If you own a small corporation or LLC and you’re struggling with debt, you might be shopping for a bankruptcy lawyer. Sooner or later someone will mention Chapter 7. The other option for a corporation or LLC is Chapter 11, a reorganization, but few small businesses can afford it, so Chapter 7 is what you need to know about. This article will outline the seven basic things that will happen to your business if you file Chapter 7. Note: this blog post is written for the typical situation of a small corporation or LLC that owns an operating business.
A Chapter 7 Bankruptcy Liquidation
A corporation or LLC is a separate legal entity from the people who own it. It can own property, take on debt and operate on its own. All of it happens in the corporation’s or LLC’s name, not the names of the shareholders or members. That separation exists to shield the owners if the business fails. A Chapter 7 bankruptcy liquidation is designed to sell every last asset of that separate business entity, use the proceeds to pay creditors, and then go out of existence.
First, the obvious one. The business will shut down. One of the first things that will happen is that a trustee will be appointed to act on behalf of creditors to sell all your business assets. Once the trustee is appointed, no one is allowed to deal with the business’s property except the trustee. So, what does liquidation mean? It means selling everything. Everything! The goal is to convert everything into cash. All of it. And with the cash generated, the creditors are paid what they can from the business’s assets.
Second, nothing is protected. When a person files Chapter 7, the law lets them exempt some property. A business is not allowed to claim an exemption, so all of the assets are fair game. Every asset is potentially saleable to pay creditors. All of the inventory, all of the receivables, all of the fixed assets are being sold for cash. That does include the equipment.
Third, and this one surprises people: A business cannot get a discharge. When the case is over, its unpaid debts remain. The business’s liabilities have not been eliminated. As a practical matter, the business no longer exists, but the debts still exist. Whether that matters to you depends on the next item.
Fourth, the personal guarantees come due. Most banks, and the SBA, will require a personal guarantee before they will lend to a corporation or LLC. That personal guarantee is a promise by an individual to pay the debt if the business can’t. So, if the bank is getting only pennies on the dollar in the corporate or LLC bankruptcy, it will turn to the guarantor and demand payment on the personal guarantee. In other words, they still have the right to come after you for the business debt if the business fails.
Fifth, an independent third party handles the shutdown. The liquidation is overseen by the trustee and the bankruptcy court. That matters more than it sounds if your creditors have been aggressive, because now it is the court and the trustee making the decisions about the business’s assets. The creditors will come to the trustee. It also means you do not need to write checks or process payments. No one from your company needs to physically move assets to sell them. Someone else will take care of it for you. Everyone can see that the business closed and that a neutral party handled the closing.
Just Walk Away
Sixth, there may be no reason to go through a Chapter 7. If a bank has a lien on all the business assets, or there is little or nothing left to sell, the case does little for anyone. So, if there is nothing for creditors, and nothing for the trustee, why do you need a bankruptcy? Why can’t you just walk away? Often you can. Many owners simply let the creditors send the business to collections or seek judgments against it. If you signed no personal guarantees, or you have already filed your own bankruptcy, none of that touches you. With no assets to levy and nobody else liable, creditors often end up writing it off and moving on. Do you have the time or patience to deal with the creditors? Are you comfortable with the nuisance of collection calls? If they keep calling and you are not up to the hassle or stress of those calls, then it may be a Chapter 7 for you.
Your Own Chapter 7
Seventh, your own bankruptcy reaches the business too. If more than half of your debt is business debt, you can qualify for Chapter 7 without regard to the means test. The business owns the assets. You own shares or a membership interest, and that is what the trustee looks at. To figure out what it is worth, add up everything the business has, subtract all it owes, and divide the leftover among all the shares or interests. Goodwill doesn’t count. Normally, that is worth nothing, because the business liabilities exceed its assets. If it is negative, that means the business is insolvent and the trustee should not sell anything because no one will buy it. If that number is positive, and bigger than what you can exempt, the trustee can take over your ownership rights. It could sell the business assets, pay the company’s creditors and keep the rest for your personal debts, or sell your shares to someone else.
Can you keep running the company after your own Chapter 7? Maybe, but be careful. Any increase in the value of the business while your case is open is part of your bankruptcy estate. So, if things go better than expected, the improvement could be used to pay creditors in your own Chapter 7 case. The case lasts until the trustee closes the estate, so go slowly on new contracts and receivables. Then there is the debt itself. A personal bankruptcy wipes out all the personal guarantees. It does not touch the business debt; it still exists and can be enforced. If your lenders hold a lien on the business assets, they don’t care about your personal bankruptcy; they still have a claim on business collateral. A personal Chapter 13 lets you keep operating during the case, provided you generate enough income to run the business, the business isn’t creating new tax or other liabilities, and your plan pays unsecured creditors at least what they would get in a Chapter 7.
So what should you do? Study this list and see which of the seven consequences are most important to you. Remember that a business Chapter 7 ends the existence of the company. You will not emerge from it with the business. Be realistic and honest with yourself about whether you need to do anything, or whether the creditors will give up and move on. Discuss your options, in particular your options that do not involve bankruptcy. Sometimes the simplest, least stressful path is to close the company, learn from this experience, and move on to the next idea.
