Small businesses are the lifeblood of the American economy but that doesn’t ensure success for all; in fact, small businesses carry with them a huge risk of failure. The bankruptcy code recognizes this, and provides small business owners who are facing financial difficulties the opportunity to take a time out to either reorganize or start over.
There are various bankruptcy options available to small businesses. Which option a business owner chooses depends on several factors:
- How is the business structured? Is it a sole proprietorship or is there a more formal structure in place?
- Is the owner personally liable for any of the business debt?
- What is the business owner’s goal for the future? Is the owner looking for a fresh start, or would they like to restructure and continue operating?
Chapter 7 Bankruptcy – Liquidation
If the business owner hopes to put the bankrupt business behind them and make a fresh start, Chapter 7 is probably the best option. Under Chapter 7, the court appoints a trustee who gathers and sells all of the debtor’s nonexempt assets and uses the proceeds to pay the debtor’s creditors. Most remaining debts are then discharged and the business dissolved. Chapter 7 bankruptcies are commonly referred to as liquidations.
Business owners should know that all of the businesses assets will be sold – including intellectual property and client lists. If the debtor hopes to hold on to some of the business assets, they should file under another chapter or be prepared to buy the assets when the trustee sells them.
If the business owner is an individual, the court will closely scrutinize the debt to make sure the filing is not an abuse of Chapter 7. An individual debtor will have to show the debts are primarily business related rather than consumer debt, and will have to undergo a means test. If the court determines the debts are primarily consumer debts, or the individual fails the means test, the court can convert the case to a Chapter 13 filing or even dismiss the case.
Chapter 11 Bankruptcy – Reorganization
When the business owner is not ready to give up on the business, Chapter 11 may be the best option. Although Chapter 11 is more commonly used by larger companies, it can be used by individual business owners, partnerships, LLCs, and small corporations who are confident the business will succeed if certain changes are made.
The disadvantage of choosing to file under Chapter 11 is the increased scrutiny that comes with it. The court-appointed bankruptcy trustee will closely monitor the business as it reorganizes and moves forward. If the trustee is not convinced the company is moving in the right direction, they can have the court convert the filing to a Chapter 7 or 13, or ask the court to dismiss the filing altogether.
Chapter 13 Bankruptcy – Repayment
If the small business is a sole proprietorship and the owner’s personal and business debts are mixed, a Chapter 13 bankruptcy may be the best choice. The number one reason sole proprietors file under Chapter 13 is to save a home from foreclosure.
In some ways Chapter 13 is an individual’s version of Chapter 11 – the debtor may maintain basically all of his or her assets so long as they can develop a reasonable repayment plan that puts them on better financial footing for the future. At the end of the repayment plan period many of the debtor’s debts, both business and personal, are forgiven.
If you are the owner of a small business and believe that some form of bankruptcy is the next logical step, you should talk to an experienced bankruptcy attorney today.