Bankruptcy for Small Business: An Overview

Chapter 7, Chapter 13, and Chapter 11 bankruptcy may help your small business if it is struggling with debt. Learn more.

If your small business has a significant amount of debt, bankruptcy can help you reorganize your debts to save your business, wipe out your personal liability for business debts, or simply liquidate the company.   Depending on your goals, this can be accomplished by filing a personal bankruptcy, business bankruptcy, or both.   Read on to learn more about your bankruptcy options under Chapters 7, 11, and 13 for you and your small business.

Who Is Liable for Business Debts?

If you are a sole proprietor or a general partner of a partnership, you are personally liable for the obligations of your company.   This means that if the business does not pay its debts, creditors may be able to take your personal assets to satisfy them.

If you are a limited partner or your business is a corporation or limited liability company (LLC), you are usually not personally responsible for business debts.   Creditors can only go after business assets. However, you may still be on the hook if you cosigned or personally guaranteed the debt.

What Are My Bankruptcy Options?

Chapter 7, 11, and 13 bankruptcies each offer certain benefits and drawbacks.   Which one is right for you depends on your debts and how your business is set up. Below, we explore each option for you and your business.

Chapter 7 Bankruptcy

A Chapter 7 bankruptcy can be filed by both individuals and business entities.  

Chapter 7 Bankruptcy for a Business Entity

If you have a partnership, corporation, or LLC, you can file Chapter 7 bankruptcy on behalf of your business.   Chapter 7 is used primarily to shut down and liquidate a business.   The business does not receive a discharge and cannot use exemptions.  

When the case is filed, a bankruptcy trustee sells its assets and pays its creditors.   It is usually an attractive option for small business owners who wish to close their business and do not want to deal with selling assets and negotiating with creditors. However, keep in mind that a Chapter 7 business bankruptcy does not eliminate your personal obligations on any business debts.

Personal Chapter 7 Bankruptcy

If you are a sole proprietor then your business cannot file Chapter 7 bankruptcy on its own. Because a sole proprietorship is not a separate legal entity from its owner, all business assets and debts are also debts of the individual business owner. As a result, you must file a personal bankruptcy to get rid of business debts.   The benefit of this is you can wipe out both personal and business debts while using exemptions to protect business assets. This means you may be able to continue operating the business even after bankruptcy.

Also, if you were on the hook for the debts of your partnership, corporation, or LLC, a personal Chapter 7 can wipe out your personal liability for business debts.   As a result, many small business owners who file a Chapter 7 business bankruptcy also file personally as well.

Chapter 13 Bankruptcy

You can only file a Chapter 13 bankruptcy if you are an individual.   A business cannot file Chapter 13 as a separate entity.

You Cannot File Chapter 13 for a Business Entity  

As we mentioned, a business entity cannot file a Chapter 13.   However, if you are a sole proprietor, you and your business are considered the same entity. So if you file a Chapter 13 all business debts are automatically included in the bankruptcy.   Chapter 13 is designed to let you keep all property and reorganize your debts through a repayment plan so it is a good choice for sole proprietors with a lot of assets.

Personal Bankruptcy Under Chapter 13

In addition to being used by sole proprietors, Chapter 13 bankruptcy allows other small business owners to discharge their personal liability for business debts.   A Chapter 13 is usually used by small business owners with a lot of personal assets or who don’t qualify for a Chapter 7.

Chapter 11 Bankruptcy

Both individuals and businesses can file Chapter 11 bankruptcy but it is significantly more complicated than both Chapters 7 and 13.

Chapter 11 for Business Entities

Chapter 11 is known as the business reorganization bankruptcy.   It is used by businesses who wish to continue operating while reorganizing their debts through a repayment plan.   Generally, it is a lot more expensive and complex compared to a personal Chapter 13 reorganization and has additional requirements such as filing ongoing operating reports and the appointment of a creditors’ committee.   Further, creditors must usually vote on and approve a plan before it can be confirmed.  

However, if your business has less than $2,490,925 worth of debt (as of April 2016), it can be classified as a “small business debtor.” The small business Chapter 11 usually proceeds more quickly because a creditors’ committee is not required and there are fewer hearings.

Personal Chapter 11 Bankruptcy

A personal Chapter 11 is rarely used because a better alternative exists under Chapter 13 for individuals.   However, individuals with more than $1,184,200 of secured or $394,725 of unsecured debt are not eligible to file a Chapter 13 and may be forced to file Chapter 11 bankruptcy.

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