Running a successful business involves many moving parts, any of which can cause a company to stumble. Difficulties obtaining materials, staffing and management issues, and increased inflationary costs are just a few of the obstacles that can leave a business unable to pay its bills. When a business generates income but can’t pay its bills due to a temporary setback, Chapter 11 bankruptcy can reorganize its debts into a manageable payment plan, giving it the breathing room needed to stay in business.
Chapter 11 is a reorganization bankruptcy that businesses file when pinched financially. For instance, a company struggling to pay vendors, payroll, rent, or taxes would likely close without debt relief. Chapter 11 allows the company to work with creditors to create a payment plan the company can meet.
From the company’s perspective, the goal is to lighten the business’s debt burden. Payment changes can include modifying interest, due dates, and other terms. It can even “discharge” or erase debt entirely.
The company and creditors negotiate new debt payment terms the business can afford. The plan might also include selling assets or downsizing the debtor’s operations to reduce expenses.
Once all required creditors agree to the plan terms, the plan becomes a new contract. In a traditional Chapter 11, if the plan involves debt forgiveness, the company immediately benefits from the debt discharge.
Surviving Chapter 11 is often in the best interest of both the company and creditors. Ultimately, whether a company will survive Chapter 11 will depend on the willingness of creditors to negotiate new payment terms.
However, finding a middle ground can be difficult when creditors believe they’re being asked to capitulate more than is fair or that they’d receive more if the company’s assets were sold in Chapter 7. To prevent such problems and ensure success, bankruptcy lawyers often work with creditors before filing a Chapter 11 case.
Chapter 11 is for ongoing businesses that have the potential to remain open with financial assistance. Individuals whose debts are too high to qualify for Chapter 13 can also file for Chapter 11.
Chapter 11 won’t help a business without a steady customer base and can’t reopen a closed business. Individuals must also demonstrate that they earn a steady income. Creditors won’t agree to a plan unless the bankruptcy filer can generate enough revenue to fund it.
Example. Charlie’s Bike Shop has multiple stores in the Washington D.C. area but lost considerable revenue when an unexpected snowstorm prevented tourists from renting bicycles during the annual cherry blossom season. Business picks up during the summer, but the bike shop can’t meet its obligations. The company hires a Chapter 11 bankruptcy lawyer who successfully negotiates a plan with creditors and files the Chapter 11 case.
Example. Moira, a famous actress, makes a social media misstep and finds herself the most recent victim of cancel culture. As a result, her studio rescinds a lucrative movie role to distance itself from the bad publicity. Fortunately, Moira’s agent finds her work, but it pays much less, and she can’t meet her current obligations. She knows she’ll lose her mansion in Chapter 7, a liquidation bankruptcy, so she opts for reorganization. Because her debts total over $3,000,000 and exceed the Chapter 13 limits, she must use Chapter 11 to reorganize her debts.
The primary advantage of Chapter 11 is that it allows the company to stay in business and creditors to get paid. When a company and receptive creditors work collaboratively, all parties benefit.
However, a successful Chapter 11 depends on the ability of all parties to agree on reasonable payment terms, which doesn’t always happen. The possibility of a Chapter 11 case turning into a Chapter 7 matter that closes the company is likely the riskiest part of the filing.
It will depend on whether an individual or company files or is involved in the bankruptcy case. Here are the basics.
Chapter 7 works differently for individuals and businesses. Individuals who file for Chapter 7 can keep or “exempt” property needed to maintain a household and employment. All other property is sold for the benefit of creditors. In exchange, the bankruptcy court discharges qualifying debt, such as credit card balances, medical bills, and personal loans.
It’s common for business owners to file an individual Chapter 7 case after the company closes and discharge personal debt and business debt, such as obligations arising from a personal guarantee. In both instances, the process usually takes four to six months, and filers don’t repay creditors.
Example. Holly’s Local Bagels, LLC closed soon after Mega Bagel Corp. moved in down the street. Because Holly personally guaranteed payment of the bagel shop’s lease, she met with a lawyer about bankrupting Local Bagels. Holly was surprised to learn she’d remain responsible for the lease even after Local Bagel’s bankruptcy. Instead, she followed the lawyer’s advice and filed for Chapter 7 herself. In her bankruptcy, Holly discharged the personal guarantee and her personal debts, receiving a fresh financial start.
It’s unusual for a small business to file for Chapter 7. Essentially, Chapter 7 closes the business without a debt discharge—businesses aren’t entitled to debt relief. All that occurs is the trustee sells the business or the business property, whichever is more valuable. A business also isn’t entitled to protect property with bankruptcy exemptions.
An exception exists for sole proprietors because they’re treated more like individuals in Chapter 7. Sole proprietors can protect property with bankruptcy exemptions and receive a discharge for qualifying individual and business debt.
However, while many sole proprietors lose their business in Chapter 7, sole proprietors with service-only companies often fare better. Why? Because the Chapter 7 trustee can’t sell the sole proprietor’s ability to provide a service. These sole proprietors can usually discharge personal and business debt without jeopardizing the service-focused business.
Example. Joseph, a motivational speaker, invested in himself early in his career. Assuming all his business needed was exposure to thrive, he accepted a nominal fee for speaking engagements nationwide. Joseph also paid his travel and hotel expenses with his credit card. However, he couldn’t demand higher speaking fees and eventually maxed out his credit card. Joseph filed for Chapter 7 bankruptcy. As a sole proprietor, he was able to discharge the business credit card debt and his personal debt. Also, because his business involved a personal service the trustee could not sell, Joseph retained his business as a motivational speaker.
Explore the differences between Chapter 7 and 11 bankruptcy.
Chapter 13 is a reorganization bankruptcy that allows paying creditors what the filer can afford for three to five years. The benefits of Chapter 13 include keeping all property, catching up on mortgage, car, and other secured payments, and keeping the collateralized property.
Companies can’t file for Chapter 13 bankruptcy. However, business owners sometimes file Chapter 13 individually. This strategy is helpful when reorganizing personal finances through a Chapter 13 plan is enough to keep the company afloat.
For instance, paying a reduced amount toward personal credit cards and other debt will often allow the owner to draw less from the business. Learn more about Chapter 13 vs. Chapter 11 bankruptcy.
Chapter 11 is a reorganization bankruptcy similar to Chapter 13. However, unlike Chapter 13, creditors participate in plan creation in traditional Chapter 11 cases, making it a longer, more complicated process. Chapter 11, Subchapter V resembles Chapter 13 more closely and has streamlined provisions to expedite bankruptcy for small business owners.
Most people choose Chapter 11 when other options don’t exist. When possible, most debtors elect to file for bankruptcy under Chapter 7 or 13 to avoid the time, cost, and risk involved in Chapter 11 proceedings.
A business won’t file for Chapter 7 unless the business is closing—and usually not even then because the benefits don't outweigh the potential to open the door for creditor litigation. Also, when a business needs help staying in business, the company’s only option is to reorganize under Chapter 11. Chapter 13 isn’t available to companies.
Similarly, individuals who want to negotiate reduced payment terms with creditors don’t file for Chapter 11 unless they must because their debts exceed Chapter 13 limits. Individuals choose cheaper, less complicated Chapter 13 when possible.
The simplest way to determine which chapter is best for you is by meeting with a knowledgeable bankruptcy lawyer.
Filing for Chapter 11 isn’t cheap; traditionally, only large corporations could afford the costs. Fortunately, Chapter 11 has evolved, and most businesses can use it to stay open.
Most small businesses still find traditional Chapter 11 filings cost prohibitive. Small businesses file the more affordable Chapter 11, Subchapter V option. It’s cheaper because its streamlined procedures are structured more like Chapter 13.
Below is a simplified explanation of the traditional Chapter 11 process, followed by a brief description of the more straightforward Subchapter V procedures.
Generally, Chapter 11 cases are voluntary and begin when the company files a bankruptcy petition seeking bankruptcy relief. However, sometimes creditors file an involuntary bankruptcy petition against the business.
All bankruptcy chapters work by stopping the collection process. Once filed, the “automatic stay” prohibits most creditors from pursuing the individual or business filer, giving the filer, creditors, and the court breathing room to address finances in an organized fashion.
For instance, the stay will temporarily stop:
The automatic stay lifts once the bankruptcy court approves a plan that acts as a new contract between the company and creditors.
Unlike other bankruptcy chapters, a bankruptcy trustee isn’t responsible for the business and bankruptcy property. The filer continues to run the everyday functions as a “debtor in possession” during the Chapter 11 bankruptcy. However, small business bankruptcies filed under Chapter 11, Subchapter V are subjected to more oversight.
The company and creditors work toward negotiating a reorganization plan. When possible, the company’s bankruptcy attorney will start negotiations before filing the case. If you’re wondering why Chapter 11 cases are complicated and lengthy, here’s why.
The debtor has the exclusive right to propose a reorganization plan for the first four months, but the court can extend it to 18 months. Once the exclusivity period expires, the creditors’ committee or other parties can propose alternate reorganization plans.
Creditors vote on whether they accept a proposed Chapter 11 plan. In reality, the debtor and creditors can agree to any plan they negotiate, which is why many Chapter 11 attorneys negotiate deals before filing the case.
If the required creditors agree to a plan, the court will approve or “confirm” it. But more often, creditors or other parties dissatisfied with the debtor’s progress will move to dismiss or convert the case to Chapter 7.
When reviewing a plan, the bankruptcy court considers the following factors:
In Chapter 11, Subchapter V cases, the bankruptcy court uses the same criteria when assessing the confirmability of the plan.
There is no absolute limit on the duration of a Chapter 11 case. Some Chapter 11 cases wrap up within a few months, but it’s more usual for it to take six months to two years for a Chapter 11 case to come to a close.
Small businesses and major corporations follow the same rules and requirements when reorganizing under Chapter 11. However, special provisions help small business debtors move through the Chapter 11 process more quickly while reducing legal fees and other restructuring expenses.
A company qualifies as a “small business debtor” by meeting the small business case requirements under Chapter 11, Subchapter V:
Benefits and special procedures applying to small business Chapter 11 matters include:
No Creditors’ Committee. Ordinarily, in Chapter 11 cases, a committee is appointed to represent the interests of unsecured creditors. A creditors’ committee can retain attorneys and other professionals at the debtor’s expense, significantly increasing the cost of Chapter 11 reorganization. Small business cases don’t involve creditors’ committees.
Additional Filing and Reporting Duties. Small businesses are subject to some reporting and filing requirements not imposed on other Chapter 11 debtors. A small business debtor, for example, must attach its most recently prepared balance sheet, statement of operations, cash flow statement, and federal tax return to its bankruptcy petition when it files for Chapter 11 relief.
Additional U.S. Trustee Oversight. The United States Trustee’s Office is the agency that oversees bankruptcy cases on behalf of the Department of Justice. Under bankruptcy laws, small business cases are subject to more oversight by the U.S. Trustee’s office than other Chapter 11 proceedings.
Plan Deadline. Generally, there is no deadline for filing a Chapter 11 plan unless set by the bankruptcy court. However, the debtor has only 300 days to propose a Chapter 11 plan in small business cases. The court can extend the 300-day deadline, but only if the debtor proves that it can obtain approval of a plan within a reasonable period.
Longer Exclusive Period to Propose Plan. In some cases, creditors file competing Chapter 11 plans. Chapter 11 plans filed by creditors typically provide for liquidating or taking over the debtor’s assets and business. The debtor usually has the exclusive right to propose a Chapter 11 plan for 120 days. In small business cases, the exclusivity period is 180 days. The extended exclusivity period reduces the debtor's risk of the business closing while litigating competing plans.
No Disclosure Statement. Ordinarily, in Chapter 11, the debtor must prepare a disclosure statement, submit it to the bankruptcy court for approval, and circulate copies to creditors and other parties in interest. Disclosure statements in Chapter 11 cases are similar to prospectuses for stock offerings. They must provide extensive information about the debtor and proposed plan and are often expensive to prepare. The bankruptcy court can waive the disclosure statement in small business cases to significantly expedite reorganization and reduce legal and other costs.
Counsel must represent all businesses that file for Chapter 11. A bankruptcy attorney will be in the best position to explain your options and the specific procedures you can expect in your case.
Did you know Nolo has made the law easy for over fifty years? It’s true, and we want to make sure you find what you need. Below are more articles explaining how bankruptcy works. And don’t forget that our bankruptcy homepage is the best place to start if you have other questions!
