Will Bankruptcy Help If I Want to Continue My Business?

Find out if bankruptcy can help your struggling business keeps its doors open.

By , Attorney · University of the Pacific McGeorge School of Law

Filing for bankruptcy can help a struggling small business survive and even thrive. Whether you'll choose Chapter 7, 13, or 11 bankruptcy to help you continue your business will depend on:

  • what the company does
  • the structure of the business
  • the company assets, and
  • the amount of income available to fund a repayment plan.

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.

Continuing Your Business: Factors to Consider

You'll want to consider several things before continuing or closing down your business. Here are a few critical considerations.

  • Is the business making money? You started your business to make a profit. If your business is consistently losing money, closing shop could be the right option. However, suppose you own a profitable company facing challenging times due to temporary factors such as the economy. In that case, it might make sense to stay operational and weather the storm. However, it's essential to be realistic about remaining open. Entrepreneurs tend to be optimistic and often funnel money into a venture long after it's time to pull the plug.
  • Are the business assets worth more than its liabilities? It's pretty evident that if your business has more assets than liabilities and is still making money, it might be worth saving. Reorganizing debt in bankruptcy (or eliminating it if you're a sole proprietor) might be just what's needed to keep the business afloat. If the solutions offered by bankruptcy aren't feasible, consider closing the business by liquidating the property and paying off the business debt outside of bankruptcy (unless you'd like the Chapter 7 bankruptcy trustee to do it for you in a transparent manner—but be sure to consider the potential downfalls discussed below). In most cases, you'll save money and generate more funds for creditors. On the other hand, if the business is severely upside down, you likely already know that it might be time to cut your losses.
  • Are you personally liable for business debts? If you're personally on the hook for your company's debts, it might be more advantageous to keep it running (without taking on more debt) while negotiating with creditors. Closing the business might leave creditors with no other option but to go after your personal assets if the company doesn't have enough assets to cover its liabilities. Another common approach is for the business owner to file an individual Chapter 7 bankruptcy and wipe out the personal guarantee.

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.

What Type of Bankruptcy Should You File?

The answer will depend mainly on the structure of the business organization and the value of business assets.

Why Businesses Rarely File for Chapter 7 Bankruptcy

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:

  • Most owners can wind down a business without help, thereby avoiding the added cost of a bankruptcy attorney and filing fees.
  • An owner can often get a better price for the assets than the bankruptcy trustee.
  • Putting a partnership into Chapter 7 bankruptcy puts the partners' personal assets at risk.
  • Filing for bankruptcy gives creditors an instant platform in which to air disputes. Specifically, the filing opens the door to litigation involving fraud, a partnership dispute, or an action to pierce the corporate veil (a lawsuit seeking to hold someone with an ownership interest personally liable for the company's debts).

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.

The Sole Proprietor and Chapter 7 Bankruptcy

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.

The Sole Proprietor and Chapter 13 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.

All Businesses in Chapter 11 Bankruptcy

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.

Need More Bankruptcy Help?

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!

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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.

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