For some businesses, filing for bankruptcy becomes an option to financial woes. If your business is in financially difficulty and is struggling to pay its debts, bankruptcy may be an option for you. Although it’s not a popular or exciting topic, you should understand the fundamentals of bankruptcy.
Deciding to file for bankruptcy can be a scary and daunting decision, but it doesn’t have to be the end of the world. We see it all of the time; business tycoons like Donald Trump file for bankruptcy and still come out on top. However, if this is a route you are thinking about taking, you should understand the present and future impacts on your business that bankruptcy will have.
What is Bankruptcy?
Bankruptcy is a federal court procedure for individuals and businesses who cannot pay their debts. The process eliminates any debts and pays them while protecting the individuals and/or businesses in bankruptcy court. The bankruptcies are often referred to as liquidation or reorganization. As a business owner who needs to file for bankruptcy, there are a few different types of bankruptcies. The type that you should file will depend on your particular situation.
Types of Bankruptcy
Chapter 7 – This type of bankruptcy is referred to as liquidation. Chapter 7 bankruptcy filing is suitable for a business that does not plan on staying open. This is because this type of filing does not include any type of repayment plan. This is the suitable choice for sole proprietors and small businesses. It becomes the responsibility of the trustee to sell any of the business’s assets and satisfy the payment of the debts. However, the bankruptcy code allows for the debtors to keep some “exempt property.” But with this type of filing, it is expected that there will be some sort of loss of property.
A business can initiate filing for Chapter 7 bankruptcy by filing with the bankruptcy court in its jurisdiction. However, depending on where the business is located or where it holds its principal place of business can result in different outcomes. For example, if a company is incorporated in Delaware but is physically located in California, it has two choices. It can either file with the bankruptcy courts in Delaware or file in the business’s local jurisdiction with the bankruptcy courts in California. Either way, a trustee must be appointed because the trustee is an impartial participant.
In certain states such as Alabama and North Carolina, the bankruptcy courts in those states act as the trustee. And there are additional documents that are required to be submitted. In most cases, the documents include schedule of assets of liabilities, schedule of current income and expenditures, statement of financial affairs, schedule of any contracts and leases, and most recent tax returns.
Chapter 11 – This type of bankruptcy allows your business to recover. So Chapter 11 is referred to as repayment and sometimes reorganization. No matter what it’s referred to, there must be a reorganization plan developed. Therefore, the filing of a Chapter 11 bankruptcy is suitable for corporations and limited liability companies although some sole proprietorships have chosen to file Chapter 11. Because it allows an organization to recover and restructuring is included, Chapter 11 does involve additional scrutiny by the bankruptcy courts.
Similar to a Chapter 7 filing, a business can initiate this type of bankruptcy by filing with the bankruptcy court in its jurisdiction. In this case the jurisdiction is domiciled, meaning its physical location. Chapter 11 is different because it can be filed by the debtors or the creditors. When a filing is initiated by a company’s creditors, it is considered an involuntary petition. Unless otherwise stated by the judge who is presiding over the case, there will be additional documents required. Most documents include schedules of assets and liabilities, schedule of current income and expenditures, schedule of contracts and leases, and statement of financial affairs.
In some cases, small businesses that file for Chapter 11 bankruptcy are treated differently than regular bankruptcy cases and are called a “small business case.” A small business case is referred to by the bankruptcy code as a case with a “small debtor.” According to the U.S. Courts, this characteristic must meet two criterions.
1. The debtor must be engaged in commercial or business activities with total non-contingent liquidated secured and unsecured debts of $2,490,925 or less.
2. The trustee has not appointed a creditors committee.
A creditors committee usually consists of the majority of the creditors that the debtor owes money to. If it is determined by the bankruptcy court that your case can be classified as a “small business case,” then there will be additional scrutiny and oversight by the bankruptcy courts.
The specific requirements and processes may be a lot to swallow. You can view additional specific legal information about the bankruptcy at www.uscourts.gov. As with anything related to your business, always complete due diligence. It is crucial while researching what solutions are best for your situation that you understand the impact that it will have on your business.
The Impact of Bankruptcy on your Business
The impact of bankruptcy will depend on the type of bankruptcy filing you choose to make and the structure of the business. As discussed filing for Chapter 7, bankruptcy will liquidate and close the business.
In the case of a sole proprietor, if you as the business owner choose to file for Chapter 7 bankruptcy, the business automatically files, as well. This is the case because you are a sole proprietor. There is nothing that separates you, the owner, from the business. Because there is no separation when a sole proprietor files for bankruptcy, their personal credit standing is a risk. This can affect you personally but also if you attempt to open up any ventures in the future.
In a partnership, it can get a little tricky. A partnership is a legal entity, so with a Chapter 7 bankruptcy, the trustee will liquidate the company’s assets. If the assets are not enough to pay off the creditors, the business will be closed and your personal assets can be at risk if you were personally liable for any of the debt. However, the bankruptcy does not automatically touch the assets of any of the other partners initially. The trustee will have to sue to liquidate any assets that the remaining partners have.
Some corporations have chosen to file for Chapter 7 bankruptcy. If you are a corporation and you make the decision to file Chapter 7 bankruptcy, all the assets of the corporation will become liquid to pay the business’s debts. And by choosing to file this type of bankruptcy, the company will close. Additionally, if you have personally guaranteed or cosigned for any business debt, you will also have to file for Chapter 7 as an individual.
Filing a Chapter 7 bankruptcy for an LLC is similar to that of a partnership and a corporation. However, the members of the LLC are also required to file for separate Chapter 7 bankruptcy petitions.
Chapter 11 bankruptcy is considered to be the choice for businesses with a large amount of assets. Although Chapter 11 bankruptcy affords your business the chance for reorganization and restructuring, it often is a complicated and costly process. For example, after the bankruptcy has been filed, all of the assets become a bankruptcy estate. Plus, the estate becomes its own entity with its own Employer Identification Number. Thus, with its creation come complicated tax issues and filings. You will need to retain an accountant and a bankruptcy attorney to assist you with these matters although the bankruptcy code makes it possible for small businesses to file. If your decision is to file for bankruptcy for your business with the end result to stay in business, then Chapter 11 may be for you.
Now that you have the fundamentals, you should dig a little deeper. Before you make the decision to file for bankruptcy make sure you thoroughly understand all the facts. Here are a few tips to help you muddle your way through it.
· Seek Advice from professionals
· Don’t be afraid of bankruptcy
· Don’t wait too long to file for bankruptcy
· Realize that it is one way to get out of debt
In the end, it ultimately comes down to the end game. At the end of the process, what would you like the result to be? There are businesses out there that have filed for bankruptcy and survived. You can, too. Yes, it will impact your business in some way, but you can get through it. And remember always: Seek the advice of your legal counsel first before making any decisions.