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We wholeheartedly encourage research and learning, but online articles can't address all bankruptcy issues or the facts of your case. The best way to protect your assets in bankruptcy is by hiring a local bankruptcy lawyer.
]]>Filing for Chapter 7 bankruptcy is an option for corporations and limited liability companies (LLCs) going out of business. But business Chapter 7 bankruptcy cases aren't filed as frequently as you might think. Why? Because LLCs and corporations don’t receive a debt discharge eliminating debt. Also, a Chapter 7 filing can open the door to lawsuits transferring debt liability from the company to an individual interest holder.
If you’re considering bankrupting a corporation or LLC in Chapter 7, keep reading to learn about the benefits and pitfalls of closing companies using Chapter 7. If you’d like a refresher on how LLCs and corporations are formed and closed, skip to “Understanding Formation and Closure Requirements of LLCs and Corporations” at the end of the article.
Yes, an LLC can declare bankruptcy, and so can a traditional corporation. However, the bankruptcy chapter filed will determine whether the LLC or corporation remains open and operational after the bankruptcy filing.
Filing a Chapter 7 bankruptcy will close the LLC or corporation. To keep a company open and operational, Chapter 11 or Chapter 11, Subchapter V are better options.
A Chapter 7 bankruptcy works differently for LLCs and corporations than individuals. Here, you’ll find a brief explanation of what to expect. A more thorough discussion of important issues follows.
The primary purpose of Chapter 7 is to allow the Chapter 7 trustee assigned to the case to inventory and sell the business property and use the proceeds to pay creditors. Allowing a neutral third party to conduct this aspect of the business closure has two primary benefits: It takes the burden off stakeholders and assures creditors of the propriety of the asset sale.
What's the result of the sale of the company assets? Selling equipment, inventory, products, and supplies ultimately closes the company.
The corporation or LLC will not receive a debt discharge in Chapter 7, leaving the company responsible for its obligations. The debt discharge isn’t necessary because creditors can’t collect from a closed and defunct company.
Leaving liability in place also allows creditors to collect in several instances:
Learn more about when you're personally liable for business debts.
One of the most significant downsides of putting an LLC or corporation in Chapter 7 bankruptcy is that it provides an easy and instant forum for a lawsuit. All a disgruntled creditor must do is file a motion or bankruptcy lawsuit called an “adversary proceeding” to ask for relief.
Unlike Chapter 11 bankruptcy, Chapter 7 doesn’t have a mechanism that allows for the continued operation of a corporation or LLC. Chapter 7 is a quick bankruptcy chapter designed for people and companies without an income source to pay debt. The primary function of Chapter 7 is to liquidate assets and pay creditors, which is why filing this chapter will shut down the company.
To achieve an orderly business liquidation, the bankruptcy trustee will sell all of the corporation or LLC assets and distribute the proceeds among creditors according to the priority rules established in bankruptcy law.
As discussed briefly above, not only will filing Chapter 7 close the business, but corporations and LLCs don’t receive a debt discharge. It isn’t needed. A creditor can’t collect from the company once it’s no longer operational. After all assets are sold for the benefit of creditors, as required in a business closure, nothing of value will be left to take.
Also, leaving the debt in place rather than wiping it out allows a creditor to pursue actions against individuals when appropriate. For instance, a creditor might seek payment under a personal guarantee (an agreement to be personally responsible for business debt) or pursue litigation under an alter ego or fraud theory.
So why would a corporation or LLC file a Chapter 7 case?
Winding down a business in bankruptcy allows for a higher level of transparency. It’s easier to prove that the closure took place in the manner required by law, which, in some cases, might prevent a disgruntled creditor from pursuing litigation. Here’s why.
A Chapter 7 liquidation can help alleviate a common creditor concern—an officer or member might divert funds into private coffers rather than paying creditors. A business Chapter 7 publicly sells the company’s assets and pays its obligations.
When it works, the officers and managing members get to step away from the closure and leave the hard work of selling off assets and paying creditors to the bankruptcy trustee.
When you file for Chapter 7, you lose control of the company. The bankruptcy trustee takes over the business assets and determines whether it’s in the best interests of the creditors to sell the business as a whole or to sell off the assets.
If you’re liable for any business debt, the lack of control might cause a problem if the sales proceeds from the business assets aren't sufficient to pay a debt you guaranteed or that you're responsible for paying by statute, like certain taxes.
After the bankruptcy, the remaining debt will often be more significant than if you sold the assets yourself for several reasons:
Any outstanding balance left after the trustee makes a payment will remain due and payable. As a result, you could owe more on a personal guarantee than if you had negotiated with the creditors and sold the assets.
Another common disadvantage is often even more expensive. Filing a case in bankruptcy court provides a disgruntled party—whether a creditor, business partner, or ex-spouse—with a forum to air any complaints about handling the business finances.
This problem concerns stakeholders because most disputes can potentially shift debt liability from the business to an individual. For instance, it doesn’t take much effort for a creditor to attend the 341 meeting of creditors—the one hearing all filers must attend—and provide the trustee with investigation-prompting information.
When this happens, it’s common for the trustee to continue a relatively short creditor’s meeting to another day for more thorough and often uncomfortable trustee questioning. The purpose of the continued meeting is for the trustee to use the new information to find assets for creditors, and yes, they’ll be on the same side.
It’s also relatively simple for a creditor to file an adversary proceeding—essentially a lawsuit—alleging liability-shifting theories that would allow a creditor to collect from an individual’s personal assets. The possibility of opening the door to these types of litigation is often enough for most to avoid Chapter 7 bankruptcy (more below).
Even though corporate entities and LLCs are responsible for debt payment, individuals can still find themselves liable for business obligations. Here are a few situations that can give rise to personal liability.
Putting the company through a Chapter 7 bankruptcy can help with these personal obligations, but only if the Chapter 7 trustee liquidates enough property to satisfy the debt. If a balance remains after the bankruptcy case, the creditor can pursue the individual’s personal assets.
To learn more, check out When You Might Be Personally Liable for LLC or Corporate Debt.
When a business is failing or closed, often the most straightforward solution to debt problems isn’t bankrupting the company. It’s frequently more efficient for the owner or stakeholder to file a consumer Chapter 7 bankruptcy personally.
An individual can usually get rid of many personal debts, such as credit card balances, medical bills, and personal loans, but also erase a personal guarantee for business debts. This is the case even if the business remains open because filers can discharge most business debt in an individual bankruptcy case.
Learn about the debts erased in Chapter 7 bankruptcy.
Better yet, if most of your debt is related to the business (as opposed to consumer debt for personal needs), you might qualify even if your income exceeds Chapter 7 limitations. You can avoid Chapter 7 income requirements and the means test if you have more business debt than consumer debt. So, even if you have a healthy income, you still might be able to wipe out the personal guarantee in Chapter 7 bankruptcy.
Find out more by reading The Bankruptcy Means Test: Are You Eligible for Chapter 7 Bankruptcy?
Sometimes, business owners find Chapter 13 offers better debt relief options. For instance, if you don’t qualify for Chapter 7, you can restructure debt over five years using a Chapter 13 plan.
Chapter 13 will also let you keep the property you’d lose in Chapter 7. And, although Chapter 7 bankruptcy won’t wipe most support arrearages, tax, and fraud debt, you can pay off these types of debts over time without worrying about creditors knocking at the door.
You likely understand the ins and outs of creating and closing an LLC or corporation. However, we include them here if you’d like a refresher.
Chapter 7 can be risky for a corporation or LLC because it's a separate legal entity. Once created by filing documents with the secretary of state and paying registration fees, the newly formed business owns assets and is legally liable for paying its debts.
Because corporations and LLCs are separate entities, people don’t own them outright. Instead, individuals own stakes in the company rather than the company itself. For instance, an individual corporate shareholder will own shares of the corporation. An LLC member will hold an ownership interest outlined in the LLC’s operating agreement. Each ownership interest entitles the holder to a portion of its value and profits.
These types of business structures work well for people who want to participate in business without risk to their personal wealth. The structure prevents business creditors from coming after an individual’s personal assets (although it doesn’t always work, more below).
Example. A shareholder or member who files an individual bankruptcy (not a business bankruptcy) won’t list the company as an asset in the bankruptcy paperwork. Instead, the filer will list the value of the corporate shares or the value of the LLC ownership interest as property owned. The bankruptcy trustee can sell only the filer’s interest in the company, not the entire business unless the filer is the sole shareholder or member.
As an aside, few bankruptcy asset buyers are willing to purchase a partial interest in a small business. This fact can come into play when filing personal bankruptcy and calculating the risk of the Chapter 7 trustee selling the filer's business ownership interest.
When shutting the doors of a corporation or LLC, the corporate officer or the LLC’s managing member must sell off or "liquidate" the company assets and distribute the funds to the creditors. Notice of proper closure must be filed with the secretary of state.
Failing to follow these procedures could subject individuals holding an ownership interest to liability. The requirements discourage the funneling of assets to insiders (stakeholders, business partners, and family members) because, in most cases—other than those discussed above—a creditor loses the ability to collect any remaining balance from the business once the business closes.
Did you know Nolo has made the law accessible for over fifty years? It’s true, and we want to ensure you find what you need. Below, you’ll find more articles explaining how bankruptcy works. And don’t forget that our bankruptcy homepage is the best place to start if you have other questions!
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Chapter 7 vs. Chapter 13 for Small Business Owners Chapter 13 v. Chapter 11 Bankruptcy for Small Business Owners |
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Helpful Bankruptcy Sites |
We wholeheartedly encourage research and learning, but online articles can't address all bankruptcy issues or the facts of your case. The best way to protect your assets in bankruptcy is by hiring a local bankruptcy lawyer.
]]>Most small business owners want to know whether bankruptcy will help them continue their business, and in many instances, the answer is yes. Filing for bankruptcy can help a struggling small business survive and even thrive. But whether you’ll choose Chapter 7, 13, or 11 bankruptcy to help you continue your business will depend on what the company does, the business structure, the company’s debts and assets, and whether the business’s income can fund a repayment plan.
Read on to learn about factors to consider when determining whether a Chapter 7 business bankruptcy, Chapter 13 bankruptcy, or Chapter 11, Subchapter V can help you save your business or wind it down in an organized manner.
It depends. Businesses are limited to filing either Chapter 7 or 11, but sometimes it’s possible for a business owner, rather than the business itself, to use Chapter 13 effectively. Before diving into the details, it's a good idea to familiarize yourself with these basics.
But businesses don’t file for bankruptcy as often as believed, especially not Chapter 7. Instead, business bankruptcy lawyers often help business owners use a bankruptcy filing more strategically. It's due to the limitations of bankruptcy and the pros and cons of each chapter.
To illustrate this, we’ve outlined important points in the “When a Business Files for Bankruptcy” chart below. Consider referencing the chart while reading about your bankruptcy options.
This chart outlines primary points to consider when determining whether you or your company should file for bankruptcy, but it doesn't address all issues. The best way to protect your assets is by consulting a business bankruptcy lawyer.
Chapter 7 |
Chapter 13 |
Chapter 11 |
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Sole Proprietor Files for Bankruptcy |
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Partnership Files for Bankruptcy |
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LLC or Corporation Files for Bankruptcy |
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Business Owner Files for Bankruptcy |
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The most beneficial chapter for you or your business will depend on whether you want to close or keep the company open. If unsure, read “Continuing Your Business: Factors to Consider” below.
Otherwise, if your business has closed or will close, continue reading. Skip to the Chapter 13 and 11 sections if you want to keep the business open.
If you’re a sole proprietor with a service-oriented company, read “Sole Proprietors Benefit Most From Chapter 7 Business Bankruptcy.”
Yes, both individuals and business entities can file for Chapter 7 bankruptcy. Small business owners can put a company in Chapter 7 or personally file a Chapter 7 case.
In most cases, filing a Chapter 7 bankruptcy will close the business. Why? Because there’s no way to protect property owned by a separate legal entity like a corporation or limited liability company (LLC). The trustee sells the business assets, pays creditors, and shuts the business down.
Also, when a company files Chapter 7, the company's debt doesn't get wiped out or "discharged." Because it remains intact, a company's bankruptcy does nothing to lessen the owner's personal liability for the business debt.
The exception to this rule? When a service-oriented sole proprietor files for Chapter 7 (more below).
