Can a Mutual Fund File for Bankruptcy?

Business bankruptcies are generally supervised by the U.S. Bankruptcy Court.

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Mutual funds are professionally managed equity holdings owned by their investors. Under normal circumstances, fund management may file bankruptcy under one of three chapters of the Bankruptcy Code. Any fund intending to liquidate and go out of business can file under Chapter 7 if it meets certain means requirements. Mutual fund management partnerships, limited liability companies or corporations intending to reorganize and continue in business can file under Chapter 11. Mutual fund management sole proprietorships intending to reorganize can file under Chapter 13. In all three cases, only those assets owned by management are subject to creditor claims. These do not include shares owned by the investors.

Chapter 7 Filings

Mutual fund management files for bankruptcy under Chapter 7 by filing with the U.S. Bankruptcy Court, which appoints a trustee. Management files a list of debts and, in most cases, a list of assets with the trustee. The trustee liquidates the assets and pays the creditors; secured creditors are paid first, followed by unsecured creditors -- any of fund management's corporate shareholders generally paid last. Note that fund management shareholders are distinct from fund investors holding stock shares managed by the fund.

Chapter 11 or 13 Filings

Filings under Chapter 11 or 13 are far more complex than Chapter 7 filings. Fund management must file not only a list of assets and debts, but a plan of reorganization. In most cases, the trustee then will appoint a creditors' committee that will have limited approval over the reorganization plan. The trustee will also approve filling deadlines and oversee the process, including distributions to creditors. In some instances, it can take several years for a fund to complete the process and be discharged from bankruptcy.

When a Fund Cannot File

Under some circumstances, a mutual fund's management cannot file for bankruptcy. Filings under Chapter 7 are subject to means tests of various kinds. If the bankruptcy court believes that fund income or assets support a reorganization plan with partial or full repayment of debt, it may refuse to allow a Chapter 7 filing; management may have to file under Chapter 11 or 13 instead. If the court determines that fund management has committed fraud -- for example, by filing false asset and liabilities lists or income statements -- it may disallow the bankruptcy, leaving management fully liable for all debt.

Investors Rights

From 1997 to 2012, more than 2,364 mutual funds went out of business, either by having investors' assets transferred to another fund or by distribution of the assets back to the investors. Investors' assets are held separate from the assets of fund management under the supervision of a custodian, usually a bank. Since the fund's stock assets are not the property of the fund's management, bankruptcy in other than exceptional circumstances does not jeopardize investor's assets. Bankruptcy is a complex legal process; if you or a fund you manage is contemplating bankruptcy, consult an attorney.