As a small business owner you can file for Chapter 7 or Chapter 13 bankruptcy if your debts become unmanageable. However, which chapter is right for you depends on the structure of your business, how much debt and assets you have, and whether you intend to continue running the business. Read on to learn more about the pros and cons of Chapter 7 and Chapter 13 bankruptcies for small businesses and when you can use each.
Both individuals and business entities are allowed to file for Chapter 7 bankruptcy. Small business owners have the option of filing Chapter 7 on behalf of their business or for themselves personally (if you are a sole proprietor, you must file a personal bankruptcy to wipe out business debts because you and your business are considered the same legal entity). However, many business owners file both because the business bankruptcy does not wipe out personal liability for business debts.
If you are a sole proprietor, Chapter 7 allows you to wipe out both personal and business debts by filing a single personal bankruptcy. In addition, you can use exemptions to protect your business assets. This means that you can continue to operate the business after wiping out its debts in bankruptcy.
If your business is a partnership, corporation, or limited liability company (LLC), Chapter 7 bankruptcy provides an easy way to close down and liquidate your business. When you file a Chapter 7 on behalf of your business, it becomes the bankruptcy trustee’s responsibility to sell off the assets of the business and pay its creditors. This leaves you free to do other things or seek employment if you choose.
Unless you are a sole proprietor filing a personal bankruptcy, your business does not receive a discharge of its debts in Chapter 7. Also, you cannot use exemptions to protect assets in a business bankruptcy. As a result, all assets of the business are sold to pay its creditors and the business is shut down.
If you were personally liable on any company obligations, you are still on the hook unless you file a personal Chapter 7 bankruptcy. As a result, it is best to file a business Chapter 7 if you wish to close up shop, the business has little or no assets, and you are not personally liable for company debts.
To learn more, see Nolo's section on Chapter 7 Bankruptcy for Small Businesses.
Only individuals are allowed to file for Chapter 13 bankruptcy. Business entities such as partnerships, corporations, or LLCs cannot file. However, similar to Chapter 7, if you are a sole proprietor you can file a personal Chapter 13 to wipe out your personal and business debts.
In a Chapter 13, you get to keep all your assets and pay back all or a portion of your debts through a repayment plan. If you are a sole proprietor with a lot of business assets, a Chapter 7 trustee may sell them if you don’t have enough exemptions. By filing a Chapter 13, you can protect all business assets and keep the business running while reorganizing your debts.
Even if your business is a separate entity like a partnership, corporation, or LLC, you can wipe out your personal liability for business debts with a Chapter 13. Further, you can do things with a Chapter 13 that you are not allowed to in a Chapter 7 such as paying off priority creditors and cramming down secured loans through your plan.
The first and foremost disadvantage to Chapter 13 is that business entities cannot file a Chapter 13. Also, Chapter 13 takes much longer than a Chapter 7 because you have to make monthly payments to a trustee for three to five years. If you have nonexempt assets, you can keep them but you must pay an amount equal to their value to unsecured creditors which can increase your plan payments significantly. Further, your discharge only wipes out your personal liability for business debts. The business itself is still responsible to pay back its debts.
To learn more see Nolo's article, Chapter 13 Bankruptcy for Small Businesses: An Overview.