Finance · June 03, 2021

What the Bankruptcy Process Means for Your Business

Current economic uncertainty has many business owners considering the prospect of bankruptcy. According to the American Bankruptcy Institute, incidences of commercial Chapter 11 filings increased by 29% in 2020, compared to 2019. If your business is struggling to stay afloat, you may have wondered if bankruptcy is the right move for your organization. Before you make a decision that could permanently affect your livelihood, it's important to understand the bankruptcy process and its implications.


What is bankruptcy?

Small business bankruptcy is a legal process available through the court system for owners who are unable to repay their debts. Bankruptcy falls into three types, with certain circumstances for each.

1 Chapter 7

Chapter 7 is the most common bankruptcy process, and it's available to businesses and consumers. It involves the liquidation of assets, with proceeds distributed to creditors. Sole proprietors who file Chapter 7 are eligible for a discharge, which means they aren't responsible for paying back business debt, and they could continue to operate their businesses once the filing is complete. Corporations, LLCs and partnerships, however, can't receive formal discharges and must close their businesses. In addition, a creditor could potentially sue a business owner to get repayment on a debt.

2 Chapter 11

Chapter 11 is a type of bankruptcy that allows a business to continue to operate while it reorganizes its debts. If a company is still viable, it can get help from the bankruptcy court to eliminate or restructure debt, sell off assets and obtain new financing. Businesses can renegotiate terms with creditors, such as extending the repayment period of a loan. This type of bankruptcy can be expensive and complex. However, in 2019, Congress enacted Chapter 11 Subchapter V to make it easier and less expensive for businesses with debt less than $2,725,625.

3 Chapter 13

Chapter 13 bankruptcy is primarily for consumers, but sole proprietors with just a few creditors can use this option, too. The court will help reorganize debt. However, this type of bankruptcy is filed under the owner's name and not the business, and personal assets can be used to pay back creditors. Filers are usually given 3 to 5 years to pay back the debt, depending on their income.

Common questions

Filing bankruptcy is a major step, and business owners often have several questions on how to claim bankruptcy.

How do I file?

Deciding which chapter to file can be complicated, and the process can be filled with emotion. You'll need to complete a list of your assets and debts, as well as a financial summary. Petitions are filed with the bankruptcy clerk's office. The US Courts has more information and forms on its website to explain the bankruptcy process. Or consult an attorney to make the best choice for your situation.

Do I have to close my business?

In some cases, the answer is yes. If you file Chapter 7 and aren't a sole proprietor, bankruptcy is the end of your business. If you want to restart operations, you'll need to create a new entity.

Will bankruptcy impact my credit score?

Most likely, but exactly how depends on the structure of your business. If a sole proprietor has debts discharged, the bankruptcy will be on the owner's credit report for 7 to 10 years. A business bankruptcy in an LLC or corporation shouldn't show up on the owner's personal credit report. However, it will be on the business's credit report. In both cases, filing for bankruptcy can impact your access to financing in the future.

Am I personally liable for my business debts?

Again, it depends on your structure. Sole proprietors are liable for their business debts, while LLCs and corporations have a legal wall between the business and the owner. Unless a business owner personally signs for a debt, they typically aren't liable.

Alternatives

It's important to know that there are other options. If you know your business is in financial trouble, cut expenses, calculate whether it's feasible to consolidate debt, sell nonessential assets and streamline business operations.

You may also be able to work with your creditors, using a written workout agreement that changes your loan terms to limit the impact on your cash flow so you can stay afloat. Creditors may be willing to negotiate, especially if bankruptcy might put them at risk of getting nothing.

Finally, find a suitable buyer. In some cases, you can sell your company to a competitor or other entrepreneur who might be better equipped to turn it around.

Business is personal when you're the owner, and bankruptcy should be your last resort. Contact your business banker to determine what resources are available before you make this critical decision.

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