A lot of small businesses face a lot of pressure from their merchant cash advance funders, from their lenders, and from their other creditors. Many small business owners feel a lot of pressure to file bankruptcy, but before you decide to do that you should know how it works, what it costs, what it will and will not do for your business, and what it will and will not do for you personally. At Delancey Street, we talk with owners in exactly that spot, so here are twelve things worth knowing before you file.
Kinds of Bankruptcy
First, there are several different kinds of bankruptcy a business in the U.S. can file. Some require you to shut down completely, others allow you to keep operating while trying to get back to solid financial footing over time. They all offer some level of relief from creditors. And it’s not just there to save the owners, the bankruptcy process has other safeguards to protect employees, vendors and other creditors as well.
Second, know what Chapter 7 means. When a business files for Chapter 7 bankruptcy, the court appoints a trustee who takes the company’s assets and turns them into cash. If it’s a restaurant, for example, that will mean selling the company’s catering vans, kitchen equipment and furniture. The trustee then distributes that cash to the company’s creditors in order of their risk, starting with the most secure (secured creditors), then lower-risk creditors (like bondholders), and then higher-risk creditors (like stockholders) if there is any money left over. A company that files for Chapter 7 must cease business operations. Chapter 7 is the most common type of business bankruptcy, although it’s also pretty common to file for Chapter 11.
Third, Chapter 11 keeps your creditors from chasing you with most collection efforts and forces them to sit down and negotiate with you about repayment plans. Some of your debts may go away, but in the meantime, your business will probably end up paying most or all of its debts over the course of five to ten years. You’ll need to come up with a plan for paying off debts in a specific order, and you’ll have to foot the bill for a court-appointed creditors’ committee, who may propose its own payment plan. Your creditors and the court must both sign off on the final plan. If you want to file Chapter 11, you should have either a significant asset base or a solid plan to restructure your debts and your business. You have to disclose a lot of financial details to the court, and you also need to be able to pay all of the bankruptcy-related administrative expenses once the reorganization takes effect.
Fourth, look at Subchapter V. In 2020, Chapter 11 got an update: Subchapter V. Intended for small and medium-sized businesses, it’s faster, cheaper and less legally tangled than the regular old Chapter 11. It also gets rid of the requirement to disclose your personal finances and lets owners keep their equity and primary control. You can use the process to break (or at least challenge) UCC liens and reduce or shed unsecured debt, and you can even work out a payment plan for the administrative expenses of the bankruptcy. With Subchapter V, you don’t shut down the business. Instead, you stay open and file a plan to pay off the rest of your debt over the course of three to five years. You have to pay unsecured creditors with any leftover income the business has while the plan is in place. You don’t have to convince creditors to agree to your plan; only a court has to approve it. As of August 2024, you need to have less than $3,024,725 in total debt to use Subchapter V.
Fifth, Chapter 12 applies only to small farms and fisheries. Its purpose is to let those businesses reorganize their finances without giving up their assets. After filing, the business has 90 days to create a payment plan for the coming three to five years, in cooperation with creditors and a trustee appointed by the court. The amount of the payments may fluctuate based on commodity prices and the economy.
How Exposed You Are
Sixth, your business structure decides how exposed you are. The personal assets of a sole proprietor are not distinguished from the business’s assets so the trustee can sell some of your personal stuff and your credit score will be negatively affected. General partners (and limited partners who signed guarantees) may also be on the hook for business debts. Owners of corporations and limited partners aren’t normally personally liable for business debts, but the corporation or partnership itself is still liable and can’t keep doing business.
Seventh, filing doesn’t necessarily mean you’re done with creditors. A creditor can file an adversary proceeding to collect, and that can quickly turn into a lawsuit that costs you a lot of money to fight.
Eighth, it’s not a clean slate. Going bankrupt might get you out of some of your debt. But even if it does, you may still be stuck making payments for years after the bankruptcy, and it’s going to be harder to borrow money in the future.
Ninth, there’s nothing stopping you from starting a new business with a different name and in the same industry as your bankrupt company. But if your creditors can get a court to declare the new business an extension of your bankrupt one, they can come after that business, too.
Get the Case Underway
Tenth, you’ll need to file a handful of different documents with your local bankruptcy court in order to get the case underway:
- a voluntary petition,
- schedules that set out the business’s property, debts, income, expenditures, contracts and unexpired leases,
- a statement of financial affairs, and
- a list of all creditors with their names, addresses and the amount and nature of their claims.
Depending on what kind of business you run and which chapter you file under, you may need to submit more documents as well. If you’re filing Chapter 11 or Chapter 12, you’ll also need to file a reorganization plan that sets out how you intend to repay your creditors, pay your employees and meet your tax obligations.
Eleventh, it seems backward, but when you file for bankruptcy, there’s a cost. You pay a filing fee, and then there are additional administrative fees based on the type of case you’re filing. For instance, if you’re filing for Chapter 11, you pay for the creditors’ committee that the court appoints.
Twelfth, you don’t need a lawyer to file bankruptcy, but you should probably have one, and if you can’t afford a business lawyer there are free or low-cost legal services that you may be able to use. A lawyer can help you figure out if bankruptcy makes sense, which type to file, which debts will and won’t be reduced or wiped out, whether you are personally liable and what property you will and won’t be able to keep. If a debt collector knows that you have a lawyer, then they’re supposed to deal with the lawyer instead.
Delancey Street is a business debt settlement company. Our advisors will negotiate on your behalf with merchant cash advance funders and lenders to reduce the balance below what you owe. We are not in the business of selling another loan. We are not a law firm. If bankruptcy is a better solution, such as a Subchapter V bankruptcy, we will be up front about that on the very first call and refer you to an independent bankruptcy attorney who we have vetted. And that first consultation is free and confidential.
Bankruptcy can help a business in trouble, but it isn’t the only option out there. It’s a decision that needs to be made with clear eyes and as much information as possible (and usually with the help of a good lawyer).