If your business is a corporation or limited liability company (LLC), Chapter 7 bankruptcy provides a way to close down and liquidate the company transparently. When these companies file for Chapter 7, it becomes the bankruptcy trustee’s responsibility to sell off the business's assets and pay its creditors.
Unless you’re a sole proprietor filing bankruptcy, your business won't receive a discharge of its debts in Chapter 7. So, if you’re somehow responsible for the business debt, for instance, you signed a personal guarantee, you’ll still be on the hook unless you file an individual Chapter 7 bankruptcy.
A few other things to consider:
Because of these reasons and more, it’s essential to seriously consider whether the risks outweigh the benefits of closing the business through bankruptcy, the primary benefit being a transparent liquidation of the business assets.
Learn more in Chapter 7 for Small Business Owners: An Overview.
Service-oriented sole proprietors who would like to keep a business open and business owners whose companies have closed benefit most from Chapter 7 bankruptcy.
Many business owners choose to file a personal bankruptcy after a business closure. It's often more effective because it accomplishes most business owners' fundamental goals of erasing their responsibility to pay personal guarantees and other business debts.
For more information, see Are You Personally Liable for Business Debts?
Filing a Chapter 7 bankruptcy rarely works to a business owner’s advantage, except for sole proprietors providing a specific service. Here are the benefits Chapter 7 offers to service-oriented sole proprietors.
As a result, Chapter 7 is an attractive option for sole proprietors with little or no business assets. It will wipe out the business debts and allow the owner to continue providing the service and keep the business running.
To learn more about Chapter 7 bankruptcy, how exemptions work, and what happens to your debts and property, see Chapter 7 Bankruptcy.
If you’re a sole proprietor who needs equipment or property to run your business and want to keep your business open, a Chapter 7 bankruptcy might be a bad option.
Almost all states protect some business property with exemptions, but the amount varies widely. Because the Chapter 7 trustee will sell nonexempt property, if you can’t preserve necessary equipment and products, Chapter 7 could put you out of business.
Yes, filing for Chapter 13 could help you keep your business, but you’d need to file personally because only individuals and sole proprietors qualify for Chapter 13. Partnerships, corporations, and LLCs can’t file.
Chapter 13 takes far longer to complete than Chapter 7 because you’ll pay creditors monthly for three to five years. But there’s a positive side to Chapter 13’s payment plan. Most people pay more toward obligations they value and less toward credit card balances, medical bills, and personal loans.
For instance, Chapter 13 filers can:
However, because of these benefits, Chapter 13 payment plans can be expensive, and not everyone has enough income to pay the required amount. You must pay for some debts in full in Chapter 13.
And, the amount you pay your unsecured creditors—those with bills other than your mortgage, car payment, and other collateralized debt—must equal or exceed the value of "nonexempt assets" or property you can't protect with bankruptcy exemptions through your repayment plan.
But this chapter doesn’t work the same for sole proprietors and other business owners. You’ll find a brief overview of the main differences below.
In Chapter 13 bankruptcy, sole proprietors list and protect business-related assets differently than other business owners and can include business debt as part of the Chapter 13 case. Here are the mechanics.
In both cases, valuable property poses a problem when the property isn’t covered by an exemption, possibly increasing the monthly required payment to an unaffordable amount.
Learn how to calculate a Chapter 13 payment and more about Chapter 13 bankruptcy for small businesses. If you have any questions, a bankruptcy attorney with business-related experience can help you determine the best overall strategy.
Partnerships, corporations, and LLCs must file a Chapter 11 bankruptcy instead of a Chapter 13 bankruptcy to reorganize debts and stay in business. A sole proprietor can file a Chapter 11 bankruptcy, as well.
Chapter 11 bankruptcy is similar to Chapter 13 bankruptcy in that the company keeps its assets and pays creditors through a repayment plan. However, a straight Chapter 11 t is usually a lot more complicated when compared to a Chapter 13 bankruptcy because the business must file continuing operating reports, and creditors must approve the plan. It’s also prohibitively expensive for most small businesses.
Fortunately, small businesses can now use Chapter 11, Subchapter V, a relatively new bankruptcy reorganization that's easier and cheaper because it's more like Chapter 13. To learn more about bankruptcy for your small business, see Small Business Bankruptcy.
Learn more about Chapter 7 vs. Chapter 11 Bankruptcy.
You’ll want to consider several things before continuing or closing down your business. Here are a few critical considerations.
These aren’t the only things to consider. You’ll find additional factors discussed below. To learn about other options when your business is struggling, see Business Cash Flow Problems & Bankruptcy.
In most cases, bankruptcy is entered into voluntarily. But that isn’t always the case. In some situations, creditors will force a debtor into bankruptcy involuntarily.
Involuntary cases are highly unusual. Creditors use the process primarily to force a company into a business bankruptcy. It’s rarely used against an individual in a consumer bankruptcy because meeting the prerequisites to file an involuntary bankruptcy isn’t easy.
Most cases require several creditors to get together and agree to file against a debtor. If accomplished, the court appoints a bankruptcy trustee to take over all aspects of the business, sell the assets, and distribute the proceeds to the creditors.
Although this seems like it would be helpful, many creditors would prefer to initiate their own collection actions. By doing so, they retain the ability to grasp a larger share of the business assets. Once in bankruptcy, a creditor must share proceeds with other creditors, taking a smaller portion or, in some cases, getting nothing.
However, it’s essential to understand that a creditor might be unable to keep funds collected shortly before bankruptcy, especially if it’s considered a preference claim favoring one bankruptcy creditor over another. But, many creditors are willing to take the risk and return the funds if necessary.
The involuntary process begins in the same manner as a voluntary action. Official bankruptcy forms get filed with the court. If you’d like to learn more, read Involuntary Bankruptcy.
Did you know Nolo has made the law easy for over fifty years? It’s true, and we want to ensure you find what you need. Below you’ll find more articles explaining how bankruptcy works. And don’t forget that our bankruptcy homepage is the best place to start if you have other questions!
Our Editor's Picks for You |
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More Like This |
Chapter 7 for Small Business Owners Chapter 13 for Small Business Owners |
Consider Before Filing Bankruptcy |
Will Business Bankruptcy Help If I Want to Continue My Business? Will Business Bankruptcy Affect My Credit? Which Business Debts Are Discharged in Chapter 7 Bankruptcy? |
Helpful Bankruptcy Sites |
We wholeheartedly encourage research and learning, but online articles can't address all bankruptcy issues or the facts of your case. The best way to protect your assets in bankruptcy is by hiring a local bankruptcy lawyer.
]]>Some business owners are responsible for the business's debts, and if you’re a responsible party, you can expect a creditor to report the debt on your credit report. You’ll determine your liability in part by looking at the business structure used when forming the business.
Even if the business structure itself doesn’t confer business debt responsibility, other ways to be responsible for business debt exist. If one applies, which they tend to more often than not, your credit could be affected.
In a few instances, your responsibility to pay a business debt can affect your individual credit report. In the first instance, you agree to be responsible when you wouldn’t otherwise. In the second, statutory law creates your obligation to pay a business debt.
In either of these situations, a failure to pay the business’s obligation after a business bankruptcy could result in a credit bureau report and affect your credit.
Did you know Nolo has made the law accessible for over fifty years? It’s true, and we want to ensure you find what you need. Below, you’ll find more articles explaining how bankruptcy works. And don’t forget that our bankruptcy homepage is the best place to start if you have other questions!
Our Editor's Picks for You |
|
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]]>For instance, sole proprietors and most partners will be responsible for business debts. At the same time, an LLC or corporation will shield members and stockholders from personal liability. But the protection isn’t absolute. Read on to learn when a business owner is personally liable for the company's debts.
You’re likely assuming that your business type—sole proprietor, partnership, LLC, or corporation—determines whether you must use personal assets to pay a business debt. Although true theoretically, examining business structure is rarely decisive because laws and standard business practices minimize the debt protection business structures offer.
The following question tree demonstrates this point while quickly helping you determine whether you’re personally liable for a business debt:
We explain the concepts in each step in detail below.
Start by checking whether you signed a “personal guarantee”—a contract promising to pay on behalf of the business. This is a regular practice when a new or established business with few assets asks for credit.
So why is this?
A bank, lessor, or supplier knows the company won’t pay the debt if the business fails. To protect against a loss, the creditor will require the business owner to agree to be personally liable for the debt if the company fails to pay. You’ve likely signed a personal guarantee if your business has done any of the following:
Because a business owner usually must provide proof of assets before entering into a personal guarantee, a failed business can be costly. Fortunately, you can erase a personal guarantee in bankruptcy (more below).
People holding an ownership interest in a company must pay certain tax obligations if the business fails to fulfill its responsibilities, regardless of business structure. Also, creditors can “pierce the corporate veil” and seek debt payment from shareholders when certain corporate formalities aren’t observed.
If you or the company owes this type of debt, you should know that tax debts and debts resulting from fraud usually aren’t dischargeable in bankruptcy. Learn more about nondischargeable debt in bankruptcy.
You might have already determined you’re personally liable for your business debt. But if the issue remains unclear, it’s time to determine whether your business’s structure protects you from debt collectors.
Below we explain how the business structures determine who is responsible for paying business debts. Remember, more often than not, companies providing your business with products, services, or real estate will have likely required a personal guarantee negating the following rules.
A sole proprietorship isn’t a separate legal entity. You’re likely a sole proprietor if you’re the only business owner and haven’t incorporated or set up a specific form of business entity. You and your business are equally liable for debts incurred by the company.
Since a sole proprietorship does not offer limited liability to its owner, creditors of the business can go after your personal and business assets. If the company doesn’t have sufficient assets, creditors can sue you personally and try to collect the debt by taking your house, car, or other property.
A partnership is a business entity owned by two or more individuals. In a partnership, liability is more like a sole proprietor than a corporation, with some exceptions for hybrid versions.
A corporation is an incorporated entity designed to limit the liability of its owners (called shareholders). Generally, shareholders are not personally liable for the debts of the corporation. Creditors can only collect their debts by going after corporate assets.
Shareholders will usually be on the hook if they cosigned or personally guaranteed the corporation’s debts. However, shareholders might also be liable if a creditor can prove corporate formalities weren’t followed, shareholders commingled personal, and business funds or the corporation was just a shell designed to shield liability. This is called piercing the corporate veil.
Like a corporation, an LLC offers limited liability to its owners (called members). Generally, members are not liable for the debts of the LLC unless they cosigned or guaranteed the debt personally. However, like a corporation, creditors may also be able to go after the members’ personal assets by piercing the corporate veil.
Except for a sole proprietorship, it would be unusual to put a closing business in bankruptcy when your goal is to eliminate your personal liability for business debts. The reason? It wouldn’t work. Chapter 7 bankruptcy—the chapter you’d use when closing a business—won’t erase a business’s debt obligation.
Instead, most people eliminate personal guarantees by filing for individual bankruptcy. Learn why it’s rare for a closing business to file for bankruptcy in Will Bankruptcy Help If I Want to Continue My Business?
Filing for Chapter 7 after your business closes has benefits, but it can be determinantal. Here are two factors to consider when deciding if filing for bankruptcy will work for you.
Most people must meet specific income requirements before qualifying for a Chapter 7 bankruptcy discharge wiping out qualifying debt. However, this rule doesn’t always apply to business owners.
You'll qualify even if you have significant income if your business-related debt exceeds your personal or “consumer” debt. This approach is possible because a person with a higher percentage of business debt can avoid taking the income-qualifying Chapter 7 means test.
Although you’d likely welcome the opportunity to eliminate the lease obligation on your closed storefront, the benefit could come at a cost. Here’s why.
You’re only allowed to keep so much property in Chapter 7 bankruptcy. So if you own more property than you can protect with bankruptcy exemptions, you’ll want to be sure that the value of the property you’ll lose is less than the total debt you’ll wipe out.
Find out more about keeping nonexempt property in bankruptcy.
If filing for bankruptcy isn’t financially feasible, another approach is to retain an attorney to negotiate down the business debt or personal guarantee. A local business bankruptcy lawyer can assess your case and help you choose the right approach for you.
Did you know Nolo has made the law easy for over fifty years? It’s true—and we want to ensure you find what you need. Below you’ll find more articles explaining how bankruptcy works. And don’t forget that our bankruptcy homepage is the best place to start if you have other questions!
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We wholeheartedly encourage research and learning, but online articles can't address all bankruptcy issues or the facts of your case. The best way to protect your assets in bankruptcy is by hiring a local bankruptcy lawyer.
