Few things are more unsettling to a small business owner than the decision to close up shop or file for bankruptcy. According to the Bureau of Labor Statistics, 20% of new businesses fail in their first two years, 45% in their first five, 65% in their first 10, and only 25% make it 15 years or more. That is sobering. But bankruptcy doesn’t necessarily have to be the end of your business. And keep in mind, a lot of businesses that close never file bankruptcy.
At Delancey Street, we negotiate with merchant cash advance funders and lenders on behalf of business owners, and we hear the bankruptcy question often. The laws vary depending on what type of business you have, but whether you incorporate or operate as a sole proprietor, you should be familiar with the rules governing the bankruptcy process, so that you’re making an informed choice. Here are eight laws of business bankruptcy every owner should be aware of before deciding to file for business bankruptcy.
Pay Creditors Back over Time While Remaining Open and Operating
The first is that bankruptcy can be a way to restructure, not only a way to close. Most businesses file for bankruptcy because they have overwhelming debt. But some businesses are able to save themselves by renegotiating some untenable debt, and essentially starting fresh. To restructure means to reorganize your systems and debts in a new and different way to help make your operations more efficient. It can mean changing the structure entirely or it could mean adding or dissolving some business units without changing the overall structure. There are several chapters of bankruptcy that allow businesses to reorganize and continue operating.
The second law is Chapter 11. Chapter 11 is the most common bankruptcy for corporations, partnerships, and sole proprietors who have a realistic chance of getting back on track. Usually that means you have either significant assets or a viable repayment plan that would convince creditors and the court to let you continue. Chapter 11 is called the ”reorganization chapter” because you pay creditors back over time while remaining open and operating. Your bankruptcy lawyer walks you through the long-term plan, makes sure documents are submitted, keeps things organized, and prepares for court hearings.
Third, Chapter 11 requires full disclosure. Chapter 11 isn’t for the faint of heart, and it really isn’t about hiding things. The very first thing you have to do is file everything with the bankruptcy court: your assets, your liabilities, your balance sheets, reports showing your profits and regular earnings, expenditures, contracts, and leases. All of it. This stuff is what you’ll use to back up your reorganization plan. In that plan, you’ll need to explain how you plan to pay back creditors, along with other bills like payroll taxes. Just be ready to lay everything on the table.
Fourth, creditors have a say. In Chapter 11, the debtor’s bankruptcy plan is reviewed by the company’s creditors, who then vote on whether or not to approve it. If they do, the bankruptcy court can approve it, and the debtor begins to implement the plan. From that point on, the business continues to collect income and pays off its creditors with the profits it generates. The owner can renegotiate and void contracts that show the potential for loss, sell off property as needed, and do whatever else they need to balance their income and expenses. The debtor may be discharged of their debts once the court has approved the plan.
A Chapter 7 Bankruptcy
Fifth, Chapter 7 is a different animal. Chapter 7 is not reorganization. It is liquidation, for a business or a sole proprietor that can’t make it on their own. Chapter 7 debtors are past the point of restructuring their debts, and usually lack assets to even get started. The court appoints a trustee who sells off company assets or anything of value for cash; that money is distributed among creditors.
Sixth, who gets a discharge in Chapter 7 depends on how you are organized. Here’s the big difference when it comes to a Chapter 7 bankruptcy: if you’re a sole proprietor, you can be discharged from any remaining liability you have on your debts. A corporation or a partnership cannot be discharged in a Chapter 7 case. That’s why your choice of business structure makes such a big difference in how a Chapter 7 case works.
Seventh, sole proprietors with regular income may have another route. Chapter 13 is known as the reorganization bankruptcy form for consumers and some sole proprietors. Here the individual with regular income enters into a repayment plan. How much the individual repays, of course, depends on that individual’s revenue, debts, and property. The plan must be approved by the court (much like Chapter 11). The individual will be able to continue to operate the business during the plan, and unlike Chapter 7, you do not have to hand your property and assets over to the trustee. The plan may run for several years. After you complete the plan the individual is discharged from all remaining debts.
Eighth, farmers and fishermen have their own chapter. Chapter 12 bankruptcy is for small fishing or farming companies, family businesses that are facing restructuring and trying to avoid liquidation. When filing under Chapter 12 bankruptcy protection, a small business has 90 days to work out a repayment plan, although this deadline is sometimes extended. After that, debts are paid off over a 3 to 5 year period. During this period, the business continues to operate as normal. A trustee is appointed by the court to oversee the process, but their responsibilities are usually limited to checking documents, monitoring operations, collecting and disbursing funds to creditors.
We are not a law firm, and bankruptcy is not the only solution for every business; some businesses rescue themselves by renegotiating untenable debt. We negotiate to pay less than the full amount owed and do not sell your business another loan. If bankruptcy, like Subchapter V, is the more appropriate path, we’ll refer you to a vetted independent bankruptcy attorney. Our first consultation is free and confidential, so call us before you decide.
