If you're a business owner and you file a personal Chapter 7 bankruptcy, you might be able to keep your business. But it could put the company in jeopardy. You'll lose the business if the Chapter 7 trustee can sell any of the following:
- the company itself
- your ownership interest, or
- any essential property needed to run the business.
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.
How Chapter 7 Bankruptcy Works
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.
Protecting a Business With Bankruptcy Exemptions
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:
- the business itself
- business ownership interests, such as company shares, or
- all equipment, product, and other assets necessary for business operations.
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.
What Type of Business Do You Own?
The structure of the business will help you determine what you'll need to protect to prevent losing the company.
- Sole proprietorships. If your business is not a partnership or incorporated, you're operating a sole proprietorship. For example, if you're a carpenter, you might operate as "Elaine Watson, doing business as Watson's Cabinet Shop." As a sole proprietor, you own the equipment you use in the business, the inventory, the accounts receivable, and all other assets. In Chapter 7 bankruptcy, there is no difference between your assets and debts, and those of the company.
- Corporations and limited liability companies. If your business is incorporated (it's an Inc., LLC, PLLC, or similar), the company is a separate entity from you. The company owns the equipment, inventory, and accounts receivable. Instead of owning all the assets personally, you own stock or shares.
- Partnerships. Partnerships are somewhat tricky, because like a sole proprietorship, partners are personally liable for the debts of the business, and therefore, the debts will be included in your personal bankruptcy. Because bankruptcy could absolve you of your responsibility to pay much of the business debt, many partnership agreements have clauses that dissolve the partnership if one of the partners files for bankruptcy. Litigation arising from a partner filing for bankruptcy is relatively common, so be sure to consult with a bankruptcy attorney.
For a comprehensive evaluation of your business in Chapter 7 bankruptcy, you should consult with a bankruptcy attorney before filing.
Business Assets You'll Need to Exempt in Chapter 7
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.
- Sole proprietorships. You'll want to exempt all business property, including equipment, product, accounts receivables, customer lists, and more. If it's more profitable to sell the company itself, you'll need to protect its value. A trustee cannot sell your future services, so if your business is based solely on your labor, you'll be in the clear.
- Corporations and limited liability companies. You'll want to exempt your ownership interest or shares. If you're the sole shareholder, essentially, you'll need to exempt the entire company. Unfortunately, there aren't many exemptions that could cover these assets, other than a wildcard exemption.
- Exemptions exist that cover property owned by a partnership. However, given that you—not the partnership—will be filing the bankruptcy, these exemptions might not apply. A local business bankruptcy attorney can explain how your state's exemption laws would apply in your case.
Selling the Business or Business Assets in Chapter 7
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.
- Can the stock be sold? Some stocks are freely traded, but others have transfer restrictions. For instance, a closely-held family corporation might allow only family members to own the stock.
- Is it a personal services business? Businesses like mobile window repair services or personal training that depend primarily or solely on personal services provided by the debtor usually have little that a trustee can sell.
- How much effort will it take to sell the business or the assets? The longer the company will take to sell, the more it will cost the trustee to maintain the property.
- Will the trustee have to run the business while it's for sale? A trustee can keep a business going with the permission of the bankruptcy court if that will maximize the value for the creditors. Sometimes, the trustee will keep a business running to liquidate inventory.
- Can the debtor buy back the business from the trustee? Perhaps the debtor can obtain a loan or substitute exempt property.
Chapter 13 Bankruptcy
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.