Understanding Business Bankruptcy for Small Business Owners and Sole Proprietors
When people start a business, they are usually optimistic about growing the business to become profitable and successful. Unfortunately, sometimes it doesn’t work out as planned. If your business is facing financial difficulties, it’s important to consider the potential benefits of exploring business bankruptcy options tailored for sole proprietors and small business owners. In this article, we’ll try to demystify the concept of business bankruptcy, including its implications for both personal and business debts of a business owner.
What is Business Bankruptcy?
A bankruptcy, at its core, is a legal proceeding which allows a party, whether a person or entity, known as a debtor to try and adjust debts that they are having trouble paying. Depending on the type of case, the debtor can have some or all debt discharged or reclassified. There are different forms of bankruptcy, which are referred to by a particular chapter of the Bankruptcy Code. For instance, rules around chapter 7 bankruptcy are found in 11 USC Section 701 – 784, while rules which apply to chapter 13 cases find their source in 11 USC Section 1301 – 1330.
The most common forms of bankruptcy filed (at least in the NYC area) are chapter 7, chapter 11, and chapter 13. It’s important to note that only individuals can file for chapter 13. Corporate entities are not allowed to file for chapter 13.
Businesses, then, will look to file either Chapter 7 or Chapter 11. Chapter 7, also known as ‘liquidation bankruptcy’, involves the sale of a debtor’s non-exempt assets to repay their creditors. Chapter 11, also known as ‘reorganization bankruptcy’, allows companies to keep running their business while creating a plan to pay back their creditors gradually. The main purpose of bankruptcy is to allow organizations to start afresh, to minimize obligations, and to close operations if recovery isn’t possible.
Another important thing to know is that a corporate entity is not entitled to obtain a discharge of debts in a chapter 7 case.
Defining Bankruptcy in a Business Context
In the context of business, evaluating whether bankruptcy may help starts with looking at the debts of the business, and who may be liable for the business debts. Chapter 11 cases can have expensive fees, sometimes reaching tens of thousands of dollars. Therefore, sole proprietors or small business debtors without significant revenue may find it impractical to file for Chapter 11. People in this situation may consider filing for personal bankruptcy to avoid and possibly discharge personal responsibility for debts. For a sole proprietorship, the owner is personally responsible for business debts. This means that to decide if they should file for bankruptcy, their personal situation needs to be assessed rather than just looking at the business.
How Business Bankruptcy Works
When starting a bankruptcy case, individuals and businesses need to submit specific documents to the bankruptcy court, regardless of the type of case filed. In almost every bankruptcy proceeding, these documents will include a voluntary petition, schedules of assets and liabilities, as well as income and expense information. Since business entities cannot file a chapter 13 case, we’ll look at what happens if you file a chapter 7 or a chapter 11 bankruptcy for your business entity.
When a debtor files for chapter 7, a bankruptcy trustee is appointed to review the filing. The job of the bankruptcy trustee is two-fold: (1) marshal any non-exempt property to sell and pay off unsecured creditors; and (2) ensure that the debtor is not committing fraud or otherwise abusing the bankruptcy process. As mentioned previously, a discharge of debts is available only to an individual debtor under chapter 7.
In a chapter 11 case, the goal is to reorganize the business by negotiating and restructuring liabilities with your creditors – a business reorganization. A plan of reorganization, detailing how the debtor believes it can keep the business operational, needs to be proposed and approved by the parties. Under this type of bankruptcy, the business’ assets are evaluated and often used to pay off a part of the debt, and creditors may be asked to reduce or forgive some portion of debt to keep the business going. If a plan of reorganization cannot be approved, the case gets dismissed.
The Implications of Business Bankruptcy to a Company
Generally, businesses that file for bankruptcy are looking to bring all of its creditors into one place, rather than having to deal with each of its creditors separately. While filing bankruptcy can help a business deal with creditors in a centralized and controlled manner, a bankruptcy filing may have adverse impacts on business operations. Creditors as well as other vendors may not want to do business with you moving forward, as the declaration of bankruptcy can significantly impact a company’s reputation. While the goal is that the business continues to operate, and creditors get paid more than they may otherwise would if the business shut down, this result may not always be achievable.
Types of Business Bankruptcy You May File
Exploring Chapter 11 Bankruptcy
Known as a reorganization bankruptcy, the goal of a chapter 11 bankruptcy is to allow a business to continue its operations while restructuring and repaying its debts. This type of bankruptcy is viable for businesses that believe they can become profitable again with some financial restructuring. The business must propose a plan to the bankruptcy court and its creditors outlining how it intends to repay its creditors while maintaining operations. One benefit of a chapter 11 case is that creditors will generally realize more money if a reorganization plan is approved, versus each creditor suing the business, and more likely than not driving it out of business. One major challenge of a chapter 11 case is that it can be expensive because of all the procedural requirements, including legal fees, accounting fees, and more.
Filing Chapter 7 Bankruptcy for Small Businesses
It doesn’t serve a corporate entity much good to file a chapter 7 case other than to bring all the business creditors into one forum. As mentioned above, a corporate entity is not entitled to a discharge of debt in a chapter 7 case. Generally, if an entity files a chapter 7 business bankruptcy, the trustee appointed will look into the financials of the corporation to determine whether there is any money to recover, particularly from the founders. What this results in is advanced discovery – the creditors of the business obtaining information about the finances of the business, where money came and went, without having to go through the expense and time of traditional litigation.
If the company was a sole proprietorship, or a corporate entity with little to no assets, then a chapter 7 filing should really be an individual chapter 7 case.
