If you own a corporation or LLC in Texas and the debt has gotten ahead of the revenue, bankruptcy has probably crossed your mind. At Delancey Street we negotiate with merchant cash advance funders, lenders and other creditors on behalf of business owners, and the question comes up. The honest starting point: Think of bankruptcy as a tool rather than the destination of all your worries. Bankruptcy works differently for a company than for a person, and owners who expect it to shield them should know that business bankruptcy does not automatically protect them. Here are six things owners should understand before they file.
Personal Guarantees
The first is that your company is not you, at least on paper. A corporation and LLC are separate legal entities from their owners. They can acquire property, incur debt, and conduct business independently. That’s one of the ways the business structure is supposed to protect the owner from liability. However, most banks and the SBA require owners of small corporations and LLCs to sign personal guarantees. This makes the guarantor personally liable for the debt. That signature undoes much of the protection the entity was meant to give you. It also means that if you are weighing bankruptcy, you are likely saddled with two debt problems - business debt and personal debt, including personal guarantees. Understand the impact of signing personal guarantees for your business loans and advances. Almost everything else in this article turns on it.
Ways to File
The second is that a business has only two ways to file. So what are a corporation or LLC’s options? They can file either Chapter 7 bankruptcy, a liquidation bankruptcy, or Chapter 11 bankruptcy, a reorganization bankruptcy. Chapter 11 allows the business to reorganize its affairs. If the business is operating, Chapter 11 can give the business more time to pay its debts. But the fees are often so high that Chapter 11 is only a viable option for a larger business, one that has a potential to turn a profit. But the reality is, if you’re a small business owner, Chapter 11 is usually not a realistic option.
The third is that a business Chapter 7 is an ending, not a fresh start. A company that files Chapter 7 is simply shut down. A bankruptcy trustee takes over all the business’ assets and sells them. It pays creditors from the proceeds. The business cannot claim exemptions to keep assets, and it never gets a discharge. It simply ceases to exist. Any debts that are not paid remain, but nobody is left to pay them. If the debt was personally guaranteed, the lender can pursue the guarantor. If there was no guarantee, the debt simply goes away. That does not make Chapter 7 useless. For the company, the liquidation is orderly and it is overseen by the bankruptcy trustee and the bankruptcy court. That can be very helpful when the owner wants it to be clear that the business has closed and that the closing transactions were handled by an independent third party. When a business has aggressive creditors, a Chapter 7 for the company can protect the owners by making it clear that an independent third party is handling the liquidation.
The fourth is that the business may not need to file at all. In some cases, bankruptcy is not a useful tool for a business. If a business has a blanket lien on all of its assets from a bank, or if it has little or no assets at all, there is little reason to file for bankruptcy. In these cases, the owner can simply walk away. Creditors can put the business into collection or seek judgments, but that does not touch the owner if there are no personal guarantees or if the owner has already filed personally. The company’s creditors are unlikely to bother pursuing a judgment against the company if there is nothing to collect on. However, if the business is being harassed by debt collectors, filing for bankruptcy in Chapter 7 can relieve that pressure.
Filing Personally
The fifth is that filing personally does not automatically end your business. Depending on the situation, the owner may be able to file for bankruptcy personally in Chapter 7 or Chapter 13. If over 50% of the debt is for business, the owner is eligible for Chapter 7 bankruptcy even if they do not pass the means test. In a personal Chapter 13, the owner can continue to operate the business. There are two caveats: the business has to generate net income for you, without running up new tax or other liabilities, and the plan must pay unsecured creditors no less than they would receive in a Chapter 7. A personal Chapter 7 is different, but the issue is still the value of the business as it relates to the owner. The business is a separate entity from the owner. The owner does not own business assets; the company does. The owner owns shares or membership interest. If the company has net liquidatable value and someone would buy it, the trustee can choose to sell the business assets, pay the business creditors, and use the remainder for the owner’s personal debts; or sell the owner’s shares or membership interest to someone else. Net liquidatable value equals the value of all business assets (inventory, receivables, cash in the bank, supplies, equipment, real or personal property) minus total business debts. Goodwill or “blue sky” value is not factored into the valuation. The business would have no value if total debts exceed total assets, in which case, the trustee will likely not attempt to liquidate it. Where there is value, the owner can only protect it by using the federal wildcard exemption, 11 U.S.C. 522(d)(5), to the extent allowed.
The sixth is that keeping the business running after a personal Chapter 7 is possible, but often not worth it. If the trustee liquidated the business, you cannot. But that is very rare. The business usually has little or no net value so the trustee will leave it alone. If you want the business afterward, you will most likely have to keep running it during the case. Keep in mind, though, that any increase in value during the case belongs to the bankruptcy estate until the trustee closes the estate, so be careful about entering into new contracts, or creating new receivables. If you can keep the business, do not think that you can stop paying business creditors. A personal bankruptcy is only a personal bankruptcy. It wipes out the personal guarantee but not the business debt. If a bank has a secured lien, it must still be paid by the business or it can take the assets. Other creditors also still have a right to be paid. So it often does not make sense to keep operating. Consider, instead, closing the business and starting a new, different business. That can be easier, simpler and less stressful.
Delancey Street is not a law firm, and whether to file is a decision for you and a bankruptcy attorney. When bankruptcy is the better path, we say so and refer owners to a vetted independent attorney. When it is not, our senior advisors negotiate with funders and lenders for less than the full balance owed. Either way, the first consultation is free and confidential.
