If an individual or business files for bankruptcy, equity will be lost. In this article, we define equity and explain what happens to it in different types of bankruptcy proceedings.
The term equity refers to the monetary value of a property with claims or liens against it reduced. For example, an individual who owns a home worth $500,000 may have $200,000 in equity for the home when the costs of how much they still owe on their mortgage, closing costs, and real estate broker fees are subtracted.
According to bankruptcy law, both Chapter 7 and Chapter 13 bankruptcy allow debtors to claim some amount of their property as exempt in order to protect equity in their houses. Exactly how much can be claimed as exempt varies from state to state.
In Chapter 7 bankruptcy, the trustee will review the debtor’s assets to determine if they have any nonexempt property. If they do, they will need to turn it over to be liquidated to pay off debt.
First, the trustee will sell the debtor’s home and pay all mortgages, liens, taxes, and exemptions. They will also take a commission as payment. The remaining amount will be distributed to creditors. If the sale of the house can’t generate enough money to be worthwhile to the creditors, the trustee may not sell it. If the trustee does demand turnover of the house, the debtor may be able to substitute cash or exempt property equivalent instead.
In Chapter 13 bankruptcy, the debtor can keep their property as long as they pay their creditors the nonexempt amount as part of their three- to five-year monthly payment. This allows the debtor to preserve equity in the house.
In corporate finance, equity is essentially the value a business has to its owners or shareholders. It is one of the most common data points used by analysts to determine a company's financial health.
The book value of equity is calculated by subtracting the liabilities from the assets on the company’s balance sheet. In contrast, the market value of equity is based on the current share price if the company is public. If it isn’t, the value is determined by investors or valuation professionals.
A company’s equity is significantly reduced if not erased entirely during bankruptcy.
If a company files for Chapter 7 bankruptcy, it must cease operations and all its assets will be sold for cash. That cash is used to pay off the administrative and legal fees incurred during the bankruptcy process. Whatever money is left, if any, goes to creditors first, meaning that very little to nothing is left for shareholders.
If a company files for Chapter 11 bankruptcy, the goal is for them to become successful again. However, the price of its stock will most likely drop significantly and the stock will stop paying dividends. It will also most likely be delisted on the major exchanges. This will diminish the equity to a great extent.