Chapter 13 Bankruptcy for Small Business Owners
Chapter 13 bankruptcy may be another good choice for sole proprietors and owners of entities that have little to no assets that need to file bankruptcy, perhaps to stay a bank levy or sheriff sale. Chapter 13 is a repayment bankruptcy in which the debtor proposes a plan to repay creditors some percentage of debt over 3 or 5 years. This can be useful for sole proprietors as their business and personal assets, and the business liabilities, are often intertwined. Under chapter 13, the business owner can file a plan to repay debts over a specified term while keeping their assets.
How to File for Business Bankruptcy?
Understanding the Bankruptcy Process
Any conversation about a business potentially filing for bankruptcy has to start with looking at the finances, particularly the revenue, the expenses, the assets and the liabilities. Often when I receive calls from small business owners curious about bankruptcy, while revenue may be shaky and assets minimal, the debts are often mixed between the business and the individual. This is critical to explore and understand because, if the business doesn’t have many assets and doesn’t look like it’s going to make it, the priority should be minimizing the exposure of the individuals behind the business.
As mentioned above, all chapters begin with the filing of a voluntary petition, plus schedules disclosing the financial history of the business or the person. From there, the process differs depending on which chapter was filed.
When a business files bankruptcy under chapter 7, you can expect to provide tax returns and bank statements of the business, as well as the same documents for any individual behind the business. For chapter 11, a plan of reorganization and other disclosures, as well as in-depth financial accounting to the trustee, has to be provided by the debtor. For a chapter 13, the individual debtor will have to provide proof of income that shows the ability to repay, as well as a plan to repay some portion of the debt over 3 or 5 years.
Bankruptcy Impacts on Small Businesses and their Owners
Effects on Company Operations
Declaring bankruptcy is a legal remedy that can often provide instant relief to a business facing threats from creditors. A small business bankruptcy, however, can seriously impact business operations, both in the short and long term. In chapters 7 and 11, the company’s control of their operations can be transferred to the bankruptcy trustee, impacting management practices and operational dynamics. In all circumstances, employees, vendors, and other relevant parties may decide that they no longer want to do business with you.
Impacts on Business Debts
Business bankruptcy serves as a means to deal with overwhelming business debts. As mentioned previously, a corporate entity is not entitled to a discharge if you file under chapter 7, so it would have no impact on the business debts. In chapter 11 and 13, the debtor has to propose a plan (of reorganization and for repayment, respectively). There is a lot of working with the trustee and with creditors in chapter 11 or chapter 13 to create a successful bankruptcy case.
Effects on Small Business Owners
A business bankruptcy can have significant personal and financial impacts on a small business owner. In instances where business and personal assets are intertwined, bankruptcy could lead to the loss of personal assets. In the case of personal bankruptcies, such as an individual filing under chapter 7 or chapter 13, creditors or other vendors may refuse to do business with you in the future, and that may make it challenging to start a new business all over again. Additionally, in the case of personal bankruptcy, there is an impact to credit, which may also make it challenging to obtain financing, even for something like a car.
Alternatives to Business Bankruptcy for Small Business Owners
Negotiation Business Debt without Filing Bankruptcy
One alternative to filing a business bankruptcy available to small business owners may be to negotiate directly with the creditors of the business. If a business has suffered a decline in revenue, and doesn’t have significant assets, a debtor may want to reach out to creditors to advise of the situation and propose coming to an agreement with each creditor without having to spend time or money going to court.
Another alternative may be to let the creditors attempt to enforce their rights in state and federal courts. Lawsuits are time-consuming and expensive. If a business doesn’t have significant revenue, does not have significant business assets, and the individuals behind the business are not liable for the business debts, you may consider letting creditors sue. Often in this instance, as long as the creditor doesn’t obtain a judgment against the individuals behind the business, then maybe it wouldn’t matter if the business is sued.
Other Debt Relief Options
Debt relief agencies and options outside the bankruptcy code are available for companies needing to manage their debts. This can be a good alternative for businesses that are dealing with debt but don’t want to file for bankruptcy. These options can include obtaining financing from a bank to work out an agreement with the creditors.
Surviving Business Bankruptcy and the Role of a Bankruptcy Attorney
Surviving business bankruptcy takes strategic planning, excellent management, and determination. Despite its challenges, many businesses emerge from bankruptcy stronger, having restructured their debts and reformulated their business operations. In the wake of bankruptcy, a business bouncing back and rebuilding are indeed possible with the right strategies.
A bankruptcy attorney plays a vital role in the bankruptcy process. They can guide business owners through the complexities of the bankruptcy code, as well as non-bankruptcy considerations, help select which chapter to file under, and represent their clients in court proceedings. They can also help business owners understand the long-term consequences and potential impacts on the company’s operations.
Navigating the complexities of small business bankruptcy is challenging without the proper guidance, which is why you need an experienced and thorough bankruptcy lawyer by your side. The Law Office of Richard Kistnen offers you the expertise and counsel necessary to handle this financially stressful situation. Your case will be handled in a completely confidential manner by an experienced bankruptcy attorney who understands the intricacies of business and bankruptcy law. Whether you’re looking for advice on debt settlement, asset distribution, or restructuring plans, the Law Office of Richard Kistnen can provide the constructive guidance you require. Reach out today to discuss your small business bankruptcy by calling the Law Office of Richard Kistnen at (718) 738-2324, or booking your confidential, no obligation consultation right now by clicking this link.