]]>Read on to learn more about the factors involved in determining whether a business bankruptcy is a good option. Also, many business owners file for personal bankruptcy. Consider learning how erasing personal debt can help you keep your business open.
You’ll want to consider several things before continuing or closing down your business. Here are a few critical considerations.
These aren’t the only things to consider. You’ll find additional factors discussed below. To learn about other options when your business is struggling, see Business Cash Flow Problems & Bankruptcy.
The answer will depend mainly on the structure of the business organization and the value of business assets.
In most cases, filing a Chapter 7 bankruptcy will close the business. Why? Because there’s no way to protect property owned by a separate legal entity like a corporation or limited liability company (LLC). The trustee simply sells the business assets, pays its creditors, and shuts the business down.
But that’s not the only reason why Chapter 7 bankruptcy isn’t regularly used to close businesses. Here are a few additional problems that can crop up:
Because of these reasons and more, it’s essential to seriously consider whether the risks outweigh the benefits of closing the business through bankruptcy, the primary benefit being a transparent liquidation of the business assets.
Although filing a Chapter 7 bankruptcy rarely works to a business owner’s advantage, a Chapter 7 bankruptcy might help keep your business open if you’re a sole proprietor providing a specific service. For instance, you’re an accountant, a freelance writer, or a fitness trainer. This type of bankruptcy can be effective because the bankruptcy trustee can’t sell your ability to perform the service. Here’s how it works.
A sole proprietor is responsible for both personal and business debts. When you file Chapter 7 bankruptcy, you’ll include all debt and wipe out both types of qualifying debt.
You can also use bankruptcy exemptions to protect the relatively minor assets associated with a service-oriented business. By contrast, exemptions are rarely sufficient to cover large amounts of product, equipment, goods, or other business assets. As a result, Chapter 7 is an attractive option for sole proprietors with little or no business assets. It will wipe out the business debts and allow the owner to continue providing the service, thereby keeping the business running.
Also, if you have more business debt than consumer debt, you’ll be able to file a business bankruptcy and avoid the means test. So if your business closes and you’re making good money working for someone else, it’s less likely that your new income will prevent you from qualifying for a Chapter 7 discharge. However, it can happen, so speak with a bankruptcy lawyer before making significant changes.
To learn more about Chapter 7 bankruptcy, how exemptions work, and what happens to your debts and property, see Chapter 7 Bankruptcy.
When You’re Forced Into Bankruptcy
In most cases, bankruptcy is entered into voluntarily. But that isn’t always the case. In some situations, creditors will force a debtor into bankruptcy involuntarily.
Involuntary cases are highly unusual. Creditors use the process primarily to force a company into a business bankruptcy. It’s rarely used against an individual in a consumer bankruptcy because meeting the prerequisites necessary to file an involuntary bankruptcy isn’t easy. Most cases require several creditors to get together and agree to file against a debtor. If accomplished, the court appoints a bankruptcy trustee to take over all aspects of the business, sell the assets, and distribute the proceeds to the creditors.
Although this seems like it would be helpful, many creditors would prefer to initiate their own collection actions. By doing so, they retain the ability to grasp a larger share of the business assets. Once in bankruptcy, a creditor is more likely to have to share proceeds with other creditors and take a smaller portion or, in some cases, get nothing at all.
However, It’s important to understand that a creditor might not be able to keep funds collected shortly before bankruptcy, especially if it’s considered a preference claim favoring one bankruptcy creditor over another. But, many creditors are willing to take the risk and return the funds if necessary.
The involuntary process begins in the same manner as a voluntary action—official bankruptcy forms get filed with the court. If you’d like to learn more, read Involuntary Bankruptcy.
Only individuals can file a Chapter 13 bankruptcy case. So if your business is a partnership, corporation, or LLC, you can't file Chapter 13 on its behalf.
If you are a sole proprietor, you can include both personal and business debts in your Chapter 13 bankruptcy, just like you can in a Chapter 7 bankruptcy. A Chapter 13 bankruptcy might be your best option if the sole proprietorship has income. You might be able to keep the business going while paying a lesser amount on nonpriority unsecured personal and business obligations, like credit card bills, utility payments, and personal loans.
However, you might run into a problem if your sole proprietorship requires you to keep a lot of goods, products, or expensive equipment on hand. Although Chapter 13 bankruptcy allows you to keep your property, you still must be able to protect it with a bankruptcy exemption (and most exemptions won’t cover significant business assets). Otherwise, you have to pay the value of the nonexempt assets in the three- to five-year repayment plan. For instance, if you owned $150,000 in nonexempt construction equipment, you’d need to pay your creditors $2,500 per month for five years plus any other required amounts.
Because many business owners are tight on cash, keeping all the property you need might not be feasible if you don’t have enough income to pay a hefty monthly plan payment.
Partnerships, corporations, and LLCs must file a Chapter 11 bankruptcy instead of a Chapter 13 bankruptcy to reorganize debts and stay in business. A sole proprietor can file a Chapter 11 bankruptcy, as well. Chapter 11 bankruptcy is similar to Chapter 13 bankruptcy in that the business keeps its assets and pays creditors through a repayment plan. However, a straight Chapter 11 t is usually a lot more complicated when compared to a Chapter 13 bankruptcy because the business must file continuing operating reports and creditors must approve the plan. It’s also prohibitively expensive for most small businesses.
Fortunately, small businesses now can use Chapter 11, Subchapter V, a relatively new bankruptcy reorganization that's easier and cheaper to use because it's patterned after Chapter 13. To learn more about bankruptcy for your small business, see Small Business Bankruptcy.
Did you know Nolo has been making the law easy for over fifty years? It’s true—and we want to make sure you find what you need. Below you’ll find more articles explaining how bankruptcy works. And don’t forget that our bankruptcy homepage is the best place to start if you have other questions!
Our Editor's Picks for You |
|
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|
What to Consider Before Filing Bankruptcy |
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We wholeheartedly encourage research and learning, but online articles can't address all bankruptcy issues or the facts of your case. The best way to protect your assets in bankruptcy is by hiring a local bankruptcy lawyer.
]]>The guidance in this article applies to both business bankruptcy and personal bankruptcy for business owners looking to protect their businesses.
Before you start making payments and restructuring your finances, you’ll need to make sure you’re making the right payments. If you make certain loan payments, that money could be later reclaimed or wasted.
You’ll need to consider your personal and business assets and debts, regardless of whether you file for personal or business bankruptcy. On the one hand, your personal assets can be scrutinized in business bankruptcy—usually when you’re personally liable for business debts. On the other, filing for personal bankruptcy can help with your business debts. Bottom line: Personal and business assets and debts can be important in both kinds of bankruptcy.
If a friend, relative, or business associate has lent you money, you might be tempted to try to repay some or all of it before filing bankruptcy. Bad idea.
When you file for bankruptcy, the bankruptcy trustee will scrutinize all payments you made during the year before the filing to make sure that some creditors weren't given an unfair advantage, receiving what are called "preference payments."
The trustee will want to "recapture" (take back) any preference payments you made to creditors who are relatives or close business associates (“insiders”) within one year of the bankruptcy filing. The trustee will then divide those payments equally among all creditors. If your relatives or associates can't come up with the money that you paid them, the trustee can sue them to recover it.
In the year before filing bankruptcy, you’re legally allowed to pay one unsecured creditor ahead of the others if the creditor isn’t a close relative or associate. For example, you can choose to pay the business line of credit that you signed a personal guarantee on before you pay your suppliers. The bankruptcy trustee will, however, look back 90 days from your bankruptcy filing at payments you made to this kind of regular creditor to make sure any payments you made were allowed.
Once you’ve filed bankruptcy, the trustee can make a company that you wrongly paid "disgorge" (return) any preference payments if you collectively paid out, as of 2022, more than $7,575. The trustee will then spread the money among all of your creditors. But if less than 51% of your debts are from your business operations and expenses, the trustee can force you to disgorge payments you made only if your total payments were more than $600. (11 U.S.C. § 547(c) (2022).)
Many people wrongly believe that they get to keep one car when they file for bankruptcy, regardless of the amount of equity in their car. So they do whatever they can to pay off their car loan before they file.
In truth, under the exemption laws of most states, you get to keep only a limited amount of equity in a vehicle, typically $1,000 to $5,000. If you have more equity in your car, the bankruptcy trustee will grab it to pay down your debts.
So find out your state's equity limit for vehicles and stay within it. For instance, let’s assume that you have $3,000 equity in your car (your car is worth $5,000 but you owe only $2,000 on it). If your state’s equity limit were $3,000, you wouldn’t want to pay any more on the loan because you would end up with more equity in the car than can be protected.
For more information, see our section on bankruptcy exemptions.
If you’re certain that you'll file for bankruptcy and there are certain unsecured debts you plan to wipe out, such as credit card bills and medical bills, it often makes sense to stop paying anything toward them. They’ll normally be fully discharged in bankruptcy, so you don't really gain anything by paying them down now.
Better to put the money toward:
Just be really sure the unsecured debt you stop paying on is dischargeable in bankruptcy before you stop making payments.
Building your equity or splurging on the finer things before taking the plunge into bankruptcy can seem tempting. But giving into that temptation can be considered fraud and lead to your bankruptcy case being dismissed—or worse, criminal charges.
If you’re headed into bankruptcy, taking goods from your LLC or corporation—like laptops, forklifts, vehicles, inventory, or supplies—is considered stealing from your creditors and bankruptcy fraud. An LLC or corporation owner who takes goods in this context can face dismissal of their bankruptcy case and even criminal charges.
The bankruptcy system treats you like an insider creditor. So if you pay yourself a bonus, repay a loan you made to the business, or otherwise take money out of the company during the 12 months prior to filing for bankruptcy, it’ll be considered a recoverable preference payment. It might even be considered bankruptcy fraud, which can result in jail time, or at least in the dismissal of your bankruptcy case.
Some people, realizing that bankruptcy is inevitable, grab whatever cash they can and buy a car or luxury items, or go on a trip before they file. Another bad idea.
If you buy luxury goods or services totaling more than $800—such as a vacation timeshare, country club dues, or a pricey new wardrobe—within three months of filing, you’re considered to have had the intent to defraud the bankruptcy court, and the resulting debts won't be discharged in bankruptcy. (That amount is as of November of 2022 and applies to cases filed on or after April 1, 2022). (11 U.S.C. § 523(a)(2)(C)(i)(l) (2022).)
But when you spend the money in this way more than three months before filing, the creditor has to prove that your intent was fraudulent. If the creditor is successful, these debts won't be discharged in bankruptcy.
If you’re found to have knowingly deceived the court—for example, by trying to hide your purchases—you could also face criminal charges.
If you take a large cash advance on a credit card before filing for bankruptcy, the credit card company can assert that you were trying to defraud it and that you had no intent of paying the money back. In this sort of situation, the bankruptcy trustee can treat the cash advance as a nondischargeable debt, or even throw your case out of court entirely because of it.
Any cash advance more than $1,100 taken within 70 days of filing for bankruptcy is usually nondischargeable. (This amount is as of November 2022 and applies to cases filed on or after April 1, 2022). (11 U.S.C. § 523(a)(2)(C)(i)(l) (2022).)
Lesser amounts should be dischargeable unless the creditor argues successfully that you had no intent to pay the money back.
If you own valuable property that you’re likely to lose—that is, nonexempt property—and you’re filing for Chapter 7 bankruptcy, you might be able to sell it before you file and use the proceeds to pay personally guaranteed loans and bankruptcy fees once you file.
Valuable property could include:
However, you shouldn't use the proceeds from selling this kind of property to increase your exempt property—for example, paying the proceeds toward your mortgage when your home equity will be protected by your state's homestead exemption. If you do, and the court determines that you intended to defraud your unsecured creditors, your case could be dismissed and charges could be filed against you.
For more information, see our article on selling nonexempt property before bankruptcy.
Bankruptcy can be scary, and it might be hard to know when you should start expecting it. When you’re in financial trouble, take preemptive measures to protect yourself and loved ones that helped you with your business.
If you borrow money from family and friends to repay your business debts but then end up filing for bankruptcy, you won’t be able to pay them back. Even if your business property is sold and the proceeds are distributed to your creditors, your loved ones won’t get a slice. Your friends and relatives can’t be repaid because the bankruptcy court is likely to classify money from a relative or close associate as a gift, not a loan.
