Most of the business owners who call us at Delancey Street are behind on paying employees, sales are tanking, bills are up the yin-yang, and before you can say “Chapter 11” they are on the phone to us. Unfortunately, a business bankruptcy may not be the thing that helps here. It might be. It might not. Either way, here is what you should understand about business bankruptcy in Texas before you decide anything.
Two Forms of Business Bankruptcy
The first thing to know is that there are generally two forms of business bankruptcy, Chapter 11 and Chapter 7, and they lead to very different places. Chapter 11 is meant for a business that needs its debts reorganized so it can survive. It’s a plan that the creditors and the court agree on, and the business gets to stay open, keep its stuff, and operate until the debt is paid off. If you are running a business that is still bringing in money, it is tempting to see Chapter 11 as a silver bullet, a magic golden key that will unlock everything and make all your problems go away. But nope, sorry, that is not how Chapter 11 works. Sure, it might be good for you, but then again it might not. Unfortunately, a majority of Chapter 11 business bankruptcy cases fail; then the court may convert it to a Chapter 7 filing.
That brings us to the second thing. A Chapter 7 can be helpful if you are overwhelmed by business debt. It’s a liquidation, or straight bankruptcy. The most common reasons a small business fails:
- business climate or economic downturns;
- lack of business funding;
- cash flow problems;
- lawsuits;
- problems with landlords.
Sometimes all a small business has done is be in the wrong place at the wrong time.
Chapter 7 Business Bankruptcy
The third thing to know is what actually happens once a Chapter 7 case is filed. The company stops doing business. A court trustee sells the assets and uses the money to pay creditors as much of the debt as possible. If it is a sole proprietorship, then personal as well as business assets can be liquidated. Corporations and partnerships do not receive any exemptions. Creditors with “secured debt,” meaning the business put up property as collateral, can take that property back. The trustee liquidates the business assets and creditors may be able to participate in the trustee’s distribution. Typical debt for a Chapter 7 business bankruptcy:
- unpaid leases,
- unpaid contracts,
- utility debt,
- credit card,
- loans,
- delinquent accounts.
The fourth thing catches a lot of owners off guard: A business that files Chapter 7 does not receive a discharge of debts. That is because there is nothing of value left for creditors to take. It is possible if the business owners gave personal guarantees (common) that they may be liable for the remaining debt owed to creditors, which would make a personal bankruptcy filing a requirement.
The fifth thing is that Chapter 7 is not all bad news, and it is worth being honest about both sides of it. For business owners that operate a sole proprietorship, they can get both the business and personal debt they accrued cleared away in one Chapter 7 filing. When the bankruptcy petition is filed, there is an immediate automatic stay that stops collection efforts like foreclosures and lawsuits from creditors. The bad part of Chapter 7: the doors to your business will close permanently.
The sixth and last thing is that how your business is set up matters a great deal. For a partnership: Your Chapter 7 filing will NOT result in the business debt being discharged. You and your partners are liable for the business debt, and the trustee could liquidate your personal assets to pay creditors. For corporations and LLCs, it is possible to shut the business in an orderly fashion, without risking loss of personal property. One thing to be wary of: If you improperly handled business assets, creditors could use an alter ego action and pierce the veil between the company and its owners and go after personal assets.
For members in a LLC, what is the effect of filing Chapter 7? Your LLC will be dissolved. Your business assets can be liquidated and divided among creditors, and you could walk away with nothing. However, if a member guaranteed the debts, mixed business and personal money, they could be liable.
Our Advice
So where does that leave you? Our advice, as always, is that it’s best to talk to a bankruptcy attorney. If bankruptcy is the better path for you, we will say so and refer you to a vetted independent attorney. Our next piece of advice is that, depending on what you say, we might advise a completely different direction: our debt settlement services, which would mean we’d negotiate with your business lenders and funders for a payoff amount that is less than the total balance of the debt owed. We don’t sell you another loan. Our third piece of advice is that, whichever you choose, you should make the free phone call and have the completely confidential chat that you need to have to make the right decision for your business today.
