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What is the Best Type of Bankruptcy for My Small Business?

Small businesses startup every day. Unfortunately many of them fail despite the best efforts of its owners. Reasons for their failures are many– lack of resources, too much competition, poor business decisions, lawsuits or overreaching. Regardless of the reasons, many of these companies and their owners seek the protection of the bankruptcy court to either liquidate their businesses or to try a reorganization and keep their company afloat. In either case, the main goal is to preserve the owner’s personal assets from being seized by creditors or the trustee.

As a small business owner, you have the option of filing either a Chapter 7 or Chapter 13, depending on whether you want to dissolve your business or keep it as a going concern. Under any filing, an automatic stay goes into immediate effect, prohibiting creditors from any further collection activities unless it can obtain a lifting of the stay under certain circumstances.

 

Chapter 7 Bankruptcy

Chapter 7 is a liquidation and is available for individuals, sole proprietorships, partnerships, LLCs or corporations. If you file Chapter 7 and list your business debts, be aware that these are personal debts as well unless your business is incorporated and the debts are corporate only with no personal guarantees on any obligations owed.

When individuals file under Chapter 7, they are given certain exemptions for personal assets such as a car, residence, retirement accounts and other personal property. Businesses are not afforded this benefit so that its assets, if any, can be seized by the bankruptcy trustee and sold off to satisfy creditor claims to some extent. If your company does have considerable assets but you wish to dissolve your business, then discuss this situation with your bankruptcy attorney who can advise you on how to file.

If you are a sole proprietor, you should list your business and personal debts together so that you can protect your own assets from seizure since business debt is personal debt. If you did incorporate, then you can file a corporate bankruptcy under Chapter 7 without having to file personally. An exception is if creditors are able to “pierce the corporate veil” in order to get at your personal assets by showing that you failed to follow corporate formalities. This includes comingling corporate and personal funds or accounts or otherwise not operating the corporation as a separate entity. If you are sued personally, promptly discuss this serious situation with a bankruptcy attorney.

A disadvantage is if your sole proprietorship or business has assets that are not exempt as personal exemptions, such as other cars and real property and other personal property whose value exceeds the exempt amount. These can be seized by the trustee and sold off.

 

Chapter 13 Bankruptcy

A Chapter 13 is a debt reorganization procedure for wage earners where you draft a repayment plan whereby your creditors are paid off, although not 100% in many instances, over three or five years. A single payment is made monthly to the trustee who distributes the funds. Individuals who do not meet the means test required to file under Chapter 7; who wish to save their homestead from foreclosure; or who have too many non-exempt assets may choose this chapter of the bankruptcy code to pay off creditor and still discharge any unpaid debts when the bankruptcy is concluded.

Corporations and partnerships may not file under this chapter. If your business debt is corporate or related to your partnership, you can use Chapter 13 to protect your personal assets.

As a sole proprietor, you can use Chapter 13 since the business debts are personal and you qualify as a wage earner. The disadvantages of a Chapter 13 is its length before discharge—3 or 5 years.

 

Chapter 11 Bankruptcy

Chapter 11 is also a reorganization and is used primarily by corporations and partnerships though small businesses may use it as well. A small business is generally defined as one having fewer than 500 employees, though for bankruptcy purposes it must have debts of no more than $2.19 million. Chapter 11 is for those businesses that can become profitable with an approved repayment plan similar to that of a Chapter 13.

If you qualify as a small business for Chapter 11 purposes, the court exerts much more oversight over the business operations and requires regular reports on its profitability and projected cash receipts and disbursements. The advantage of a Chapter 11 is that you can renegotiate unfavorable contracts and leases and seek new funding sources while in bankruptcy. Unfortunately, if the trustee feels that your business is not progressing and cannot demonstrate profitability, your corporate bankruptcy will be converted to a Chapter 7.

Discuss any of these options with your bankruptcy attorney to determine which chapter best suits your circumstances.

Dheeraj K. Singhal
About the Author
I help people keep the things they want and get rid of the things they don't want. I have been a lawyer for over 12 years and there are few things I enjoy more then getting great results for the people that trust me with their legal problems.