Chapter 7 vs. Chapter 13 for Small Business Owners

Most small business owners want to know whether bankruptcy will help them continue their business, and often, the answer is yes. The best bankruptcy chapter to file will depend on your business structure: sole proprietors typically file personal Chapter 7 or 13, while small corporations and LLCs either file Chapter 11 Subchapter V or close with the owner filing personally.

Undoubtedly, filing for bankruptcy can help a struggling small business survive and even thrive, but your choice depends on many factors. It requires analyzing the company's activities, business structure, debts, and assets, as well as whether the business's income can fund a repayment plan. You'll compare those factors to determine whether saving your business with bankruptcy is possible, or whether it's time to wind it down in an organized manner.

Which Bankruptcy Chapter Is Right for Your Business?

Business bankruptcy lawyers help owners use bankruptcy strategically, given the limitations and pros and cons of each chapter. Whether the company is closed or can remain open determines the chapter choice. Here are the basics.

Chapter 7 Bankruptcy

Chapter 7 is a "liquidation" bankruptcy, in which the trustee appointed to the case sells property and distributes the proceeds to creditors. (11 U.S.C. § 701 et seq.) Almost all businesses that file for Chapter 7 have already closed or shut down during the process.

Chapter 7 is the quickest and most cost-effective bankruptcy type. Individuals must meet the Chapter 7 means test requirements unless exempt (which many business owners are, more below).

Chapter 13 Bankruptcy

Chapter 13 is a "reorganization" bankruptcy for individuals and sole proprietors only. Other business entities can't file. Chapter 13 can help an owner reduce individual debt, such as credit card balances and personal guarantees, which sometimes is enough to help a business stay open. (11 U.S.C. § 1301 et seq.)

Filers can't exceed the Chapter 13 debt limits: $526,700 for unsecured debt and $1,580,125 for secured debt. (11 U.S.C. § 104; amounts valid until March 31, 2028.)

Chapter 11 Bankruptcy

Chapter 11 is also a "reorganization" bankruptcy that anyone can file. Still, it is primarily used by income-generating businesses that are struggling but could remain operational with debt relief. Traditional Chapter 11 is lengthy and costly. However, Chapter 11, Subchapter V offers a cheaper, more efficient option for small businesses. (11 U.S.C. § 1101 et seq.)

As of April 1, 2025, the Subchapter V debt cap is $3,424,000, following the expiration of the temporary $7.5 million cap on June 21, 2024. (11 U.S.C. § 1182(1); amount valid through March 31, 2028, unless adjusted earlier.)

Business Bankruptcy Options Compared by Structure

While the chart below outlines many primary points, it doesn't address all issues. The best way to protect your assets is by consulting a business bankruptcy lawyer.

Chapter 7 Bankruptcy for Businesses

Both individuals and business entities can file for Chapter 7 bankruptcy. Sometimes putting a small business in Chapter 7 can meet your needs. However, you might find filing personal bankruptcy yourself more efficient.

What Happens When a Corporation or LLC Files Chapter 7?

Not much. The trustee appointed to the case sells the company assets and distributes the proceeds to creditors. Because corporations and LLCs aren't entitled to a discharge, outstanding debt balances remain collectable.

Company Property in Chapter 7

The Chapter 7 trustee sells all the corporation's or LLC's assets because bankruptcy exemptions—the laws that protect property from creditors—are only available to individuals. The loss of assets essentially shuts down the company.

Company Debt in Chapter 7

When a company or LLC files Chapter 7, its debt isn't wiped out or "discharged." (11 U.S.C. § 727.) Because the debt remains intact, a company's bankruptcy doesn't reduce the owner's personal liability for business debt. The exception? Sole proprietors, which are discussed in more detail below.

Tip. It's a common misconception that a business bankruptcy will wipe out both the business's debts and the business owner's responsibility to pay under a personal guarantee or similar obligation. But, because it doesn't work that way, business owners often file for individual bankruptcy after a business closure.

Pros and Cons of Chapter 7 for Small Businesses

There are times when filing a business in Chapter 7 makes sense. Still, in most cases, the potential downsides outweigh the benefits.

Advantages of Filing Chapter 7 for Your Business

A Chapter 7 takes the burden of selling the company property and distributing the assets to creditors off the shoulders of the owners or stakeholders. Not only does the trustee assume this responsibility, but process transparency helps assure creditors that they received proper payment and that they would be unlikely to receive more through litigation.

Disadvantages of Chapter 7 Business Bankruptcy

• Unless you're a sole proprietor, your business won't receive a discharge of debt. You'll remain liable unless you file an individual Chapter 7 bankruptcy.
• Business entities can't use exemptions to protect assets. The trustee sells all business assets, and the business shuts down.
• Most owners can wind down a business without help, avoiding bankruptcy attorney costs, trustee payments, and filing fees.
• Business owners often get better prices on assets and pay more business debt, leaving less for the owner to pay through personal guarantees.
• Business bankruptcy opens the door to litigation over fraud, partnership disputes, or creditors' claims that officers didn't follow corporate formalities.

