Have you ever met a business owner who hears the word bankruptcy and assumes everything is over? It’s not necessarily the case. There are several different types of business bankruptcy available in the U.S. Some do involve the closure of the business, but there are other options that allow a business to remain in operation and regain financial stability. Regardless of what type of business bankruptcy you file, your business is legally given some relief from creditors. However, in return, you’ll be incurring certain costs and restrictions. Let’s check out eight things that you can expect once you file for bankruptcy.
File Under Several Different Chapters
The first thing that happens is a choice. When a business files for bankruptcy, it can file under several different chapters, and the chapter has a huge impact on what happens to the business. If you pick Chapter 7, the business closes and its assets are liquidated. Chapter 7 is the most frequent form of business bankruptcy. If you choose Chapter 11 (reorganization, which is also common), Chapter 11 Subchapter 5, or Chapter 12, the business continues to operate as it makes payments on its debts according to a plan. Chapter 12 is available to small-scale farms and fisheries only.
Second, creditors back off. If the business decides to file bankruptcy, it is immediately given some relief from its creditors. Chapter 11 protects the business from most collection activities during the bankruptcy process. Creditors are also forced to negotiate payment plans with you. Chapter 12 has an automatic stay against collecting, plus court-supervised meetings with creditors. In fact, bankruptcy is not all about helping the business owner: It also provides for the protection of employees, vendors and creditors.
Third, the paperwork. Before you walk through the court’s doors, you have to file with the local bankruptcy court. You will file what’s called a voluntary petition. You will file “schedules” containing information about the property, debts, income, expenditures, contracts and unexpired leases of your business. Then you need to send to the court a statement of financial affairs and a list of every creditor, with its address and the amount and nature of the claim. And if the nature of your business and the chapter under which you are filing require it, even more stuff. Then you have to pay. There’s the filing fee, and then the administrative fees (which vary depending on which chapter you choose to file under). Under Chapter 11, for example, you will have to pay for the court-appointed creditors’ committee.
Fourth, living under a plan. In chapter 11, you have to have a plan for how you’re going to pay back your creditors in the correct order. The plan can renegotiate leases and contracts, reduce the debt (often by repaying with business assets), and restructure the business to be more profitable. The plan must specify how you’ll repay your creditors, pay payroll and meet tax obligations and be supported by balance sheets and profit reports. The creditors’ committee may propose an alternative plan. The final plan must be approved by the creditors and by the court. To qualify, you need significant assets or a workable restructuring plan, you will disclose a lot of financial information, and you must be able to cover the administrative expenses when the plan takes effect. Some debt can be discharged but most likely, you’ll have to pay back most, if not all, of the debt over the span of five to ten years. After your plan is approved, you can sell your assets, void contracts that will cost you more money, and pay back your creditors out of the profits.
Fifth, smaller businesses get a faster lane. Subchapter 5 of Chapter 11 was created in 2020 for small and mid-size companies. It’s faster, cheaper, and less legally complicated than ordinary Chapter 11. There’s no requirement for personal disclosure, and the owners keep ownership and primary control. All it takes for approval is the court, not the creditors. Use it to pay remaining debt over 3-5 years by using your disposable income to pay your unsecured debt holders while the plan is running. If you like, you can set up a payment plan to pay off the administrative expenses. It can also be used to challenge or break UCC liens and shed unsecured debt. For eligibility, the debt amount must be less than $3,024,725 as of Aug. 2024. Chapter 12 farms and fisheries get 90 days to propose a three-to-five-year plan, and payments can shift with commodity prices and the economy.
Known as Liquidation
Sixth, in Chapter 7 the business ends. Chapter 7 is sometimes known as liquidation. In this form of bankruptcy, a court appoints a trustee who sells off all of the company’s assets. Say the business is a restaurant and the trustee sells off all the catering vans and equipment, furniture, and anything else the business owns. The proceeds are used to pay creditors in a hierarchy, with secured lenders getting paid first, then low-risk creditors like bondholders, and finally high-risk creditors like stockholders, if anything is left. The business stops operating.
Seventh, your personal exposure depends on how the business is set up. In a sole proprietorship, you and the business are basically the same. When you file Chapter 7, the trustee will take some of your personal assets, and your credit record takes a hit. It is possible that any remaining obligations will be discharged. Different states provide exemptions. For instance, in Washington State these are your equity in a home, up to a certain dollar amount, a modest car, a bit of cash, a few household goods, any prescribed health aids, most tax exempt retirement accounts, and up to $15,000 in “tools of your trade.” If you are a general partner, or limited partner that has signed a guarantee, you may be on the hook for some business debt. Corporation shareholders and limited partners don’t ordinarily carry any personal liability or see an effect on their credit reports, but the corporation is still liable and must cease operation.
Eighth, and finally, the debt doesn’t vanish. You’re at least a little better off for filing bankruptcy. But you’re probably still going to be trying to pay off some debts for years to come. If nothing else, you will be less able to get loans than before you filed. Also, the fact that you filed bankruptcy does not get all your creditors off your back. They can easily file an adversary proceeding to collect against you. That could easily end up with a costly lawsuit. Technically, there is nothing stopping you from going ahead with your idea to open a second business in the same line of work, under a new name. But a court can hold that the new business is an extension of the old bankrupt one, and that creditors can collect against it.
Need a Lawyer for Bankruptcy
Will a business need a lawyer for bankruptcy? Technically, no. But it’s probably worth it. If you don’t have the means, there are free or low-cost legal service organizations available in some areas. Your lawyer can advise whether or not you should file for bankruptcy, which type of bankruptcy you should file for, which debts you can eliminate or reduce, and whether you’re personally responsible for any or all of your debts. They can also help handle debt collectors. Once you communicate to a debt collector that you have a lawyer, they should direct all communication to your lawyer, rather than you.