Even if you don’t plan to file for bankruptcy any time soon, you should consider—as good business practice—alternative methods of borrowing so friends and family can contribute to your business without the contribution being classified as a gift. For instance, your sister can be an equity investor or your friend can be a shareholder in your corporation.
The utility companies can't use your declaring personal or business bankruptcy as an excuse to immediately shut off services (although they can require you to post a reasonable deposit to keep on the lights, phone service, and heat). As long as you pay future bills on time, you should be fine. (For more information, see our article on how to use a Chapter 7 bankruptcy to prevent a utility shut-off.)
Similarly, as long as you keep paying rent on your home or business, your landlord can't evict you. Don't be spooked by the clause—common in commercial leases—that says that you're automatically in default (in violation of your lease) if you file for bankruptcy. These clauses are generally not enforceable (except against sublessees and assignees).
If you're leasing equipment and are going out of business, return the equipment to the leasing company before you file for bankruptcy. No doubt the company will bill you for the amount owed under the remainder of the lease, but this debt will be discharged in bankruptcy.
On the other hand, if you try to soldier on with your business post-bankruptcy and want to keep leased property, you'll need to keep making payments on time. Your obligation won't be discharged by your bankruptcy because the debt is secured by the equipment.
If you need to keep your liability insurance in force because you think some unknown claims might surface later, you should file for bankruptcy just after you renew your policy. That's because when you file, you'll want to have insurance in place that extends at least 12 months into the future. Otherwise you may have a tough time finding an insurance carrier willing to renew your business coverage or issue a new policy.
As long as you continue to pay on time for existing coverage, the insurance can't be canceled because of your bankruptcy, and you'll enjoy some peace of mind.
To learn more about alternatives to bankruptcy and bankruptcy itself, see our section on Small Business Bankruptcy. If you think filing could make sense for you, talk to an attorney who has had experience with bankruptcy cases like yours. They can help you figure out which debts will need to be paid back and which will be discharged, and what property you can keep. They can also help you develop a strategy and represent you in court, if necessary.
]]>Whether there’s been an economic downturn or you’re ready for your next chapter, learn here about important considerations when deciding the fate of your business.
The decision to sell or hibernate your business lies in the outlook for potential profits and in your and your associates’ personal investment in the venture. If you’re ready to end your association with the business to enjoy retirement, start a new business, or rejoin the workforce, then selling your business could be the best option.
But if you don’t want to close the doors just yet and your sales have hit what looks like a temporary lag, there’s a less permanent solution. Hibernating a business can be a great alternative for people who:
For instance, suppose a gym opened in 2016 and experienced good profits before the pandemic hit but is having trouble getting customers to come back. The owner might want to hibernate the business until customers feel safe returning to the gym. In the meantime, the owner could close their physical location and switch to offering their own personal trainer services in the park.
We take you through the ins and outs of selling and hibernating a business below. As you read and think about whether to sell or hibernate, consider how your business’s structure factors in. For instance:
In a partnership or limited liability company, you’ll usually need every partner’s or member’s consent to sell the entire business.
Hibernating your business means that your business still legally exists, but its operations have either completely or mostly ended for the time being. You and your co-owners should strip your company to its bare bones. You should only have enough money coming in to cover the most basic expenses.
If you choose to hibernate your business, you’ll want to cut costs wherever you can to stay afloat. Focus on the expenses and operations that are absolutely necessary. For some businesses, that means limiting yourself to one or two clients or projects per year to help you break even.
As you start to cut expenses, you might realize that your business doesn’t need to fully hibernate to survive. Instead, maybe you can downsize and restructure your business to make more money. The key to downsizing a business is to categorize costs to find ways to save money.
Essential costs are any costs that are necessary to keep your business legal and operational. These costs include paying any fees to the Secretary of State’s office so your business can remain in good standing as well as any licensing or membership fees that are required by your industry.
If you have employees, payroll software is usually essential. The penalty for cutting corners on payroll software is a risk of liability—both criminal and civil. Struggling with your payroll duties can also cost you lots of time. It’s a big responsibility for most business owners to learn and maintain appropriate payroll services, but it’s also an essential one.
Nonessential costs are costs that aren’t necessary to your business. Often you can reimagine and reduce nonessential costs, or even cut them out completely, depending on your business functions. Business owners can often reduce or eliminate the following nonessential costs.
Rent
In many industries, employees can work from home instead of making the trip to the office every day. Alternatively, you can trade in your office building for a part-time or shared workspace to reduce rent. And, if you’re in retail, a physical storefront can be turned into a virtual one.
For example, a clothing store can switch to selling goods online through their own website or through a third-party like Amazon or Etsy. The shop owner will need to pay a small fee for the web hosting or product listings, but this fee will be a drastic reduction from their rent.
Staffing
Perhaps the most difficult choice and change to a business is reducing the roles of staff. There are two options to cut costs when it comes to staffing.
The more straightforward option is to reduce the number of staff. Weigh the costs and benefits to keeping each team member. For example, if your coffee shop has seen fewer customers throughout the week, it might make more sense to keep two baristas on staff rather than three.
The other option is to switch some employees from full time to part time or to take on an independent contractor (if the nature of the work allows you to) rather than continue with an employee. Part-time employees usually don’t require benefits, and independent contractors are often less expensive to hire.
Customer Relationship Management Software
If you’re hibernating your business, then cutting out customer relationship management (CRM) software makes sense. But if you’re downsizing, you’ll likely still benefit from keeping your CRM platform.
If you need it, keep this software, but to save money consider a free option or downgrade to a less expensive plan in your current subscription. When downsizing, you probably won’t need all of the higher-tier features, so revisit which features are most important. For example, you might not need a plan that offers unlimited data storage and advanced customization.
Accounting
You can reduce accounting costs in various ways. For instance, if your business uses an accountant year-round, you can save money by switching to accounting software and hiring an accountant during tax season to tie up loose ends.
If your business already uses accounting software, you might be able to find free accounting software or take advantage of accounting services that are built into your CRM platform.
Other Software
There are plenty of software tools that make managing your business more convenient. But when you’re trying to reduce costs, these software options might be the best ones to cut early, especially when free versions are available.
From time and project management to sales and marketing, take the time to compare pricing and research ways to make the free offerings work for your business.
If you decide to put your business into hibernation, you should take these steps:
1. Cut costs. Eliminate any expenses that aren’t essential to the legal operation of your business.
2. Plan for business staff. Since you’re hibernating your business, you’ll probably no longer need people to perform their usual duties. You might be forced to lay off some or all of your employees. Alternatively, you can furlough employees, which requires them to take some time off during the hibernation. By furloughing employees, you avoid layoffs. But make sure you’re not violating the Fair Labor Standards Act by furloughing an exempt employee.
3. Finish existing contracts. Factor in any responsibilities for existing contracts when timing your business’s hibernation. You can either continue these contracts or assign your responsibilities under the contract to another company, if the contract allows it.
4. Notify customers. Let your customers know that your business is taking a break but that you expect your business to return. For example, you can say that your business is closing temporarily but you hope to reopen next spring.
If you’ve decided against hibernation or downsizing and are ready to sell your business, then it’s time to start the winding down process. You’ll want to work with an attorney throughout the sale process to ensure the sale is successful and finalized. Here are some key steps to selling your business.
1. Determine your business’s value. Make sure you have your finances in order so you can clearly demonstrate your assets, liabilities, and profit projections. You can work with a valuation expert or self-evaluate your business to determine an appropriate listing price.
2. Broker the sale. Determine whether you want to use a broker to help you secure a buyer. A good broker can identify serious buyers, reach a favorable price and deal, and handle the legal and tax complexities associated with the sale. A broker’s fee is usually a percentage of the sale. You can also sell your company online. Selling your business online has one big advantage: You have access to a whole network of potential buyers that wouldn’t be available in the physical world.
Here are a few ways to sell your business online:
3. Prepare and sign the sales agreement. To officially sell your business, you’ll need to prepare and sign a sales agreement. The agreement should cover the purchase price and terms of payment. It should also address what’s included in the sale—for example, is all the kitchen equipment included in the sale of a restaurant? The agreement should further specify how the transfer of ownership will take place (gradual or outright), and what conditions each side must meet. Have an attorney draft or look over your sales agreement to protect your business interests.
4. Notify your employees. It’s usually best to tell employees right after the sale is finalized. During the transition period, you should answer their questions and introduce employees to the new owner, if possible.
5. Review existing contracts. Review any existing contracts to make sure the change in ownership won’t affect these agreements. In any case, you’ll want to inform the other party to any contract of the change in ownership—the contract might even require the notification.
6. Notify your customers. Once you finalize the sale, you should have a period to notify all past and existing customers of the sale. For example, you might send a notice through email or letter and post an announcement on your website or storefront. You can also post a notice in the newspaper or in your company newsletter. Give your customers a way to contact the new owners and update them on any changes they can expect from this ownership transfer. You may also need to notify your county or state of your intention to sell your business assets. For example, in California if you are selling inventory of a retail, wholesale, or manufacturing business (in a “bulk sale”), you’ll need to record the notice with the county recorder, publish a notice of the sale in the local newspaper, and notify the county tax collector 12 days before the sale.
7. Figure out taxes on the sale. You’ll need to determine how much you owe in taxes from the sale. You can ask a CPA to help you figure out how much you owe and what forms you need to file. You’ll probably need to complete IRS Form 8594, Asset Acquisition Statement and file it with your final tax return.
The requirements to hibernate or sell your business can also vary from state to state, so be sure to check your state statutes and revenue and tax codes—or lean on your lawyer for the relevant information. You should also look back at your bylaws or operating agreement, if you have one, for any instructions on selling your business.
Selling or hibernating your business is a big decision. Although the information in this article should help, if you’re seriously considering selling your business, it’s a good idea to consult an attorney on whether it’s time to sell and for help closing the deal.
]]>In this article, you’ll learn about things to be aware of when opening a new business while having a bankruptcy in your recent past.
After a business fails, filing an individual bankruptcy in your name isn’t unusual. Most bankruptcy lawyers will tell you it’s an efficient way to eliminate your responsibility for business debt while wiping out credit card balances, medical bills, and other personal debt.
For instance, after a business closure, many prior owners wipe out “personal guarantees,” or legally binding promises to pay the closed company’s debt, by filing for bankruptcy. Many creditors require a business owner or someone with interest in the company to agree to be financially accountable for the business debt because of the frequency businesses go out of business. The contract is known as a personal guarantee.
After a personal bankruptcy, your credit will likely take a hit, and you might not have as much income and assets. So, if you’re starting a new business that requires a significant capital outlay, you’ll need to do strategic and careful financial planning.
Learn more about starting a new business.
It’s not a good idea to get into the same business type shortly after closing the old business and filing for bankruptcy. When a company isn’t doing well, and the bills start piling up, it’s tempting to shut it down or put the business in Chapter 7 bankruptcy before starting the business anew.
Unfortunately, such tactics are more likely to be counter-productive than helpful. Here’s why:
You're unlikely to have a problem if the new business is a unique venture. If it’s similar, it would be prudent to consult with a business lawyer.
You know to expect banks and other lenders to ask about your personal credit history when deciding whether to provide business financing. You might be able to increase your chances of approval by:
You might be thinking about turning to the small business administration for funding. If you are, exercise caution. Often, the small business administration requires not only a personal guarantee but will also expect you to use personal assets to secure the business debt—most commonly your home.
Just because you can’t get financed doesn’t mean you have to put aside your dream of working for yourself. You might want to consider:
Here are a few other things you’ll want to consider before starting your new business after bankruptcy.
Did you know Nolo has been making the law easy for over fifty years? It’s true—and we want to make sure you find what you need. Below you’ll find more articles explaining how bankruptcy works. And don’t forget that our bankruptcy homepage is the best place to start if you have other questions!
Our Editor's Picks for You |
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More Like This |
When Can I Get a Mortgage After Bankruptcy? |
Helpful Bankruptcy Sites |
We wholeheartedly encourage research and learning, but online articles can't address all bankruptcy issues or the facts of your case. The best way to protect your assets in bankruptcy is by hiring a local bankruptcy lawyer.
]]>Below we focus primarily on the benefits of restructuring business and personal debt through payment plans using Chapters 11 and 13. Consider learning about other small business bankruptcy topics, including Chapter 7 bankruptcy for small business owners.