Tip. It's almost unheard of for partnerships to file for Chapter 7 (and likely isn't allowed under the partnership agreement) because it can put the partners' personal property at risk. You can count on the trustee evaluating whether personal assets can be sold to pay creditors.

When Chapter 7 Makes Sense for Business Owners

Service-oriented sole proprietors who want to keep a business open and business owners whose companies have closed benefit most from Chapter 7 bankruptcy.

How Business Owners Benefit From an Individual Chapter 7 Filing

It's often more effective for business owners to file for personal bankruptcy after their businesses close for several reasons.

• It erases personal obligations, like credit card debt and medical bills—obligations that many owners rack up while trying to keep their businesses afloat.
• An individual Chapter 7 discharge discharges personal guarantees and other business debts for which an owner is personally liable.
• An individual whose business obligations exceed consumer debts (household maintenance expenses) can make more money than most and still be eligible for Chapter 7 because they aren't required to take the means test to qualify.

Tip. The most significant problem business owners face when considering an individual Chapter 7 is the potential loss of property. Start by reviewing your state's bankruptcy exemptions. If you find that you'd lose valuable assets, consider filing for Chapter 13.

How Sole Proprietors Benefit From an Individual Chapter 7 Filing

Unlike other business owners, Chapter 7 bankruptcy can be beneficial for sole proprietors—especially those who provide specialized services that need little or no business assets. It erases business debts, allowing the owner to continue providing services and keep the business running.

• Sole proprietors—being that they're responsible for personal and business debts—can wipe out both in a single Chapter 7 case.
• Service-oriented businesses—accountants, freelance writers, fitness trainers—often survive Chapter 7 because the trustee can't sell their ability to perform services.
• Sole proprietorships that can protect needed equipment and products with bankruptcy exemptions can survive. (11 U.S.C. § 522.)

Tip. If you're a sole proprietor who needs equipment or property to run your business and want to stay open, Chapter 7 might be problematic. 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.

Example. A home baker operating as a sole proprietor accumulated $50,000 in credit card debt for baking supplies and social media advertising. After meeting with a bankruptcy lawyer, she learned she could protect her assets with bankruptcy exemptions and that her business would be safe because it consisted primarily of her personal services, which the trustee couldn't sell. However, she could be required to stop baking during the bankruptcy unless she provided proof of liability insurance. Deciding that discharging $50,000 was worth a temporary shutdown, she filed and was debt-free four months later.

Chapter 13 Bankruptcy for Business Owners

Chapter 13 could help you keep your business. Still, you'd need to file personally, as only individuals and sole proprietors qualify (11 U.S.C. § 109(e)). Partnerships, corporations, and LLCs can't file.

What Business Owners Can Expect in Chapter 13

Chapter 13 takes far longer than Chapter 7 because you'll pay creditors monthly for three to five years. But there's a positive side.

Because of payment priority rules that classify some debts as more critical than others, most people pay more toward obligations they value, such as past-due mortgages and tax debt, and less toward credit card balances, medical bills, and personal loans, which are in the lowest payment category.

For instance, the priority rules give Chapter 13 filers a better chance of doing the following.

• Saving a house from foreclosure or a car from repossession.
• pay off debts bankruptcy won't eliminate over time, such as tax debt and domestic support obligations, and
• reduce some secured loans to the property's value using "lien stripping" or a "cramdown."

However, Chapter 13 payment plans can be expensive, and not everyone has enough income to afford one. For instance, filers must pay unsecured creditors at least as much as the value of nonexempt property or the assets they'd lose in Chapter 7.

Example. When Greta and Chuck opened their yoga studio in the local strip mall, the landlord required that they sign a personal guarantee for the five-year lease. When they closed two years later, the lender pursued the $108,000 lease balance under the personal guarantee, and they filed for bankruptcy. To avoid losing the house in Chapter 7, they chose Chapter 13. Through the plan, they fully paid for $36,000 nonexempt home equity and $15,000 in outstanding tax debt, and a minimal amount toward the yoga studio lease. At the end of five years, they retained their home and were debt-free, except for their monthly mortgage payment.

Chapter 11 Business Bankruptcy and Subchapter V Options

Anyone can file for Chapter 11, including individuals and sole proprietors who don't meet Chapter 13 debt limits. However, partnerships, corporations, and LLCs seeking to reorganize and remain open must file for Chapter 11 bankruptcy to obtain debt relief. (11 U.S.C. § 1101 et seq.).

Large businesses use the traditional, complicated, and expensive Chapter 11 process. Small businesses that qualify for Chapter 11, Subchapter V, can use the more streamlined version, which works more like Chapter 13.

