Understanding Business Bankruptcy Law

By: First Union | Date:

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Understanding Business Bankruptcy Law

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Obviously, as a small business owner facing the prospect of bankruptcy isn't the ideal option; however, sometimes you have no other choice. Declaring bankruptcy, depending on the amount of debt by which you're burdened, can mean the difference between giving your company a fighting chance of having to close the doors altogether. There are primarily two types of bankruptcy for which a small business can file: Chapter 13 and Chapter 11. Additionally, if it appears that a business's intent is indeed to close, then there is a Chapter 7 option which might be pursued. Choosing which option makes the most sense for your struggling company is hugely important. Choose wrong and this process could hurt more than help you. So we've decided to offer here a brief guide regarding the differences between the various filings and how to potentially make the best choice for your small business.

If You Are a Sole Proprietor

As a sole proprietor, you are personally connected to your business; in other words, you are responsible for its debts and liabilities on a personal level because you are seen as the same. Therefore, when you do a petition to file for bankruptcy, you have to include both personal and business debts.

Chapter 7 Bankruptcy

Unlike Chapter 11 or 13, when filing a Chapter 7 bankruptcy all debts (business and personal/) are essentially wiped out. You will not have to continue to make any payments once the bankruptcy is discharged. There are certain exemptions to this—some debts are not automatically eliminated as a result of a Chapter 7 discharge, among them federal tax debt and student loan debt along with several others. You will want to consult with a bankruptcy attorney to understand exactly what financial responsibilities you will still have following your Chapter 7 bankruptcy.

What will happen then is that all assets—except for the exempt assets—become part of the bankruptcy estate? It is then left to the bankruptcy trustee to sell off said assets and distribute any money received to those who are owed. Depending on how much you do own, you may get to keep a fair amount of it. In this case, a Chapter 7 bankruptcy probably makes the most sense for you.

Chapter 13 or 11 Bankruptcy

With both Chapters 11 and 13, you can continue to own and operate your business as you will be set up with a repayment plan to pay back your creditors. The good news is that the payment plan will likely be significantly smaller than what you were struggling to pay back before the bankruptcy. However, keep in mind, you have to demonstrate that the business can handle a monthly repayment installment. Some key reasons you might go this route as opposed to Chapter 7:

  • You don't want to give up the business, and you're confident it will continue to make enough money to pay back the agreed-upon monthly installment.
  • For whatever reason, you do not qualify for a Chapter 7, and yet you still need to somehow garner protection from your creditors.
  • You need to keep more of your property than Chapter 7 would otherwise allow you to keep.

If You Have a Partnership or Corporation

If you have a partnership or corporation you will have to file a business bankruptcy versus a personal one. And unlike with a sole proprietor, there is no option for discharging the company debts. Additionally, business property is not protected as there are no exemptions with business bankruptcy.

Chapter 7 for Partnerships and Corporations

With a Chapter 7, your business is set to close and thus liquidate all remaining assets. Sometimes this is accomplished much easier via bankruptcy as you are not having to worry about handing any of this—the bankruptcy trustee is responsible for selling off the inventory, equipment, accounts receivable and so forth. This makes it a great deal easier for you; plus, the process is more transparent and may incidentally help you to avoid litigation from angry creditors.

As with a sole proprietor, partners are also responsible for business debt. Therefore, with Chapter 7, as it cannot discharge partnership related debt, you will then be personally responsible for outstanding bills.

In a corporation, generally, shareholders are protected from business debt. However, there is something called alter ego litigation which you may come up against. This can try and force the shareholders to cover the corporation's remaining debts.

Chapter 11 for Partnerships and Corporations

Chapter 13 is only an option open to sole proprietors or in the case of personal bankruptcies. With Chapter 11 however, a partnership or corporation can get some of the same protection. Much as it works with personal bankruptcy, the company can still get a lesser monthly payment amount than they might be currently facing. Keep in mind, this does cost more and the creditors do have more rights with a Chapter 11. For several small businesses, this may not be an option for those reasons.

If you need additional funds to help you get back on your feet after a slower sales time, First Union Lending would love to discuss your options. Our flexible business loan programs have helped many small businesses stay afloat. Let's see what we can do for you!

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