Chapters 11 and 13 both allow debtors to propose a plan to restructure their finances, which can help a company stay in business. If you qualify, a Chapter 11 or a personal Chapter 13 (with limitations) plan can:
Keep in mind that a business can't file Chapter 13 (with the exception of sole proprietors). But even so, a small business can benefit from an owner filing for Chapter 13 because it can free up cash, which is why some small business owners choose Chapter 13 over Chapter 11.
By contrast, Chapter 11 can provide more flexibility for the business itself, but it usually costs too much and takes too much time to be a realistic option for small business owners. Fortunately, business owners now have a cheaper choice that works more like Chapter 13 bankruptcy called "Chapter 11, Subchapter V."
Virtually anyone can file for Chapter 11 bankruptcy, but all small businesses are ineligible to file for Chapter 13 except for sole proprietors. Here's how it works.
Chapter 13 eligibility. Chapter 13 is available to individuals and sole proprietors with regular income. Small companies formed as corporations, partnerships, or other entities aren’t eligible for Chapter 13 relief. However, that's not to say that someone who owns a business can't file an individual Chapter 13, and sometimes doing so helps.
Most filers' plans direct income toward the debts filers want to be paid most, like mortgages, car loans, equipment payments, and other secured obligations. Filers pay significantly less toward credit card debt, medical bills, and unsecured personal loans. Also, business debts you're personally liable for will be included in your plan.
However, not everyone qualifies for Chapter 13. You'll need sufficient income to support a Chapter 13 plan and will be subject to debt limitations that change periodically and other Chapter 13 eligibility requirements.
As of April 1, 2022, a filer's debt can't exceed $1,395,875 in secured debt and $465,275 in unsecured debt. These figures apply to cases filed between April 1, 2022, and March 31, 2025.
Chapter 11 eligibility. Almost anyone can file for bankruptcy under Chapter 11. Individuals, corporations, partnerships, joint ventures, and limited liability companies are all eligible to be Chapter 11 debtors. There are no debt or income requirements or limitations for filing bankruptcy under Chapter 11.
Chapter 11 Subchapter V is limited to "small business filers" with a total debt burden of $3,024,725 or less (valid April 1, 2022, through March 31, 2025).
Learn about other options for struggling businesses in Small Business Bankruptcy.
Chapter 11 cases are complex and expensive, which is the most significant disadvantage for small business owners. It’s also why Chapter 11 cases make up only a tiny percentage of bankruptcy cases filed. However, special procedures available to small businesses through Chapter 11, Subchapter V can help lower costs significantly.
Important Chapter 11 advantages include:
Also, small business debtors can take advantage of special provisions that help streamline Chapter 11 matters. You’ll qualify as a small business debtor under Chapter 11, Subchapter V if you’re an individual or entity who is:
For more information, see Chapter 11 Bankruptcy: An Overview.
The biggest downside to Chapter 13 is that it’s available only to sole proprietors filing as individuals. Also, the debt limitations are significantly lower than those for small businesses in Chapter 11, Subchapter V.
Other limitations include:
However, sometimes, a business owner really only needs help with personal debts. In that case, an individual Chapter 13 filing would likely be the preferred choice because:
Find out more in Chapter 13 Bankruptcy for Small Business Owners.
Did you know Nolo has been making the law easy for over fifty years? It’s true—and we want to make sure you find what you need. Below you’ll find more articles explaining how bankruptcy works. And don’t forget that our bankruptcy homepage is the best place to start if you have other questions!
Our Editor's Picks for You |
|
More Like This |
Will Business Bankruptcy Help If I Want to Continue My Business? |
What to Consider Before Filing Bankruptcy |
Chapter 7 for Small Business Owners |
Helpful Bankruptcy Sites |
We wholeheartedly encourage research and learning, but online articles can't address all bankruptcy issues or the facts of your case. The best way to protect your assets in bankruptcy is by hiring a local bankruptcy lawyer.
Updated April 14, 2022
]]>Before making a bankruptcy decision, you’ll want to learn about other bankruptcy options available to business owners, as well as the differences between Chapter 7 and 11 and Chapter 13 and 11 bankruptcy.
Individuals who file for Chapter 7 don't lose everything. You can designate some of your property as "exempt" (protected) so that after the case, you'll have the things you’ll need for a fresh start. In exchange for forgiveness (discharge) of most or all of your debts, you must turn over all nonexempt property to the Chapter 7 trustee, who will sell it and use the proceeds to pay your creditors.
Exempting your company or its assets is the key to keeping it in Chapter 7 bankruptcy. Depending on the business, you’ll need to be able to protect either:
To find out whether you’ll be able to do so, you’ll look to the exemptions of the state where you live or the state where the business assets are located. Some states allow debtors to choose between the state exemptions and a list within the bankruptcy code itself (the federal exemptions).
You might have difficulty protecting everything you need, but it will be possible for some business owners. Exemptions typically cover clothing, household furnishings, a modest vehicle, some equity in a residence, and a retirement account.
Other exemptions exist, too. For instance, many states let filers protect "tools of the trade," which are usually personal assets used by an individual to carry on a trade or profession. Think of a mechanic's tools, a work truck, or a lawyer's library of law books. A wildcard exemption—an exemption that lets a filer protect any item of the filer’s choosing—can come in handy for assets that aren’t covered by exemptions, such as corporate shares. The value is usually limited to a few thousand dollars.
The structure of the business will help you determine what you’ll need to protect to prevent losing the company.
For a comprehensive evaluation of your business in Chapter 7 bankruptcy, you should consult with a bankruptcy attorney before filing.
A small number of states have exemptions that could cover some specific business assets, but they’re rare. Here’s what you’ll need to exempt.
You'll need to consider what will happen to the assets that you can't protect. The trustee has two choices in dealing with a nonexempt asset: sell it or abandon it.
Before selling an asset, the Chapter 7 trustee will decide whether selling will bring in enough money to benefit the creditors. If the trustee can't realize enough money to make it worthwhile, the business or asset will be considered "burdensome to the bankruptcy estate," and abandoned back to the debtor.
Here are some of the issues the trustee will consider.
If you'd like to stay in business, you might have a better chance of doing so if you qualify to file for Chapter 13 bankruptcy. If the company has value or assets that you can't exempt, you can pay that value to your creditors over a Chapter 13 three- to five-year repayment plan.
To learn more, see Chapter 13 Bankruptcy for Small Businesses: An Overview.
]]>Instead, most people who've signed personal guarantees agreeing to pay for partnership or corporate business debt usually choose to wipe out their individual liability by filing for Chapter 7 bankruptcy themselves. If you're considering filing for bankruptcy, but you aren't sure which type would be best, help is available. Start by reading the following:
The answer depends mainly on the structure of your business and if you've signed a personal guarantee. A personal guarantee is an agreement that you'll pay the business debt personally if the business fails to do so. Once signed, you're liable for the debt, regardless of the business structure. Otherwise, your liability will depend on the business type.
If you're a sole proprietor, you and your business are treated as one. You'll be able to discharge all qualifying debt—both personal and business—by filing a Chapter 7 bankruptcy in your own name. If you have more business debt that personal debt, you likely won't need to worry about how much income you make—you won't need to pass the Chapter 7 means test.
You can protect both personal and business assets by using bankruptcy exemptions. So with Chapter 7, it’s possible to wipe out your debts and continue operating the business. Because most states allow you to keep a modest amount of property—basically, the bare necessities—this works best when you have a service-oriented business, such as if you’re a personal trainer or accountant.
People who own businesses that require costly equipment, goods, and supplies—such as a restaurant or clothing store—might have a difficult time retaining the business after filing for Chapter 7. The Chapter 7 trustee appointed to oversee your case would sell any nonexempt property, which in many cases, would make it impossible for the business to continue. In fact, the trustee might attempt to sell the business itself, if possible.
A partnership is a separate legal entity and can file a Chapter 7 business bankruptcy. When the partnership files for bankruptcy, there is no discharge of the business debt. Also, the partners can’t use exemptions to protect property. The trustee will close and liquidate the business by selling it or all its assets to pay creditors.
In a general partnership, all partners are personally liable for the business debt which can cause a problem if the partnership files for bankruptcy. If there aren’t enough business assets to pay off all creditors, the bankruptcy trustee (or the creditors) could go after the personal assets of each partner to satisfy any outstanding obligation.
In most cases, it’s better for the individual partners to each file for Chapter 7 bankruptcy after the business closes (in their own names—not the business name) and discharge both personal and business obligations. Keep in mind that most partnership agreements contain a clause that dissolves the business if one of the partners files for bankruptcy.
Similar to a partnership, a corporation can also file Chapter 7, but again, it won’t receive a discharge. The benefit of a business Chapter 7 is the simple and orderly liquidation it provides by placing the burden of selling assets and paying creditors on the trustee instead of the owners.
It’s rare for the benefit to outweigh the risks of this bankruptcy type, however. For instance, any stockholder who cosigned or personally guaranteed a corporate debt will still be on the hook for the debt (unless the shareholder files a Chapter 7 in his or her own name). Most corporations would do better selling the property at a higher price (compared to fire sale bankruptcy prices) and negotiating down the debt with creditors. This would leave less financial burden on those responsible for corporate debt.
Also, filing for bankruptcy gives creditors an easy forum to claim that the officers failed to follow corporate formalities—an action called piercing the corporate veil. Winning this type of lawsuit has the effect of making shareholders liable for corporate debt.
An LLC works almost precisely the same way as a corporation when it comes to bankruptcy and debt liability. You can liquidate the business by filing a business bankruptcy, but you must wipe out your liability for business debts through personal bankruptcy. Also, the same risks apply.
To learn more about what happens when your business files for Chapter 7, see Chapter 7 for Small Businesses.
Each case is unique. Before moving forward with a business or personal bankruptcy, you'll want to find out which bankruptcy type will best meet your needs. A bankruptcy attorney can review the facts of your case, then explain your options and the ramifications of each choice. Also, most attorneys will consult with you free of charge.
]]>Both Chapters 7 and 11 strike a balance between providing debt relief to filers and payment to creditors. However, the type of relief available to individuals and businesses varies significantly, and it isn’t always intuitive. Here are the basics:
You'll find links to more information about small business bankruptcies after the comparison chart at the end of the article.
Only filers who don’t have enough income to pay into a lengthy repayment plan will qualify for Chapter 7. And creditors will receive payment only if the debtor—the person filing the case—owns assets that can be sold by the Chapter 7 trustee—the person responsible for administrating the case. The lack of a repayment plan makes Chapter 7 the fastest bankruptcy chapter to complete.
How long a particular Chapter 7 will take will depend on the property owned by the debtor. For instance, a “no-asset” case in which the filer can protect all property using bankruptcy exemptions is the quickest. With no property to sell and no creditors to pay, this type of case is over in about three to four months.
By contrast, some filers can protect only some assets, and others aren’t entitled to use exemptions at all. These “asset” cases stay open longer, about six months to a year on average, to give the trustee time to liquidate (sell) the property. Cases involving real estate or property ownership litigation often take longer to resolve.
The most attractive benefit of Chapter 7 is that it allows some debtors—but again, not all—the ability to discharge (erase) qualifying debt. The filer will receive the debt discharge after three to four months, even if the case itself remains open while the trustee sells assets for the benefit of creditors.
If you now realize that one of the complicating factors of Chapter 7 is that it doesn’t treat all filers alike, you’re correct. But the rules aren’t random. The filer’s status as an individual, sole proprietor, or another business entity determines the rules you’ll apply in the following categories:
You’ll find specific examples after “How Chapter 11 Bankruptcy Works.”
When learning about the Chapter 7 process, remember that applying the wrong law could result in significant property loss because a debtor doesn’t have the right to dismiss a Chapter 7 case without court approval. Consult with a bankruptcy lawyer experienced in business-related cases to avoid unexpected results.
Not all struggling businesses are destined to close. When an unexpected event reduces the income stream of an otherwise viable company—as experienced by many at the onset of the coronavirus pandemic—Chapter 11 can help. A filer can restructure debt to allow the company to remain open as long as the filer, creditors, and the court agree on the strategy. For instance, a plan of reorganization can include:
Chapter 11 relief is also available to individual wage earners who don’t qualify for Chapter 7 or Chapter 13. Because such filings are rare, this discussion pertains to businesses only.
The U.S. trustee (or bankruptcy administrator in North Carolina and Alabama) keeps track of the overall case progression by monitoring business operations, overseeing investigations, and ensuring the timely submission of filings, operating reports, and fees. But the U.S. trustee isn’t as directly involved as the trustee in Chapter 7 or 13 cases.
