Chapter 13 Bankruptcy for Small Businesses: An Overview

Although many would like to be able to put a company in a Chapter 13 business bankruptcy, it's available only to sole proprietors and individuals. However, a business owner can file an individual Chapter 13 and reduce the amount paid toward credit card payments and other debts, which can be enough to help the business in some cases.

If the business itself needs cost-effective business bankruptcy relief similar to Chapter 13, it can file Chapter 11, Subchapter V. Learn more about who can file for Chapter 13 bankruptcy and how it might help your business.

How Does Chapter 13 Bankruptcy Work?

In Chapter 13 bankruptcy, filers keep property while reorganizing debts through a three- to five-year Chapter 13 repayment plan. The bankruptcy trustee assigned to oversee the case sends the plan payments to creditors. After completing the repayment plan, the remaining balances of qualifying debts are "discharged" or forgiven.

How Are Bills Reduced in Chapter 13 Bankruptcy?

The monthly plan payments depend on the filer's income, expenses, property, and debt types. The higher your income and the more property you own, the more you'll likely be required to pay.

Also, filers must fully repay some debts through the plan. The most common include late house and car payments, recently incurred IRS taxes, and domestic support obligations. If the debts you must pay in Chapter 13 are significant and you don't make enough to repay the required amounts, reorganizing through Chapter 13 might not be possible.

Example. John's lawyer explained that he must be able to pay the following before the court would "confirm" or approve a Chapter 13 plan: a $800 BMW payment and $800 child support arrearages. However, after monthly expenses, John had only $1,000 for debt payment. He proposed to pay $800 monthly in arrearages, $200 toward his other bills (totaling $75,000), and to return the BMW to the bank. The bankruptcy judge approved the plan because it fully repaid the support arrearages and committed his remaining disposable income to his other creditors (another bankruptcy rule).

Can a Small Business Use Chapter 13 Bankruptcy?

If your business isn't a sole proprietorship, the short answer is no—Chapter 13 bankruptcy is for individuals and sole proprietors only. However, a business owner can file for Chapter 13 personally. Sometimes, having less personal debt to pay can be enough to help a business survive.

Can I Keep My Business If I File Chapter 13?

In many cases, yes. However, like any other asset, you must protect the company's value with a "bankruptcy exemption." Here's how this works.

In bankruptcy, a filer can protect or "exempt" items needed to maintain a home and employment. Unlike in Chapter 7, Chapter 13 filers don't lose nonexempt property. Instead, they pay creditors any nonexempt property value through the Chapter 13 plan.

You'll look to your state's bankruptcy exemption statutes to determine what you can protect and what you'll have to pay for. Some states allow filers to use the federal bankruptcy exemptions instead.

If your state doesn't offer an exemption to protect your business—and most don't—you'd have to pay creditors an amount equal to the company's value through the Chapter 13 plan. (Check for "tools of the trade" and "wildcard" exemptions.) This requirement often makes Chapter 13 unfeasible when the company is worth a significant amount.

Example. Suppose your company is worth $100,000, and you can protect $15,000 using a wildcard exemption. To propose a confirmable Chapter 13 plan allowing you to keep your business, you must pay $85,000 of your dischargeable debts, or over $1,400 monthly for five years. The payment would be in addition to any other required amounts.

Can Chapter 13 Erase Personal Guarantees?

A significant benefit of filing a personal Chapter 13 is the ability to discharge a personal guarantee. Although Chapter 13 will not eliminate the business's responsibility to pay the underlying debt, it will take care of the owner's responsibility under the personal guarantee. For many owners, releasing this burden offers significant peace of mind.

Personal guarantees are usually for substantial dollar amounts, and they have incredibly detrimental effects on an owner's finances after a business closure. They often drive owners into Chapter 7 and cause significant property loss.

Chapter 13 Bankruptcy for Sole Proprietors

Below, we explain why a sole proprietor can file for Chapter 13 and the benefits available.

Why a Sole Proprietor Can File a Chapter 13 Business Bankruptcy

Unlike other business structures, a sole proprietor is personally responsible for individual and business debts. This unique structure allows the reorganizing of all aspects of a sole proprietor's financial life under Chapter 13 bankruptcy. Essentially, a sole proprietor's Chapter 13 is a personal bankruptcy, not a business bankruptcy.

Example. Suppose Ava, the sole proprietor of "Ava's Doggie Treats," falls behind on payments to her suppliers and hopes to get back on track using bankruptcy. When it's time to fill out the bankruptcy forms, she won't file Chapter 13 under the business name "Ava's Doggie Treats." Ava will reorganize her personal and business debts in Chapter 13 bankruptcy under her name, Ava Roberts, and use the income from Ava's Doggie Treats to fund the Chapter 13 plan.

How Chapter 13 Can Benefit a Sole Proprietor of a Small Business

Chapter 13 bankruptcy has features that can help keep a small business running. Here's how.

Keep business assets. A sole proprietor who would lose property needed for a business in Chapter 7 can pay to keep the property in Chapter 13.

Discharge debt. A sole proprietor will include all debts in Chapter 13 and will likely pay a minimal amount on qualifying debts, like credit card balances, utility bills, medical bills, and unpaid invoices.

Cram down secured loans. Your Chapter 13 plan might allow you to reduce the balance of certain secured debts, such as auto loans, to the property's value. To learn more, see Cramdowns in Chapter 13 Bankruptcy: The Basics.

Chapter 7 for Service-Oriented Sole Proprietors

If your business doesn't require property, filing for Chapter 7 could erase your debt and leave your company in place. Examples of service-only companies would include consulting and coaching businesses, some trades, and accounting and legal practices. Learn about Chapter 7 for small business owners.

Consult With a Bankruptcy Lawyer

Filing for bankruptcy when you own a business is complicated, and many factors can't be anticipated or addressed in a short article. The best way to protect your interests is by meeting with a bankruptcy attorney who is familiar with both the laws of your state and the practices of the local bankruptcy court.

Need More Bankruptcy Help?

Did you know Nolo has made the law easy for over fifty years? It's true, and we want to ensure 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!

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.