Sure, there’s a certain stigma to filing for bankruptcy. The fear of shaming your employees, customers and suppliers into thinking you’re a bad or incompetent businessman is very real. But a lot of what owners believe about bankruptcy comes from people who have never been through one. Knowing the basics about what bankruptcy actually is and what it’s for can help you figure out what’s the best solution for your situation. Here are nine of the most common mistakes.
The first is assuming that filing means the business has to close. Bankruptcy doesn’t have to be the death of a business. There are cases where the business can keep operating. Many owners are shocked to find that the business can continue to operate, even under Chapter 7 or Chapter 13 bankruptcy protection. Sole proprietors and single-member LLCs sometimes file precisely so the business can survive.
The second is thinking the business files and the owner walks away clean. The thing is that the business debt is owed by the business; the owners personally guarantee the debt, so the debt really is owed by the owners. Small business owners almost always sign that guarantee, which means that if the business can’t pay its business loan, the owner (or owners) must personally repay the business loan. That is not a fun idea. Remember, you set up the corporation to limit your liability, that was your intent. But with a guarantee in place, what looks like a business bankruptcy usually turns out to be a personal one. Small businesses typically don’t file a business-only bankruptcy.
The third is believing you need Chapter 11, or the newer Subchapter V created by the Small Business Reorganization Act. Many people believe that “Chapter 11” or “reorganization” is the proper way to save a business. It’s not a mistake to file a Chapter 11, but it’s not often necessary. Most small business cases today are filed under Chapter 7 or Chapter 13, and there’s no requirement to use Chapter 11 or Subchapter V to save a small business. Small businesses file Chapter 13 all the time. You do have to qualify under the debt limits in 11 USC 109, which are adjusted periodically, but the legal fees are more affordable and the case is easier to administer.
The fourth is treating it like an ordinary consumer bankruptcy. So a lot of people who are thinking about bankruptcy assume that it is just like personal bankruptcy for a person, but when it comes to businesses, it’s not. This is not as straightforward as they think. Deciding whether a business should file takes much more analysis. It depends on what business debts the company has, and whether the company needs to keep its assets to operate the business. It depends on how those assets are held and structured. Ideally you want an attorney with a business background as well as experience in both consumer and business bankruptcy.
The fifth is expecting your credit lines to survive the filing. They won’t. Bankruptcy will close them down, and you’ll have to build new ones from the ground up. Therefore, you have to consider how you’re going to pay your bills after you file. Can you do it without the line of credit? For most businesses it means you will have to pay cash for inventory and supplies, maybe on a daily basis. You must be able to stay in business without credit at least until your credit can be re-established with your primary vendor(s) after filing.
The sixth is not separating what the business owns from what you own. These are separate entities, each with their own property. The business owns some property, and the owner owns other property. That distinction matters. Your exemptions don’t apply to property owned by the business. Here’s the tricky part: Does the business own the truck? Or does it belong to you personally and you are just using it in your business? Or, if the business is a corporation or an LLC, maybe your corporation or LLC owns it. The answer can make a big difference.
The seventh is filing a Chapter 7 without thinking about timing. Many people believe you can’t continue to operate a business after you file for Chapter 7. In fact, you can if you know when to file your Chapter 7 case. You must have a plan in place on how you will continue to run the business without being able to receive credit. Accounts receivable can also play a role in when you will file your Chapter 7 bankruptcy. For instance, if you are a real estate agent, and you have a scheduled closing date for next month and you know you will be receiving a commission check, filing before the closing means the commission check will belong to the bankruptcy estate and be lost. If the filing is delayed until after the commission has been received, and properly spent, that money isn’t lost to the trustee. Timing a Chapter 7 properly can mean a great deal of money saved.
The eighth is believing you can’t borrow money in Chapter 13. In fact, you may be able to borrow money in Chapter 13 to fund working capital. There are situations in which a debtor is required to borrow money just to operate their business. The best way to handle this is to make sure that the bank is on board with the Chapter 13 bankruptcy filing. Many times the bank will still finance the business, particularly if it is collateralized by a pledge of assets. However, the line of credit may be reduced due to the filing. There are reports required to be made to the Chapter 13 trustee and the trustee wants to know that taxes are paid.
The ninth is assuming you’ll lose your equipment and inventory. In Chapter 7, the assets that make up your business, such as tools, fixtures, and inventory can be sold by the bankruptcy trustee. Chapter 13 lets you keep all of your assets. Those items are often given a low liquidation value in the plan, and you can keep them for your use. Always find out how your items are valued in the plan.
The Key to Making a Decision
Generally, the key to making a decision is understanding exactly why you’re filing and what value you expect the filing to provide. Understanding the advantages and disadvantages of small business bankruptcy is important, so the more you can prepare before you file the better off you and the business will be. One final thought: If you’re considering filing for bankruptcy, don’t “do it alone.”
