Dissolving the Business
In the US: Small business does not have the option to choose between “bankruptcy” and “liquidation.” Chapter 7 is “liquidation.” 2026 Small business: Chapter 7 – Liquidate in federal bankruptcy court. Liquidate outside of court and dissolve under state law. Chapter 11 – Continue to operate the business. If it is a corporation or LLC it will not discharge its debt. This decision will depend on the amount of liability the owner will be exposed to, the control the owner wishes to retain while dissolving the business, the pressure from the creditor, and cash available for the proceeding.
The point most owners miss is that a business entity receives no discharge in Chapter 7. Section 727(a)(1) of the Bankruptcy Code gives a discharge only to individuals. A corporation or partnership that liquidates in Chapter 7 simply ends with its unpaid debts still on paper. Chapter 11 has a similar limit. Under section 1141(d)(3), a plan that sells off substantially all of a company’s property, where the company then stops doing business, does not discharge the company either. A sole proprietor is in a different position, because the owner and the business are the same legal person. A sole proprietor who files Chapter 7 is an individual debtor and may be able to discharge business debts personally.
A Chapter 7 Business Case
Single Trustee and sale of assets. A Chapter 7 business case has three main components. The first is the payment of a filing fee of $338. Second is the appointment of an impartial case trustee by the United States Trustee, an arm of the U.S. Department of Justice. In Alabama and North Carolina, the Bankruptcy Court appoints the trustee rather than the United States Trustee. Third is the trustee’s responsibility to sell any non-exempt property and use the proceeds to pay creditors. From the date of the filing of the bankruptcy petition the company no longer has control. Section 721 of the Bankruptcy Code grants a Chapter 7 trustee authority to run a business, but only briefly, and only with the permission of the court. A creditors meeting is held 21 to 40 days after the filing date. A company representative will answer questions from the trustee and the creditors under oath.
Pre-filing Transactions
The Chapter 7 trustee also has the ability to review pre-filing transactions. Section 547 allows the trustee to recover payments to non-insider creditors made within 90 days of the filing. For insider creditors, like an owner who repaid a personal loan to the company, or a relative paid on the payroll, the period is one year. If the case is a non-consumer case filed on or after April 1, 2025, the trustee generally cannot pursue a preference action if it is for less than $8,575. Trustees also have state law fraudulent conveyance claims. If the owner used the business to repay a personally guaranteed loan, or withdrew cash from the company within a year of filing, these transfers should be scrutinized.
Out of Court Process
Outside of court, the main alternative is an assignment for the benefit of creditors, or ABC. In an ABC, a company transfers its assets to an assignee under state law. Unlike a Chapter 7 case, the company chooses its assignee, rather than having the government appoint one. The assignee sells the assets and pays creditors in the same priorities as under Chapter 7. There is no U.S. Trustee, and no filing fee. An ABC can be estimated to take between two and six months, compared to the 12-18 months of a typical Chapter 7 case, and they can execute an asset sale as fast as 10 business days. But the cost of the speedy sale is that you lose the automatic stay. Any pending litigation can be continued, and new lawsuits can be filed.
The third option is to simply dissolve the company per state law. This is probably the right process for a company with few creditors and no pending lawsuits. Section 281 of the Delaware General Corporation Law is typical: directors are protected from liability to company claimants under the court supervised process or the out of court process. The out of court process requires directors only to set aside sufficient funds for claims likely to be presented within 10 years, and the Court of Chancery has ruled in In re RegO Co. that an insolvent company winding up in this fashion must pay existing creditors pro rata, and not in full. The Delaware Supreme Court has ruled that the company remains liable after proper dissolution.
Debts Are Not Discharged
However certain debts are not discharged regardless of the form of the winding up process. The personal guarantee on a lease, bank loan or equipment financing contract is the responsibility of the owner. An ABC process or the company’s Chapter 7 bankruptcy will not relieve the owner from this responsibility. Unpaid payroll taxes are another potential source of liability. Section 6672 of the Internal Revenue Code authorizes the Internal Revenue Service to assess any “responsible person” who willfully fails to pay over to the Internal Revenue Service withheld employee income tax and the employee share of the Social Security and Medicare taxes with respect to all of the “responsible person’s” taxes, an amount equal to the amount not paid over. The employer share of Social Security and Medicare taxes is not part of the penalty. Officers, owners and employees of a company with signing authority may be “responsible persons.” This responsibility survives the closing of the company.
Rights for Employees
There are rights for employees in connection with a company shutdown. In bankruptcy, all employees have a priority claim for up to $17,150 for wages that were earned within 180 days before the bankruptcy filing for bankruptcies filed on or after April 1, 2025. The priority claim takes precedence over general unsecured claims. Under the federal WARN Act, an employer with 100 or more employees must give 60 days written notice of the closing of a plant that leads to the termination of the employment of 50 or more workers at a single site. A notice isn’t required due to unforeseeable business circumstances. If an employer doesn’t give notice and no exception applies, the employer must pay back pay as a substitute for notice. Many states have more powerful versions of their own WARN Acts.
Subchapter V
A going concern of the business under the debt, so a small-business Chapter 11 case under Subchapter V may have more value than a liquidation. The business owner remains in control in a Subchapter V, with the assistance of a standing trustee in an attempt to negotiate a plan, and there is typically no committee of creditors. The owner can retain the equity without a “new value” contribution that otherwise would have been required under the absolute priority rule. Only the owner’s entity may propose a plan, and it must be filed within 90 days. The plan calls for payment of the creditors over three to five years. The filing fee in a Chapter 11 is $1,738.
The eligibility limit for Subchapter V cases is changing in 2026. The limit was reduced from $7.5 million on June 21, 2024, and it has been $3,424,000 as of April 1, 2025. Now Congress has passed H.R. 7730, the Bankruptcy Threshold Adjustment Act of 2026. The House passed it on September 16 and the Senate on September 28. As of early October it was pending the President’s signature. It would fix the eligibility limit permanently at $7.5 million, and the limit would apply to only cases filed after the law takes effect, so the timing of the filing can determine whether the company is eligible. Demand has increased: In 2025, 2,446 entities elected the Subchapter V process and it increased by 67% in the first quarter of 2026.
If creditors are aggressively trying to collect debts by suing and freezing bank accounts, the automatic stay that happens when a company files a Chapter 7 or 11 could be more valuable than the time and costs saved. If creditors are chill and a buyer is waiting, an ABC or a careful state dissolution is likely to pay more money to the creditors, and it might be cheaper than filing. The owner can’t always choose. Three or more creditors with a combined $21,050 in undisputed unsecured debts can petition for involuntary bankruptcy for a company that is not paying its debts, leading to a court-administered liquidation of the company that the owner didn’t ask for.