The filer or “debtor in possession” is responsible for carrying out everyday business operations. But that’s not all. The debtor in possession also fulfills all noninvestigative bankruptcy requirements, such as completing filings and reports, reviewing and objecting to creditor proof of claims, and hiring court-approved experts. The need to be actively involved is partly why a traditional Chapter 11 is cost-prohibitive for most small companies.
One of the Chapter 11 case hallmarks is the extensive creditor negotiations that occur before and after the case filing. It’s not unusual for the parties to resolve issues without entering into a formal plan. As with any form of bankruptcy, it’s an abuse of process to use Chapter 11 as a delay tactic with no intention of subjecting to the process.
Find out what individuals and small businesses can expect when filing under either Chapter 7 or 11 bankruptcy, or click one of the links below to go straight to the information you're seeking:
These Chapter 7 filers can keep property using bankruptcy exemptions and discharge qualifying debt. It’s best suited for a low- or no-income debtor whose property is fully protected by bankruptcy exemptions and whose debts qualify for discharge. But as long as the debtor would come out ahead financially, meaning that the amount of erased debt would adequately exceed the value of property lost, Chapter 7 would likely make sense.
These filers must qualify by passing the Chapter 7 means test unless the filer’s business debt exceeds the filer’s consumer debt, thereby exempting the filer from the means test requirement. The exemption creates a “loophole” that prevents a high-earning filer with substantial business debt from automatically disqualifying.
However, keep in mind that another test exists. The trustee will compare the current income figures listed on Schedule I: Your Income to the expense totals disclosed on Schedule J: Your Expenses. The bankruptcy judge will likely convert the case to Chapter 13 if, after subtracting the two figures, income remains that the filer could use to pay creditors through a repayment plan. For instance, a filer with a $5,000 monthly income and $3,500 in monthly expenses would have $1,500 available to pay creditors each month. The bankruptcy judge would likely convert the case to Chapter 13.
Individuals can protect or exempt property using bankruptcy exemptions, such as some equity in a home and car, household furnishings, clothing, a retirement account, and some tools needed in a profession or trade. Many states also have wildcard exemptions a filer can use to protect assets of the filer’s choice.
Sole proprietors can also keep any property covered by bankruptcy exemptions. If exemptions protect vital business assets—such as needed equipment and product—a sole proprietor might even be able to keep the business open. By contrast, a service-oriented sole proprietorship will almost always survive Chapter 7 because a trustee can’t sell the owner’s future services.
When an individual files for Chapter 7 bankruptcy, qualifying personal and business debts are wiped out with the debt discharge, and personal guarantees are included. The same applies to sole proprietors. Credit card balances, utility and medical bills, lease balances, and personal loans are debts commonly discharged in Chapter 7.
If a filer would lose important property in Chapter 7, negotiating debt directly with creditors and selling assets might be the better option. Also, Chapter 13 has mechanisms not available in Chapter 7 that will allow filers to do the following:
Find out when Chapter 13 works better than Chapter 7.
Chapter 7 provides limited benefits to these entities. It works best when the business has substantial assets to sell, and the partners or stakeholders want to relinquish the work of selling it to someone else. Essentially, the filing allows the closing company to hire the Chapter 7 trustee to take the rowing oar in the wind-down process and to assume liquidation and asset distribution-related tasks. Because all property gets sold, filing for Chapter 7 will effectively close the company.
Stakeholders interested in filing for Chapter 7 should consider that the trustee’s interests are aligned more closely with creditors than the debtor, making them natural partners. The more assets the trustee uncovers, the bigger the trustee’s payday, giving the trustee ample incentive to investigate the company’s affairs and potentially mishandled or hidden assets.
Although the transparent nature of bankruptcy can be beneficial, the other option—closing the business outside of bankruptcy—is often more economical and offers less stakeholder scrutiny. Business bankruptcy attorneys decide on closure strategy on a case-by-case basis.
Here are some procedural details that apply when these debtors file for Chapter 7.
Most filers must take and pass the Chapter 7 means test to qualify for Chapter 7. However, an exception exists when business debt exceeds consumer debt. Because businesses don’t have consumer debt, filing businesses are exempt from the need to qualify for Chapter 7.
When a business files for Chapter 7, the trustee sells all of the business property at fire-sale prices. The trustee then deducts sales costs and an additional percentage as payment for the trustee’s efforts before distributing the remainder to creditors.
This practice can be problematic for stakeholders personally liable for business debt, leaving higher balances than might be possible otherwise. Stakeholders can often limit exposure by negotiating down debt, selling the property for top dollar, and distributing funds outside of bankruptcy. This approach tends to pay more toward creditor payments, leaving less for stakeholders to pay with personal assets.
The partnership, LLC, or corporation won’t receive a debt discharge. Stakeholders remain responsible for any personal guarantees for business debt and other nondischargeable obligations, such as trust fund tax debt.
Partnerships rarely file for Chapter 7 because general partners are personally liable for business debt. If a partnership without adequate assets to repay creditors filed for Chapter 7, the trustee could pursue the partners for payment personally and individually—possibly even forcing them into bankruptcy.
Red flags for any business filers include rumblings from disgruntled creditors, business partners, or even ex-spouses. Not only are these individuals the most likely to ask uncomfortable, if not downright dramatic questions at the 341 meeting of creditors—the one hearing all Chapter 7 filers must attend—but things could, and often do, escalate from there. In a nutshell, the trustee gains from the information provided by disgruntled creditors. It can help uncover assets.
Also, a bankruptcy filing increases the chances of a creditor lawsuit. Once a business files a case in bankruptcy court, creditors start looking for ways to get paid. The most basic is by filing a proof of claim. However, if selling the business assets won’t pay much toward claims, creditors might initiate litigation asserting that the stakeholders mishandled assets and attempt to go after their personal assets. Even when meritless, defending a lawsuit is costly.
Large businesses with debt exceeding Chapter 11, Subchapter V (Chapter 11, Sub V) small business limits must use the traditional Chapter 11 procedure. Because of the large number of creditors involved and the votes required to approve a plan, Chapter 11 is the most cumbersome and expensive form of bankruptcy, making it unavailable to most small businesses.
It works well if the functioning business has a sufficient income stream to support a reorganization plan (although, in some instances, the company can take out a loan for operating capital). Here are some of the procedural requirements that set it apart from Chapter 11, Subchapter V (discussed further below).
Creditors have significant involvement in a Chapter 11 case. The U.S. trustee appoints a creditors’ committee made up of the seven largest unsecured creditors with the following responsibilities:
The committee is comprised of unsecured creditors because an unsecured debt—an obligation not backed by collateral—carries with it the least amount of protection in bankruptcy. Hence, it’s most at risk of being discharged in a bankruptcy case. By contrast, secured creditors have significant protection—they’re entitled to the property collateralizing the claim if the debt isn’t paid, even in a bankruptcy case.
The debtor in possession must fully disclose background information so that a creditor can make an informed decision about the feasibility of the proposed plan. The disclosure statement describes how the plan would pay each class of creditors, along with other information, such as:
Creditors use the company snapshot provided to raise plan objections disguised as disclosure statement objections. Because creditors can also object to the proposed plan, the process gives creditors two “objection” bites at the apple, creating two litigation rounds.
Once the disclosure statement is approved, the court will set dates for plan objections and creditor voting. The debtor must wait to begin soliciting creditor votes until then unless negotiations predated the bankruptcy filing.
Once the requisite amount of creditor votes is received and the plan is confirmed, the property in the bankruptcy estate vests in the debtor per the plan.
Also, after creditor consensus is received and the plan is confirmed, the debtor receives a debt discharge erasing debts identified in the plan. The discharge occurs at the time of confirmation, not after the debtor makes required payments, because the confirmed plan becomes a new binding contract between the debtor and creditors.
Chapter 11, Subchapter V, requires far less creditor involvement in a process that can more closely resemble Chapter 13 than Chapter 11.
A business must be functioning and have an income stream sufficient to support a reorganization plan. Also, the company's debts must be $3,024,725 or less if filed between April 1, 2022, and March 31, 2025.
Because it can be difficult for a small business to remain profitable and propose a feasible plan, the U.S. trustee provides more oversight throughout the process. For instance, the debtor in possession must submit to an initial interview with the U.S. trustee—something not a part of a traditional Chapter 11—and provide extensive financial information earlier in the process.
Some of the requirements that typically generate litigation in a traditional Chapter 11 aren’t required in Chapter 11, Subchapter V, such as:
As long as the plan pays creditors according to bankruptcy rules and is objectively fair, the bankruptcy judge can confirm (approve) it over creditor objections.
A debtor must make all plan payments before receiving the debt discharge if the judge confirms the plan without creditor consent.
If a business debtor’s filing involves one piece of commercial real estate or residential property with four or more residential units, it’s considered a single asset real estate filing. Special rules that help protect a secured creditor from loss apply in these cases.
In a single asset real estate filing, a creditor with a secured interest in the property can bring a motion asking the court to lift the automatic stay so that the creditor can move forward with foreclosure or other collection actions. If the debtor in possession can’t file a feasible reorganization plan or pay interest payments to the creditor, the creditor will win the motion.
Because these cases also often involve cash collateral—a contractual agreement to turn over property rents, accounts receivables, and other cash equivalents to the creditor—these cases often end quickly. Without the use of cash collateral, many single asset real estate debtors can't pay the necessary interest payment.
These benefits and procedures apply in both Chapter 7 and 11 cases.
An "automatic stay" order immediately stops most creditors from pursuing collection efforts, including wage garnishments, levies, and many lawsuits. Filing for bankruptcy won’t stop all legal actions, however. Criminal cases, some family law matters, and government civil enforcement proceedings will continue.
The automatic stay will go into effect if it’s the filer’s first bankruptcy. The rules discourage people from misusing the system by limiting the stay to a month or preventing it from going into effect when someone has filed and dismissed cases recently, usually within the last 180 days.
Anyone can file for Chapter 7 or 11, including individuals, married couples, and business entities. But not every chapter is a good match for every filer—some chapters come with significant pitfalls. Also, filers who have received a debt discharge in the past must wait until the required time elapses before qualifying for a second bankruptcy discharge.
Filers must complete a credit counseling course within 180 days before filing and include it with the petition and other official bankruptcy forms. Businesses must be represented by counsel and possess proper filing authority. A filing fee or waiver is also required (more below).
All filers attend at least one hearing called the 341 meeting of creditors. Before the meeting, filers submit verification documentation supporting the petition's financial disclosures, including tax returns, profit and loss statements, bank statements, and more. At the meeting, the trustee conducting the meeting places filers under oath, verifies identity, and asks standard questions, along with questions raised by the petition. Creditors can appear and ask questions, as well.
The costs associated with bankruptcy can add up quickly. Here’s what you can expect to pay.
Whenever a business is involved in bankruptcy, it’s best to seek professional advice. For instance, many business people find it more beneficial to file individual bankruptcy after a business closure. An attorney experienced with business bankruptcy cases will evaluate all of the options available and determine how to protect your assets while meeting your goals.
This table highlights some primary differences between Chapters 7 and 11, and Chapter 11, Subchapter V.
