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Bankruptcy - What Happens in Chapter 7? - Updated
Friday, May 29 2009 @ 02:42 AM EDT

What happens if a company ends up in Chapter 7 bankruptcy? Here's the overview from Cornell University School of Law's Legal Information Institute:
Bankruptcy law provides for the development of a plan that allows a debtor, who is unable to pay his creditors, to resolve his debts through the division of his assets among his creditors. This supervised division also allows the interests of all creditors to be treated with some measure of equality. Certain bankruptcy proceedings allow a debtor to stay in business and use revenue generated to resolve his or her debts. An additional purpose of bankruptcy law is to allow certain debtors to free themselves (to be discharged) of the financial obligations they have accumulated, after their assets are distributed, even if their debts have not been paid in full....

There are two basic types of Bankruptcy proceedings. A filing under Chapter 7 is called liquidation. It is the most common type of bankruptcy proceeding. Liquidation involves the appointment of a trustee who collects the non-exempt property of the debtor, sells it and distributes the proceeds to the creditors. Bankruptcy proceedings under Chapters 11, 12, and 13 involve the rehabilitation of the debtor to allow him or her to use future earnings to pay off creditors.

It sounds so simple, when they put it like that. But we've seen how very complex it can end up, in watching SCO in bankruptcy court. But they've been in Chapter 11, where the point is rehab. Catch the point that Chapter 7 is called liquidation? That's the point of it. So if the court grants the motions by the U.S. Trustee's Office, IBM and Novell to send SCO to Chapter 7, then what happens?

Someone has to oversee the liquidation, and in Chapter 7, that means the court has to appoint a trustee, who takes the steering wheel away from the executives and becomes the designated driver. He or she can even run the business for a limited time, while the liquidation is ongoing. So he distributes whatever there is left, following the rules of distribution, and then the slate is wiped clean, and the bankrupt owes no more. In the case of a company, as opposed to an individual, it also means it exists no more. Of course, with SCO, nothing is that simple, and because of the litigation, there has to be some way to get that all worked through and decided. But it's the trustee who decides what to do, not the current executives.

Normally, there's an interim trustee at first chosen by the US Trustee, and then a permanent trustee can be chosen by vote of creditors, but in the case of SCO, the creditors never did form any kind of cohesive interest in doing anything, with the result that there is no creditors' committee, so I gather in such a case the interim trustee can become permanent if there is no voted-in trustee. I can only guess how complicated the twists and turns might be between the lines of all this.

Here are the duties of a trustee:

§ 704. Duties of trustee
(a) The trustee shall—
(1) collect and reduce to money the property of the estate for which such trustee serves, and close such estate as expeditiously as is compatible with the best interests of parties in interest;

(2) be accountable for all property received;

(3) ensure that the debtor shall perform his intention as specified in section 521 (2)(B) of this title;

(4) investigate the financial affairs of the debtor;

(5) if a purpose would be served, examine proofs of claims and object to the allowance of any claim that is improper;

(6) if advisable, oppose the discharge of the debtor;

(7) unless the court orders otherwise, furnish such information concerning the estate and the estate’s administration as is requested by a party in interest;

(8) if the business of the debtor is authorized to be operated, file with the court, with the United States trustee, and with any governmental unit charged with responsibility for collection or determination of any tax arising out of such operation, periodic reports and summaries of the operation of such business, including a statement of receipts and disbursements, and such other information as the United States trustee or the court requires;

(9) make a final report and file a final account of the administration of the estate with the court and with the United States trustee;

(10) if with respect to the debtor there is a claim for a domestic support obligation, provide the applicable notice specified in subsection (c);

(11) if, at the time of the commencement of the case, the debtor (or any entity designated by the debtor) served as the administrator (as defined in section 3 of the Employee Retirement Income Security Act of 1974) of an employee benefit plan, continue to perform the obligations required of the administrator; and

(12) use all reasonable and best efforts to transfer patients from a health care business that is in the process of being closed to an appropriate health care business that—

(A) is in the vicinity of the health care business that is closing;

(B) provides the patient with services that are substantially similar to those provided by the health care business that is in the process of being closed; and

(C) maintains a reasonable quality of care.

So, he runs the show, for as long as it's in place, and answers questions from parties in interest, pays off claims, etc. That's why I can't believe SCO will let this happen, actually, if they have any choices left at all. But so many of you asked about what happens in Chapter 7 that's different from Chapter 11, I collected whatever I could find to answer your questions.

Chapter 7 isn't the only choice in the motions. The other is dismissal, and of course SCO can put forth its own reorganization plan if it has the money in hand. Here's an explanation of the dismissal option, comparing it with conversion, and setting forth all the options a judge has. In bankruptcy court, the judge apparently has a lot of discretion. We'll find out what SCO's fate will be when the judge rules after the hearing in June on the 3 motions. Hopefully this very basic look at Chapter 7 will be enough to help you to at least follow along meaningfully.

Update: SCO has now told Tom Harvey at the Salt Lake Tribune that SCO will be answering the three motions. They hope that the appeals court in Denver will rule before June 15, but I gather they'll ask the court to consider that factor, if not:

SCO officials hope the 10th Circuit Court of Appeals in Denver rules in favor of the company's appeal of Kimball's ruling and sends the case back to Utah before any decision is reached on the liquidation motions in bankruptcy court. They believe that would bolster their position before the bankruptcy court that SCO can remain a going concern able to pursue the lawsuits, continue to sell Unix and prosper with new software applications for mobile phones, including a partnership with FranklinCovey Products....

"It is probably not a big surprise that IBM and Novell would like to see us liquidated before our claims are heard by a jury," McBride said in a statement. "The timeline Novell and IBM have set is troubling given the fact that our appeal in the Novell case was heard by the appeals court a couple of weeks ago and a ruling to clear things up should be forthcoming sometime in the near future."

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