Filing for bankruptcy is not something any business owner wants to do. According to the United States Bureau of Labor Statistics, over 20,000 businesses file for bankruptcy every year. Although there might be many reasons why a business might go bankrupt, given the statistics, there is a good chance that a business owner might themselves having to consider making the difficult decision of filing for bankruptcy. In this article, we will cover the basics of business bankruptcy.
What is Business Bankruptcy?
Bankruptcy is the process a business goes through to eliminate or repay debt. The business must go through the process in Federal Bankruptcy Court. Bankruptcy can be a reorganization of the company or complete liquidation.
Does Corporate Structure Matter in Bankruptcy?
Yes, the corporate structure of a business impacts the bankruptcy proceedings. Businesses registered as sole proprietorships are an extension of the individual owner. Under a sole proprietorship bankruptcy proceeding, the individual owner is liable. As a result, their personal assets may become part of the bankruptcy proceedings. Businesses registered as corporations or partnerships are considered independent of their owners. In these types of bankruptcies, the owner’s assets are less exposed unless there was some sort of comingling of the assets.
What Kind of Bankruptcy is There?
Bankruptcy is referred to chapters due to where they are located in the federal bankruptcy code. There are three different forms of bankruptcy available to businesses. Those three different types include: chapter seven, eleven, and thirteen.
Chapter 7 Bankruptcy
This type of bankruptcy is a form of liquidation. Businesses usually file Chapter 7 when their business model no longer works for the business to succeed in the future. Another reason why a business might file for a chapter 7 bankruptcy is if the debts of the business are so great, there is no reasonable way for the business to pay off the debts. Oftentimes, sole proprietorships, corporations, and partnerships use Chapter 7 bankruptcy.
In Chapter 7 bankruptcy, federal bankruptcy court appoints a trustee to catalog and value the assets of the business. It will be the trustee’s job to distribute the assets equitably to the creditors. In a sole proprietorship chapter 7 bankruptcy, the business owner will be discharged of all debts. In a corporation or partnership, the business will still be liable for the debts.
Chapter 11 Bankruptcy
This type of bankruptcy is a form of reorganization. Chapter 11 is often used for corporations and partnerships whose business model does allow for future growth but needs to eliminate debt to survive. In the cases where a sole proprietorship has a high level of income, they may also file for chapter 11 as well.
In a chapter 11 bankruptcy, the federal bankruptcy court will appoint a trustee to oversee the business operations while it continues to run. The trustee will develop a business model to move the business forward and come up with a plan to either pay off creditors or discharge certain debts. Chapter 11 also allows for the business to restructure or cancels current contracts, agreements, and/or leases. The creditors must agree to the plan and the court must approve it.
Chapter 13 Bankruptcy
Chapter 13 bankruptcy is a form of reorganization. Since chapter 13 is for individuals, so this option is attractive to sole proprietorships as they are an extension of the individual. The goal of chapter 13 is to allow the business to repay debts. The owner must file a repayment plan with the federal bankruptcy court.
Filing for bankruptcy can be a very complex and complicated process. Anyone considering filing for bankruptcy should consult an attorney to determine which chapter of bankruptcy is best for them and their business. The experienced attorneys at Dowd Law will evaluate your business model, debts, and assets and advice you on the best course of action.