Should Your Business File Bankruptcy?

Many businesses are failing due to the COVID-19 Pandemic, especially small businesses.

Business owners are faced with the difficult decision of whether to try to save their business, or fold up and close.

I get many calls each week from business owners who tell me they need to file bankruptcy, but do not understand what it does, or does not, accomplish.

There are a lot of misconceptions about options businesses have in bankruptcy.

This article will try to answer common questions about when to file bankruptcy for a business.

And whether filing bankruptcy is necessary.

What to do depends on the type of business structure, the value of assets, and your goals (e.g. stay in business, or go out of business).

How Is Your Business Set Up?

The first step is to identify the legal structure of your business.

Is your business set up as a separate legal entity (i.e. a corporation, LLC, partnership) or is it just your self-employment?

Self-Employed/DBA Businesses

If your business is simply a dba of yours, meaning you are a sole proprietor/self-employed,  there is no separateness between you and your business.

You and your business are one and the same;  all assets are owned by you.

In this case you would need to explore your options for a personal/individual bankruptcy case (as well as non-bankruptcy options for individuals).

Corporations/Partnerships/LLCs

If your business is any of the following, there still might be a basis for it filing a bankruptcy case:

  • Corporation (including S-Corps and C-Corps (“Inc.s”))
  • Partnership
  • LLC
  • LLP

For purposes of this article, all the above bulleted business types will be referred to as “corporations”.

Choices For Business Bankruptcies

Corporations have two bankruptcy choices:

  1. Chapter 11:  If trying to stay in business and reorganize, or 
  2. Chapter 7:  (Going out of business) If business operations are terminating and assets are to be liquidated to pay creditors.

Chapter 11: If you are trying to stay in business, a Chapter 11 case can enable you to reorganize by giving you a temporary break from creditor collections and allow you to propose a repayment plan.

How much must be repaid depends on numerous factors including the value of assets of the corporation, types and amounts of debts involved, and to what the creditors will agree.

Chapter 11 is very powerful and allows for rejection of existing contracts and leases, and for repayment of debts over an extended period of time, often at less than 100% of what is owed.

Chapter 11 is expensive, and the requirements and qualifications are rather involved and beyond the scope of this article.   See the link in the box to the right for more information about Chapter 11 and schedule a consultation with an experienced bankruptcy attorney in your area.

Chapter 7:  It is important to understand that corporations do NOT receive a discharge of debts in Chapter 7.  This means that its creditors can continue to pursue collections against the corporation after the bankruptcy case is over, against whatever assets the corporation has.

Thus, in most cases, there is no reason to file a bankruptcy case for a corporation that is going out of business.

The primary reason for a corporation to file a Chapter 7 case is to liquidate (sell) assets and pay creditors as part of a corporate dissolution.

If there are a lot of assets, then filing a bankruptcy can assist in a couple of ways:

  1.  An independent trustee is appointed to sell the assets and pay creditors according to their priority from the assets.  This takes the corporation’s owners off the hook for having to prove they sold the assets for the highest value and did not prefer one creditor over another.
  2. It gives notice to the corporation’s creditors that nothing else is left.  Meaning, whatever assets are there are being sold and disbursed.  So, while they can still sue the corporation after the bankruptcy, there would be no reason to do so.

Thus, if your corporation has a lot of assets that can be sold and a lot of creditors that need to be paid, a Chapter 7 for the entity might be worthwhile.

Will Filing Bankruptcy For My Corporation Remove The Debt From Me Personally?

NO.  Unless, of course, the debt is somehow paid in full by the corporation’s assets.

For some reason, this concept is very difficult for many to business owners to understand.

Owners of corporations have liability for certain corporate debts.  Typically this includes contracts/leases with landlords, certain trust fund taxes (such as employee payroll and sales taxes), and any other obligations on which there is a personal guarantee signed.

Those personal obligations are independent of the corporation’s obligations on those debts.

Just like if you guarantee a loan for a relative (co-signing on a car loan, or lease, or student loan, for example).  If your relative files a bankruptcy case, they may be able to eliminate their liability on the debt, but not yours.  The only way to remove your liability on the debt is for you to file your own bankruptcy case.

Thus, even if a corporation could receive a discharge of debts in a Chapter 7 bankruptcy case (which it cannot), that discharge would not alter any liability of the owners.

How Do I Handle Debts That I Owe Personally From My Business?

This is usually the real issue in cases where corporations are going out of business.

If you have liability for business debts which you cannot pay, you may need to file a personal bankruptcy case.

This would be a bankruptcy case that you the owner files, not your corporation/partnership.

The only way you can discharge personal liability on debts, whether they come from a business or otherwise, is to file a personal bankruptcy case.

Individuals can file bankruptcy under Chapters 7, 11, or 13.  Which your are eligible for and which is best for you depends on the specifics of your situation.

A consultation with an experienced bankruptcy can help you learn your bankruptcy, and non-bankruptcy options for dealing with these debts.

 

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