Example. After the cost of brisket skyrocketed, Chuck's Bistro and Barbeque fell behind on equipment leases. However, customers continued to come for barbecue and beer, providing Chuck's with a steady, albeit insufficient, income stream. After a local bankruptcy attorney assisted the LLC's stakeholders in using Chapter 11, Subchapter V, to confirm a plan that reduced Chuck's monthly debt, the beloved restaurant remained open and prospered.

Should You Continue or Close Your Business?

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

• Is the business profitable? If your business consistently loses money, closing could be the right option. However, if you own a profitable company facing temporary economic challenges, staying operational might make sense. Be realistic about remaining open—entrepreneurs tend to be optimistic and often funnel money into ventures long after it's time to close.
• Are assets worth more than liabilities? If your business has more assets than liabilities and is making money, it might be worth saving. Reorganizing debt in bankruptcy (or eliminating it if you're a sole proprietor) might be needed to keep the business afloat. If bankruptcy solutions aren't feasible, consider closing the business by liquidating property and paying off debt outside of bankruptcy. On the other hand, if the company is severely underwater, you likely know it's time to cut losses.
• Are you personally liable for business debts? If you're personally on the hook for company debts, keeping it running while negotiating with creditors might be more advantageous. Closing the business might leave creditors with no option but to pursue your personal assets if the company doesn't have enough assets to cover liabilities. Another common approach is for the business owner to file an individual Chapter 7 bankruptcy, thereby wiping out personal guarantees.

When Creditors Force Bankruptcy

In most cases, bankruptcy is voluntary, but in unusual situations, creditors can force a business into involuntary bankruptcy. Here's the process:

• Several creditors agree to file against a debtor.
• The court appoints a bankruptcy trustee to take over all aspects of the business, sell assets, and distribute proceeds to creditors.

One reason it rarely occurs is that many creditors prefer initiating their own collection actions. It gives them the potential to grasp a larger share of business assets. Once in bankruptcy, a creditor must share proceeds with other creditors, taking a smaller portion or, in some cases, getting nothing.

FAQs About Business Bankruptcy

• Will filing for bankruptcy close my business?
• Can I keep my business equipment in Chapter 7?
• What's the difference between filing personally vs. my business filing?
• How do personal guarantees work in business bankruptcy?
• Can partnerships file for Chapter 13 bankruptcy?
• How much does business bankruptcy cost?
• Do I have to take the means test if I'm a business owner?

Will filing for bankruptcy close my business?

Not necessarily. Sole proprietors can often keep service-based businesses open in Chapter 7 and other businesses open in Chapter 13. Also, companies filing Chapter 11 and Chapter 11 Subchapter V, which are designed to keep businesses open, don't close if they successfully reorganize their debt. Corporations and LLCs filing Chapter 7 close because the trustee sells all business assets.

Can I keep my business equipment in Chapter 7?

Only if you're a sole proprietor, because business entities can't use exemptions. For instance, a sole proprietor could protect business equipment using a "tools of the trade" exemption or a wildcard exemption. The amount you can protect varies by state.

What's the difference between filing personally vs. my business filing?

When you file personally, you discharge your personal debts and any business debts for which you're personally liable, including personal guarantees. Your business continues to operate and remains responsible for its own debts. When the business entity files for Chapter 7 or 11, the trustee handles only the business's property and debts. Your personal debts remain. The exception would be a sole proprietorship, in which both personal and business debts and property are handled in the same case.

How do personal guarantees work in business bankruptcy?

Personal guarantees are discharged when you file an individual bankruptcy under Chapter 7, 13, or 11, not when the business files. For instance, if you have an ownership interest in an LLC or corporation that files for Chapter 7, you'll remain personally liable under the guarantees you signed. Because of this, many business owners file for personal bankruptcy after their businesses close.

Can partnerships file for Chapter 13 bankruptcy?

No. Chapter 13 is only available to individuals and sole proprietors. It's essential to consult a bankruptcy lawyer due to the increased liability associated with partnerships in bankruptcy.

How much does business bankruptcy cost?

Chapter 7 filing fees are $338, but attorney fees typically range from $1,500 to $3,500 for straightforward cases. Chapter 13 filing fees are $313, with attorney fees ranging from $3,000 to $6,000. Chapter 11 Subchapter V is more expensive, though still far less than a traditional Chapter 11, which can cost $50,000 to $100,000 or more.

Do I have to take the means test if I'm a business owner?

If your business debts exceed your consumer (personal) debts, you don't have to take the Chapter 7 means test. This exemption allows business owners to file for Chapter 7 even if they have higher income than typical Chapter 7 filers.

Need More Help?

Did you know Nolo has made the law accessible for over fifty years? It's true, and we wholeheartedly encourage research and learning. However, online articles and resources can't address all bankruptcy issues and aren't written with the facts of your particular case in mind. The best way to protect your assets in bankruptcy is by hiring a local bankruptcy lawyer.