
Payment follows the absolute priority rule, and the order is fixed by statute. The general sequence runs like this:
- Secured creditors. Lenders who hold a lien on specific property — a building, equipment, receivables — are paid from the value of that collateral first. If the collateral is worth less than the loan, the shortfall becomes an unsecured claim.
- Priority unsecured claims. Certain claims that Congress placed ahead of ordinary trade debt, including most wages earned shortly before the filing and certain taxes.
- General unsecured creditors. Suppliers, vendors, bondholders, and others who extended credit without collateral. They are paid from whatever remains, often cents on the dollar.
- Shareholders. Owners are paid only after every creditor is paid in full. In liquidations, that rarely happens, so equity holders are commonly wiped out.
This hierarchy is the spine of the whole case. A reorganization plan can technically rearrange it, but only with the consent of the classes that are being asked to give up their priority, or over their objection if the plan meets the statutory fairness tests.
Who runs the company during Chapter 11?
In most cases, the existing management stays in charge and operates as a debtor in possession. The company continues to run day to day, but it answers to the court, and major decisions — selling substantial assets, borrowing new money, hiring professionals — require court approval. A creditors' committee, made up of unsecured creditors, watches management's conduct and negotiates on the group's behalf.
In cases involving fraud or serious mismanagement, the court can appoint a trustee to replace management. That step is the exception, not the rule. The default design of Chapter 11 assumes the people who know the business best should keep running it, under supervision.
While the case is open, the company must keep paying for the goods and services it buys after the filing. These post-petition obligations sit ahead of most pre-filing debts, which is how the law keeps suppliers willing to deal with a company in bankruptcy. This connects to our earlier piece, Court Vacates FTC's Expanded HSR Form, Restoring Pre-2025 Premerger Filing Rules.
What does a reorganization plan actually do?
A Chapter 11 plan is the company's proposed settlement with everyone it owes. It sorts creditors into classes by priority, states what each class will receive — cash over time, new debt, equity in the reorganized company, or nothing — and asks the court to confirm it. Each class of creditors votes on the plan. A class accepts when a majority in number and a specified share in dollar amount of the claims that vote approve it.
If a class votes no, the court can still force the plan through in a process called a cramdown, but only if the plan is fair: no class receives less than it would in a Chapter 7 liquidation, and senior classes are not paid ahead of junior ones while senior claims go unpaid. Shareholders have the weakest hand here. Under the priority rules, they can be excluded entirely whenever creditors are not being paid in full.
Once the court confirms the plan, the company exits bankruptcy with a restructured balance sheet and, in most cases, a fresh set of owners — the creditors who took equity in exchange for forgiven debt.
What happens to employees, contracts, and shareholders?
Employees usually see the effects before creditors do. In a Chapter 11, payrolls generally continue, but the company can reject burdensome contracts, including union agreements, with court approval. In a Chapter 7, employment ends when the business closes, and unpaid wages become claims in the case — many of them near the front of the priority line, though recovery still depends on what assets exist.
Ordinary contracts can be kept or rejected by the debtor, which is one of Chapter 11's most powerful tools. Leases on unwanted space, supply agreements with bad terms, and other commitments can be shed, with the counterparty left holding a claim for damages.
Shareholders face the sharpest trade-off. Trading may continue on the public markets during a case, but the shares represent the last claim on the company. In a liquidation they are almost always worthless. In a reorganization, existing holders sometimes retain a small stake, but only if the plan leaves value to spare after creditors — and the plan's terms, not the stock price, decide that.
Our take: the hierarchy is the story
The cleanest way to understand any bankruptcy filing is to read it as a negotiation over that payment ladder. Chapter 11 exists because a running company is usually worth more than its parts, so the law lets creditors trade some of their claims for a share of the going concern. Chapter 7 exists for the cases where that trade would leave everyone worse off. Neither chapter is a moral judgment; both are scheduling systems for loss. The company's fate follows from where it sits on the ladder — secured and salvageable, or unsecured and out of options — long before the petition is filed.
This article is general information about how the process works, not legal advice for any specific situation. Outcomes in individual cases depend on facts, collateral values, and terms the public record does not always show.
