Three Types of Business Bankruptcy

Businessman and lawyer discussing business bankruptcy or business contract

As a business owner, there are very few things more unsettling to consider than shutting down your business or filing bankruptcy. The US Bureau of Labor Statistics (BLS) finds that 20% of new businesses fail during the first two years, 45% during the first five, and 65% during the first 10. Only 25% of new businesses make it to 15 years or older.

These are sobering statistics, to be certain. However, filing for bankruptcy does not necessarily have to spell the end of your business. Similarly, many businesses that do close never pursue bankruptcy. Typically, most businesses that file bankruptcy do so due to overwhelming debt. There is a bright side to all this: some businesses are able to save themselves by renegotiating untenable debt situations and essentially ‘starting fresh’.

Knowledge is your first weapon against unnecessary financial and legal risk should your business ever face potential bankruptcy. Arm yourself with this knowledge and you will be prepared to pursue the most viable options available to your business. Our firm will be by your side if you need to file for bankruptcy. Depending upon the structure of your business, we will examine three types of business bankruptcy available to US business owners, as follows below.

Chapter 7 Bankruptcy

Chapter 7 bankruptcy is often referred to as liquidation. Liquidation of the company includes the closure of the business and selling off of all assets in order to repay the debts owed. This is the option that most people think of when they believe that their business will not survive. There are several instances in which filing Chapter 7 bankruptcy may be the most viable solution:

  • If the debts owed by a business include outstanding tax debts, which will have priority in repayment after liquidation.
  • If the business has a significant amount of inventory or equipment which needs to be liquidated.
  • If the business is a sole proprietorship with very few assets besides the owner’s skills and knowledge. In this case, a personal Chapter 7 bankruptcy can be filed. Here, both personal and business debts are taken into consideration and dealt with in the bankruptcy proceeding.

During a Chapter 7 bankruptcy, the court appoints a trustee to liquidate the assets of the former business, potentially recover assets that were transferred prior to the bankruptcy, then redistribute them amongst the creditors in order to pay off the debt. The trustee is also paid for their services. In the event of a sole proprietor’s personal Chapter 7 bankruptcy, the individual debtor would also receive a discharge at the end of their case. This discharge would absolve them from any additional debts in question. Corporations and partnerships are not eligible for this discharge of debts in a Chapter 7 bankruptcy.

Chapter 11 Bankruptcy

Chapter 11 bankruptcy is also known as reorganization. Reorganization can be a viable option for businesses that stand a realistic chance of surviving despite - or even due to - filing bankruptcy. Chapter 11 business bankruptcy is used in the cases of:

  • Corporations
  • Partnerships (including LLCs)
  • Sole proprietorships with high levels of income or debt

Filing Chapter 11 requires working in close collaboration with creditors as well as the court, in order to devise a valid reorganization and repayment plan. Often, this plan must be voted upon and approved by the creditors in order to be approved by the court. 

This type of business bankruptcy was created in order to allow businesses the opportunity to continue operations while also gaining a second chance to repay their creditors over time. 

In 2019, the Small Business Reorganization Act was signed into law, creating a subchapter V to Chapter 11 bankruptcy. This subchapter V only applies if the debtor wants it to, and provides several additional benefits to the small business debtor as it does not require that creditors have to approve a plan or impose additional Chapter 11 fees. Under either scenario, however, Chapter 11 is a time-consuming and intensive process that should be pursued with the help of a highly qualified bankruptcy lawyer like Johnson May attorneys.

Chapter 13 Bankruptcy

Chapter 13 bankruptcy is another type of reorganization. The difference is that Chapter 13 is only reserved for individuals. However, this type of reorganization can also be used in the case of sole proprietorships, as sole proprietors are legally indistinguishable from their individual owners. 

With a Chapter 13 bankruptcy, similar to a CHapter 11, a debtor creates a plan to repay a certain amount to their creditor's overtime, often over the course of several years. As a sort of trade-off, the business owner is not required to hand over their assets and property, which is a particular relief for those sole proprietors whose personal assets are tied up with their businesses. Business operations may continue over the course of reorganization and payment. With a bit of legal counsel, planning, and foresight, this can be a viable option for some sole proprietorship business owners.

Local Legal Representation for Bankruptcy

Each of the types of business bankruptcy carries with it its own set of challenges and complexities in terms of both determining whose business is eligible and what their course of action should be. However, bankruptcy is not a permanent stain on your credit score, nor is it a death sentence to every business. With the right legal representation by your side, you can decide upon the best bankruptcy option based on the needs of your business. To discuss your business bankruptcy needs with an experienced bankruptcy lawyer, contact our law firm today.

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