“Business bankruptcy” isn’t a term anyone wants to consider, especially regarding their own company. However, filing for bankruptcy may be an intelligent choice for a business that is failing or having difficulty financially. This is particularly the case for businesses that are unable to pay their creditors. Certain types of bankruptcies for business allow you to keep your business, while others relieve you from debt obligation.
The amount of debt and how the business is organized will determine what type of bankruptcy the business should file. Due to the complex nature of bankruptcies for businesses, you may want to consult with a bankruptcy attorney before you take the step of filing for bankruptcy.
What Type of Bankruptcy Can I File?
There are three types of business bankruptcies. Some only apply to certain types of businesses and have limits on the debt that is allowed. All have different purposes depending on your goals and your finances.
The first step is to focus on what you want to accomplish with the bankruptcy. Whether you want to pay off outstanding debts, increase the value of your business, or cut your losses, keeping the goal of business bankruptcy in mind is very important in deciding which version of bankruptcy you want to file.
The amount of debt and how the business is structured help determine what type of bankruptcy should be filed. Examples of ways businesses may be structured include:
- Sole proprietorship
- Limited liability company
- Partnership
- Corporation
The types of bankruptcy of primary relevance to business owners are Chapter 7, Chapter 11, and Chapter 13. These will be discussed in more detail below.
What Is Chapter 7 (Liquidation) Bankruptcy?
In a Chapter 7 bankruptcy, the business is liquidated. Chapter 7 bankruptcies are available to all types of business and to personal bankruptcies as well. Chapter 7 business bankruptcy allows you to eliminate most (if not all) of your unsecured debts, including medical bills, personal loans, payday loans, cash advance loans, and credit card debt. Once you file for Chapter 7 bankruptcy, it typically takes about six months to receive your discharge.
Chapter 7 bankruptcies are meant for businesses with very little left in the way of assets and businesses that are service-based and never had many assets. Chapter 7 is best suited to sole proprietorships and small businesses because these are the businesses most likely to have little chance of succeeding once they owe creditors, landlords, employees, and others more than they can pay.
Filing Chapter 7 requires the business to close down completely for all of its assets to be liquidated. These assets are taken by the bankruptcy trustee and are sold off to pay the business’s debts. If, after the sale of all the business’s assets, there are still not enough proceeds to pay for all the debts, then the remaining debts are discharged.
Individuals filing for private bankruptcy must meet income requirements (show that their income is low enough), but this is not a requirement for businesses filing under Chapter 7.
It should be noted that, whether the bankruptcy is for an individual consumer or a business, they will be barred from filing a Chapter 7 bankruptcy if they had a bankruptcy petition dismissed within the last 180 days for failure to appear in court or to otherwise comply with the court’s orders.
A downside to Chapter 7 is that it remains on your credit record for 10 years. If you should choose to open a new business, you cannot file for Chapter 7 bankruptcy until 8 years have passed.
What Is Chapter 11 (Reorganization) Bankruptcy?
When businesses have financial difficulty but do not need to liquidate completely, reorganization can be the best solution. This type of bankruptcy is attractive because it helps businesses to keep operating. Creditors prefer it because there is still a chance that you will repay the full debt, whereas in Chapter 7, they typically receive only pennies on the dollar.
With Chapter 11, you’ll submit a reorganization plan that shows how you’ll change your business plan to repay your creditors. The reorganization plan can be drafted to allow for an extended period to pay creditors back – you need not worry that you’ll have to pay them right away. When you obtain debt relief through a Chapter 11 claim, an automatic stay is put in place, meaning creditors cannot attempt to collect repayment during the term of the stay.
The court will approve the plan and appoint a trustee to oversee it. Chapter 11 is available to corporations, partnerships, and sole proprietorships. Corporations most commonly use it. On the downside, Chapter 11 business bankruptcy is very complex, takes a long time to move through the courts, and is expensive (i.e., higher filing fees and court costs).
What Is Chapter 13 (Sole Proprietorship) Bankruptcy?
Chapter 13 bankruptcies are another type of reorganization bankruptcy. They are meant for sole proprietors. As in a Chapter 11 bankruptcy, Chapter 13 requires you to submit a reorganization plan to the court, showing how and when the business proposes to pay off its creditors.
One of the primary reasons why a sole proprietor may use this type of bankruptcy instead of Chapter 7 is that the Chapter 13 bankruptcy will separate the business owner’s personal assets from their business assets. Many sole proprietors have personal assets combined with their business assets. In Chapter 13, you can avoid losing your personal assets – versus Chapter 7 business bankruptcy, where some (but not all) of your personal property is exempt from being sold.
With a Chapter 13 bankruptcy, you can even apply for a Hardship Discharge to dismiss your debts. It is also typically a faster and cheaper process than Chapter 11.
Chapter 13 will not work for larger businesses because there are limits on the dollar amount of debt that can be discharged. There is a limit for secured debt and another for unsecured debt. It will only work for businesses that are quite small and don’t have many creditors,
Chapter 11 bankruptcies can have very long repayment periods – as much as 20 years – because the amount of debt is large. Chapter 13 bankruptcies have shorter repayment periods (typically 5 years) because the amount of debt is considerably lower.
Should I Consult a Bankruptcy Attorney Before Filing for Bankruptcy?
Bankruptcies for businesses can be quite complex. If you are considering filing a business-related bankruptcy, contact a bankruptcy lawyer. The attorney can help determine whether bankruptcy is right for you and, if so, what type of bankruptcy best suits your situation. They can then file the bankruptcy on your behalf and guide you through the process.
If you need to develop a reorganization plan, they will know, based on experience, what items should be included to increase the chances that your plan will be accepted. Another important function that a bankruptcy lawyer will perform is negotiating with creditors, stockholders, bondholders, and the court itself. Their legal services will help things move smoothly and, hopefully, more quickly.
