Bankruptcy isn’t only for individuals. A struggling company can use it to stay open or to close its doors cleanly. But a business case is more complicated than a consumer filing, and small misunderstandings here and there can have huge consequences. The final call will require the expertise of a lawyer or other advisor, but in the meantime it’s important to be informed and ask the right questions. Here are eight to bring to that first meeting.
First, should I file a business bankruptcy or a personal one? Your debt decides. If it’s primarily consumer debt, the kind spent on groceries, rent or a vacation, you file a personal case; if business debt outweighs it, you file a business case. Courts disagree about what “primarily” means, though. Some compare dollar totals, while others count the number of debts. A court’s decision on the test to use, dollars or debts, might be the difference between bankruptcy for you as an individual or bankruptcy for your business.
Liquidate or Reorganize
Second, should we liquidate or reorganize? If your company is failing, Chapter 7 allows you to close it in a neat and orderly way. A trustee will sell the company’s assets and distribute the proceeds among your creditors. Without this option, a disgruntled creditor could very well claim that you are looting company assets before you close up shop. Such allegations could lead to costly litigation. At the same time, filing for bankruptcy removes a big chunk of the burden of closing the business from your shoulders. However, many business owners prefer to keep the business open and try to get back on track. If the business is viable but under severe financial pressure, you might want to reorganize the debts under Chapter 11. Under Chapter 11, the company continues to operate while it renegotiates its debts with creditors and works out a manageable repayment plan.
Third, which chapter fits my business? Any business can file for Chapter 7 (liquidation), but only a sole proprietor can discharge debts in that chapter. Chapter 11 (reorganization) is open to all business entities with no debt limits, but can be prohibitively expensive for a small business to win the approval of creditors and the court. Subchapter V is a hybrid form of Chapter 11 and Chapter 13, a more cost-effective method for a small business to continue to operate. A sole proprietor could also file for Chapter 13 (if they are under the debt limits), remain in business and use this method to pay off their creditors over a period of three to five years.
Your Personal Assets and Your Business Assets
Fourth, are my personal assets at risk? If you have a sole proprietorship, you and the business are basically the same person when it comes to bankruptcy. Your personal assets and your business assets end up in the case together. There are exemptions that allow you to keep certain assets. Your nonexempt property will be sold by the trustee for the benefit of the creditors. Partners are personally responsible for a partnership’s debts. That’s why few partnerships file for Chapter 7. The trustee may end up selling each partner’s personal property to satisfy the company’s debt. LLCs and corporations usually shield their owners. The exception: if the owners treated the business’s money as their own - if there was no clear separation between the business’s bank accounts and their own - someone harmed can bring an alter ego action to pierce the corporate veil, and bankruptcy makes that suit relatively easy to bring.
Fifth, which of my debts count as business debt? It isn’t the name on the paper, but why you borrowed it. A business debt is a debt you took out to run a business: a business loan, the lease on your office space, a van for deliveries. A home equity loan used to open a diner counts as a business debt too, even though your house is what secures it. A single credit card used to buy inventory and your morning coffee has both kinds of debt on it. Student loans and tax debt are different: courts have had mixed views on whether those are business debts.
Sixth, will my debts actually be wiped out? Partnerships, LLCs and corporations don’t get to “discharge” (wipe out) their debts in Chapter 7, but rather just liquidate and pay creditors. An individual or sole proprietor, however, can get a Chapter 7 discharge once every eight years, not sooner. That is, you can file again before eight years, but you won’t get to wipe out the debts. Chapter 11 has no limit between discharges for any business. Still, tell your lawyer if you or the business violated a court order or had another case dismissed in the 180 days before filing, because you may not get a discharge.
Seventh, what happens to my corporation if I file personal bankruptcy? You own shares, not the company, and you’ll have to list and value them. Few states have an exemption aimed at stock, but sometimes you can protect them under a wild card exemption. If not, in Chapter 7 the bankruptcy trustee would try to sell them. If you’re the only plumber in your plumbing company and won’t stay on, the business is worthless without you, so the trustee’s unlikely to sell your stock. In Chapter 13 you can keep nonexempt shares by paying creditors their value through your plan.
Involuntary Bankruptcy
Eighth: One of the most important questions a business should ask an attorney is if they could potentially be put into an involuntary bankruptcy against their will. Under Chapter 7 or Chapter 11, yes, but it’s rare. With fewer than 12 creditors, a single one can force it if its claim meets the amount requirement and is both undisputed and unsecured. If you have more than 12 creditors, three would have to sign on. Most creditors don’t bother because they’d have to share in any assets recovered, and a creditor might instead prefer to collect 100% of its debts on its own. And if the court finds a creditor filed in bad faith, it may have to pay the other side’s attorneys’ fees.
Filing bankruptcy should be one of your last options for dealing with debt. The consequences are lasting and costly, and in the end only you and your bankruptcy attorney know the right answer. So, it’s worth doing the prep work and spending the time to be smart about what happens next. The first consultation is often free.
