If your business is failing and you have decided it is time to close your doors, whether or not you choose to file for bankruptcy may depend on the value and nature of your business assets, the attitudes of your creditors and your availability or that of management to oversee the process. Companies can go out of business without filing bankruptcy by liquidating their assets and ceasing operations. Additionally, out-of-court agreements with creditors or debt counseling services may provide an alternative to a bankruptcy filing.
Bankruptcy proceedings can be initiated either by the small business owner or by creditors. Once they have begun, both sides are subject to limitations. Business owners are restricted from selling or transferring assets, and creditors are restricted from contacting the business owner for the purpose of collecting the debts.
Bankruptcy Eligibility and Business Structure
Corporations, limited liability companies and partnerships are legal entities separate from their shareholders or partners. They can file Chapter 7 or Chapter 11 bankruptcy in their own right.
Proprietorships, since they are just an extension of the owner, cannot file bankruptcy alone. The proprietor must file bankruptcy, since the assets and the liabilities of the business are really just one form of assets of the proprietor. The individual owner may file Chapter 7, Chapter 11 or Chapter 13 bankruptcy.
Chapter 7 Bankruptcy
Chapter 7 bankruptcy is the most common form of bankruptcy. It involves the total liquidation of the company's assets in order to repay debts owed to qualified lenders. An appointed trustee collects all of the assets that have been designated as non-exempt by the bankruptcy court, sells them and distributes the proceeds to creditors. Thus, filing a petition under Chapter 7 may result in the loss of property.
If the debtor's "current monthly income" is more than the state median, the Bankruptcy Code requires application of a "means test" to determine whether the Chapter 7 filing is presumptively abusive.
To qualify for relief under Chapter 7, the debtor may be an individual, a partnership or a corporation or other business entity. Bankruptcy liquidation in Chapter 7, whether for the individual or a corporation, may be the best choice when the business has no future, it has no substantial assets or qualities that cannot be reproduced after bankruptcy or the debts are so overwhelming that restructuring them is not feasible.
Chapter 11 Bankruptcy
Debtors who are engaged in business, including corporations, partnerships and sole proprietorships, may prefer to remain in business and avoid liquidation. Such debtors should consider filing a petition under Chapter 11 of the Bankruptcy Code.
While Chapter 7 bankruptcy is referred to as a liquidation, Chapter 11 bankruptcy is referred to as a reorganization or rehabilitation of the business. The goal of Chapter 11 bankruptcy is to restructure the business and debt payments so that the business may meet its obligations from future earnings. Similar to a Chapter 7 bankruptcy, Chapter 11 reorganizations are supervised by a court-appointed trustee. Under Chapter 11, the debtor may seek an adjustment of debts, either by reducing the debt or by extending the time for repayment, or may seek a more comprehensive reorganization.
Before filing for Chapter 11 bankruptcy, consider that a reorganization can be expensive and it can drain an already stressed organization of management's time to participate in bankruptcy proceedings. Also, businesses that require little capital, have few assets or are really just extensions of the owner's skills and personality are ones that it may not pay to reorganize. The owners may be better off liquidating the business, in or out of bankruptcy, and starting over in a new entity.
Chapter 13 Bankruptcy
In addition to Chapter 7 and 11, sole proprietorships may be eligible for relief under Chapter 13 of the Bankruptcy Code. A Chapter 13 bankruptcy is also called a wage earner's plan. It enables individuals with regular income to develop a plan to repay all or part of their debts. Under Chapter 13, debtors propose a repayment plan to make installments to creditors over three to five years.
Chapter 13 offers individuals a number of advantages over liquidation under Chapter 7, such as an opportunity to save their homes from foreclosure. By filing under this chapter, individuals can stop foreclosure proceedings and may cure delinquent mortgage payments over time. Chapter 13 also allows individuals to reschedule secured debts (other than a mortgage for their primary residence) and extend them over the life of the Chapter 13 plan, which may lower the payments. Chapter 13 acts like a consolidation loan under which the individual makes the plan payments to a Chapter 13 trustee who then distributes payments to creditors.
Any individual, even if self-employed or operating an unincorporated business, is eligible for Chapter 13 relief as long as the individual's unsecured debts are less than a certain amount, which is adjusted periodically to reflect changes in the consumer price index. A corporation or partnership may not be a Chapter 13 debtor.
The decision to file for bankruptcy can involve complex issues, so you may want to consult an experienced bankruptcy attorney so that you get expert advice and can make the best decisions possible for your circumstances.