Chapter 7 |
Chapter 11 |
Chapter 11, Sub V |
|
Type of Bankruptcy |
Liquidation |
Reorganization |
Reorganization |
Who Can File? |
Individuals, married couples, and business entities |
Individuals, married couples, and business entities |
Individuals, married couples, and business entities |
Debt Restrictions |
No debt limitation. |
No debt limitation. |
$3,024,725 for cases filed between April 1, 2022, and March 31, 2025. |
Income Qualification Restrictions |
Income must be low enough to pass the Chapter 7 Means Test unless business debt exceeds consumer debt or another exemption applies. |
Business or personal income must be sufficient to fund the Chapter 11 plan. |
Business or personal income must be sufficient to fund the Chapter 11 plan. |
Other Eligibility Restrictions |
Must take a credit counseling course during the180 days before filing. Counsel must represent a business entity and file proof of filing authority. |
Must take a credit counseling course during the 180 days before filing. Counsel must represent a business entity and file proof of filing authority. |
Must take a credit counseling course during the 180 days before filing. Counsel must represent a business entity and file proof of filing authority. |
Filing Fees |
$338 payable in four installments with court permission (Dec 2020). Fee waiver available. |
$1,738 (effective Dec 2020) |
$1,738 (effective Dec 2020) |
What Happens to Property in Bankruptcy? |
Trustee can sell all nonexempt property to pay creditors. |
The debtor remains in control of the property, including the business, throughout the case as a "debtor in possession." A trustee isn't appointed. |
The debtor remains in control of the property, including the business, throughout the case as a "debtor in possession." A trustee isn't appointed. |
What Happens to Debt in Bankruptcy and How Long Does it Take to Receive a Discharge? |
Three to four months for individuals and sole proprietors to receive a debt discharge erasing qualifying obligations—other businesses ineligible. |
Businesses receive a debt discharge upon plan consensus and confirmation. |
Discharge received after completion of plan payments when the bankruptcy judge confirms the plan without creditor consensus. |
Benefits |
Individuals and sole proprietors can quickly discharge qualifying debt, including personal guarantees and other business-related obligations. Sole proprietors will include personal and business assets and debts in the case. Businesses can shift the wind-down obligation to sell the business's property to the trustee. |
Debtors maintain control over the business and property while restructuring debt, often allowing a struggling business to remain open. Provides a way to catch up on missed payments to avoid foreclosure or repossession. |
Debtors maintain control over the business and property while restructuring debt, often allowing a struggling business to remain open. Provides a way to catch up on missed payments to avoid foreclosure or repossession. Doesn’t require a creditors’ committee, disclosure statement, or creditor consensus, making it more cost-effective for small businesses. |
Drawbacks |
The trustee can sell nonexempt property. Doesn't provide a way to catch up on missed payments to avoid foreclosure or repossession. The personal assets of partnership partners can be at risk. Filing for bankruptcy opens the door for creditor litigation. |
Prohibitively expensive for most small businesses. Filing for bankruptcy opens the door for creditor litigation, although the risk is lessened by the ability to negotiate with creditors. |
Filing for bankruptcy opens the door for creditor litigation, although the risk is lessened by the ability to negotiate with creditors. |
Did you know Nolo has been making the law easy for over fifty years? It’s true—and we want to make sure you find what you need. Below you’ll find more articles explaining how bankruptcy works. And don’t forget that our bankruptcy homepage is the best place to start if you have other questions!
Our Editor's Picks for You |
|
More Like This |
Will Business Bankruptcy Help If I Want to Continue My Business? |
What to Consider Before Filing Bankruptcy |
Chapter 7 for Small Business Owners |
Helpful Bankruptcy Sites |
We wholeheartedly encourage research and learning, but online articles can't address all bankruptcy issues or the facts of your case. The best way to protect your assets in bankruptcy is by hiring a local bankruptcy lawyer.
Updated April 14, 2022
]]>A Chapter 13 bankruptcy allows you to keep your assets while reorganizing and paying off all or a portion of your debts through a repayment plan. The Chapter 13 repayment plan usually lasts three to five years. You make monthly payments to the bankruptcy trustee assigned by the court to oversee your case. The trustee will pay your creditors according to your plan.
How much you have to pay back will depend on your income, expenses, and the types of debt you have. The higher your income, the more you’ll be required to pay. However, certain debts (called priority debts) must be repaid fully through your plan regardless of income. These include certain taxes and domestic support obligations, among others.
If you’re unable to demonstrate that you have enough income to repay these debts in full—along with other required payments—you might not be able to reorganize through Chapter 13 bankruptcy. At the completion of your repayment plan, any remaining balances of qualifying debts will get discharged (forgiven).
The short answer is no—Chapter 13 bankruptcy is for individuals only. But there’s a workaround if you own a business as a sole proprietor.
For example, suppose that Ava, the owner of “Ava’s Doggie Treats,” falls behind on payments to her suppliers, and she hopes to get back on track using bankruptcy. When it’s time to fill out the bankruptcy forms, she won’t be able to file under the business name, “Ava’s Doggie Treats.” However, because Ava is a sole proprietor, she can file for Chapter 13 bankruptcy under her own name, Ava Roberts, and reorganize both her personal and business debts.
Here’s why this works.
A sole proprietor isn’t a separate legal entity like other companies, such as LLCs and corporations. One of the key differences is that a sole proprietor is personally responsible for both individual (consumer) and business debts.
For bankruptcy purposes, all of a sole proprietor’s property and income is available to pay all debt—consumer and business debt alike. This unique structure gives all creditors a full and equal opportunity to get paid, thereby allowing for the reorganization of all aspects of a sole proprietor’s financial life.
Partnerships and Bankruptcy: Not a Good Mix
Technically, a partnership isn’t a separate legal entity, so it’s feasible that a partner might be able to benefit from Chapter 13 bankruptcy. However, most partners stay away from bankruptcy altogether—and with good reason. Many partnership agreements contain clauses that dissolve the business the instant one partner files for bankruptcy, which, of course, would defeat the goal of keeping the business open. Why have such clauses? When it comes to partnerships, the results in bankruptcy (especially in Chapter 7 bankruptcy) can be unexpected. For instance, if a nonfiling partner has sufficient personal assets to repay business debt fully, a savvy creditor might object to a proposed Chapter 13 repayment plan on the grounds that the creditor would receive more in a Chapter 7 case and seek to move the matter into Chapter 7 bankruptcy. Once in Chapter 7 bankruptcy, the bankruptcy trustee would likely go after the nonfiling partner’s personal assets—a result most partners actively seek to avoid.
Chapter 13 bankruptcy has features which can help keep a small business running.
In bankruptcy, all filers can protect (exempt) certain items needed to maintain a home and employment—which is good because most sole proprietors need equipment and other types of property to function. A benefit of Chapter 13 bankruptcy is that you can keep both exempt and nonexempt property—although it comes at a cost.
You’ll look to your state’s bankruptcy exemption statutes to determine what you can protect and what you’ll have to pay for.
Again, if you are a sole proprietor, your business debts aren’t distinguished from your personal debts. You’ll include everything you owe in the bankruptcy and, like anyone else, you’ll likely pay a minimal amount on debts that aren’t secured by collateral, like credit card balances, utility bills, medical bills, and unpaid invoices. And you’ll receive a discharge of any qualifying balance when you complete your plan. After discharge, the creditor cannot collect from you or the business.
If your business has priority debts like taxes, you can pay them off in your repayment plan if you are a sole proprietor or are otherwise personally liable for them.
Through your Chapter 13 plan, you might be able to reduce the balance of certain secured debts (such as car or equipment loans) to the value of the property. This option can reduce the burden on your business by consolidating these loans into your repayment plan and lowering your monthly payments.
(To learn more, see Cramdowns in Chapter 13 Bankruptcy: The Basics.)
It’s common to end up personally responsible for a business debt, and you can discharge this type of debt in a Chapter 13 case.
Much of this debt occurs because new businesses aren’t profitable. Creditors know this and commonly require the person behind the business to agree to use personal assets to pay unpaid business debt (known as a personal guarantee). Individuals regularly sign personal guarantees for property leases and mortgages on commercial buildings.
It’s also common to find yourself personally responsible for unpaid business tax or debt from a dissolved partnership or sole proprietorship.
The tricky part is that most personal guarantees don’t come due until after the business fails to pay the obligation—in other words, after the company closes down—so many times, this benefit won’t help keep a business open. If, however, the business is still open, keep in mind that the bankruptcy will wipe out your obligation to pay the debt only. An operating business will remain responsible for the business obligation (to the extent it remains unpaid).
Business Chapter 7 Bankruptcy: No Income Qualification
If you’re facing a significant amount of debt after the closure of a business, you might be better off filing for Chapter 7 bankruptcy—even if you have a significant income. When you have more business debt than personal (consumer) debt, you don’t have to take and pass the means test. You can get a discharge in Chapter 7 bankruptcy—and avoid paying into a repayment plan—even if your income is quite high. Of course, you’ll still have to give up any assets that aren’t covered by a bankruptcy exemption. So this might not be a good option if you have a lot of property that you can’t protect. (More on exemptions in the “Keep Business Assets” section above.)
Filing for bankruptcy when you own a business has its own set of complications, many of which cannot be addressed in a short article like this. The best way to protect your interests is by meeting with a bankruptcy attorney who is familiar with both the laws of your state and the practices of the local bankruptcy court.
]]>To start, keep in mind that because the bankruptcy wiped out your unsecured debt and you cannot file for bankrupty again for a certain number of years, lenders may consider you to be less of a credit risk than you might think. However, you should anticipate having to shop around for loans, explaining what caused you to file bankruptcy, and demonstrating that your finances have changed and you are now a good credit risk.
Before you try to get credit for your business, make sure you have a solid, organized business plan to present to potential lenders. The industry in which you are seeking a loan might also make a difference as to your success. If you're seeking funds for a business with a high rate of failure, such as a restaurant, prepare solid responses to likely questions.
Bankruptcy provides you with a financial fresh start, so make sure to take advantage of that and avoid any pitfalls that contributed to your financial troubles before bankruptcy. You may increase your chances of getting a business loan if you can show the lender that you have kept your debt to a minimum after bankruptcy. Additionally, demonstrating financial responsibility may help convince your lender to offer you a loan. Be prepared with evidence, such as statements showing that you’ve consistently paid your mortgage or rent payments and car payments on time since the bankruptcy.
One of the most important factors a lender will consider is whether your income supports your ability to repay the loan you’re seeking. In order for a lender to approve your loan, you must have enough income to repay the loan and your income must be consistent and unlikely to be reduced.
You are allowed to attach a brief explanation to any item on your credit report. Therefore, if your financial troubles were caused by a major event, such as a divorce, car accident, or catastrophic illness or injury, you can place a short statement on your credit report explaining what happened. Lenders may consider this information when determining whether you are eligible for a loan.
It is also useful to create and print out a short statement explaining what caused the bankruptcy, to show the lender what created your financial hardship and demonstrate why your circumstances are different now. Make sure you keep this statement brief and leave out any emotion or negative statements. For example, don’t hand the lender a page about how awful your former spouse was because he or she failed to provide child support payments. Instead, make a simple statement about the facts and explain why the circumstances are different now.
Print out several copies of your statement and provide them to lenders with your application. Make sure you are prepared to articulate the highlights of the statement as well, in case you are asked about it.
All lenders have their own criteria by which they determine eligibility for loans, so your best bet is to find lenders that specialize in small business loans and ask them about their lending criteria. If you don’t have any luck, consider credit unions. Your local chamber of commerce may be able to suggest lenders that offer loans after bankruptcy.
Bear in mind that, because of your credit history, a lender will often charge you a higher interest rate and may require that you secure the loan with collateral, such as the equipment purchased with the loan funds or your own house or car. If you are still having trouble finding a lender, consider asking someone with a good credit history if he or she will cosign for you.
]]>You or your spouse may be personally responsible for your business debts under the following circumstances:
If you are a sole proprietor or a general partner of a partnership, you have unlimited personal liability for the obligations of your business. Your spouse would be liable for the business's debts in the same way that she or he would be liable for personal debts. For example, if you and your wife owned the business as a general partnership, both of you will be on the hook for its debts.
However, if you are a limited partner or your business was formed as a corporation or a limited liability company (LLC), you are generally not personally responsible for business debts.
One of the most common ways to make yourself personally liable for a business debt is to cosign or personally guarantee it. Regardless of whether your business provides limited liability, if you or your spouse cosigned the loan documents as a borrower or executed a guarantee you are responsible to pay that debt back if the company cannot.
However, even if only you cosigned a business debt your spouse can still be held liable depending on if you live in a common law or community property state. Below, we discuss these differences in more detail.
The majority of states follow the common law rules of property division. In these states, the general rule is you are only liable for a debt if you signed the loan documents, your name appears on the account, your credit information was used to obtain the loan, or it was for necessary items such as food and clothing for the family.
If your spouse incurred a business debt for his or her business, you are usually not liable for that debt unless you also cosigned or guaranteed it. However, if you jointly own the business as a general partnership, you are responsible for all its debts.
In community property states, almost all income and property acquired during the marriage is owned equally by both spouses even if only one spouse is on title. Similarly, most debts incurred during the marriage are deemed to be community debts regardless of who is on the loan documents. This means that if your spouse takes out a loan, community property (which you both own) can be used to satisfy that obligation.
If your spouse owns a business and he is personally liable for its debts, then your portion of the community property can be taken by creditors if he or she does not pay the debt. This essentially means that in a community property state, you may be automatically held liable for your spouse’s business debts if they are community debts.
Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin are community property states. Also, in Alaska married couples can choose to treat their property as community property.
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