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One of the most frequent questions that an attorney is asked is whether or not a small business should file for bankruptcy. This article should help an owner to decide whether their small business would qualify for bankruptcy protection and also to shed some light on general questions, facts, and misconceptions about bankruptcy filings.
First of all, they must establish in which category their small business qualifies. In general, all small businesses are considered to be a corporation, a partnership, a joint venture, or simply a sole proprietorship or “DBA.”
Sole Proprietorships/DBA’s/Individual Business
According to the US Courts, "A business is considered to be a sole proprietorship if you individually own the business or if you co-own the business with your spouse as a partner" [1]. In this case, a small business would NOT be considered a corporation or a legally formed partnership.
If this is the case for a small business, their options are limited. Consequently, the debt that their business has complied would be considered personal debt. Therefore, they would have to file for personal bankruptcy protection under Chapter 7, Chapter 13, or Chapter 11. In this situation, their business debts would be considered as personal rather than professional liabilities.
Corporations, Partnerships, and LLCs
If their business is considered to be a corporation, and this would include Limited Liability Companies or LLC’s, and/or is considered to be a true partnership, they have two options to consider for their business. Chapter 11 reorganization would allow them to remain in business and reorganize the debts accrued by their business.
They would be able to repay their debts on a structured Court Approved Repayment plan. However, if they are in debt over $500,000 and they determine that they cannot salvage their business, then the owners would have to choose Chapter 7 Bankruptcy. At this point, their business would cease operations and all assets would be liquidated to settle loans and outstanding debts. Please note that Corporations DO NOT receive a discharge of their debts when Chapter 7 is filed.
What Would be the Benefit of Filing Chapter 7 Liquidation?
While this option may sound risky on paper; according to lawyers.com, "Chapter 7 will allow the appointment of an Independent Trustee to sell the assets and pay the creditors the funds received from the sale.
Consequently, the Trustee decides the proper order of the payments…” [2]. Another excellent benefit of filing Chapter 7 is all that all prior and current creditors will receive notice that the company has been approved for bankruptcy protection under federal law. This step could possibly prevent multiple lawsuits from being filed against the corporation.
Although, technically, it is a creditor's right to sue the cooperation after bankruptcy proceedings have been closed, most legal counsel members would oppose this option as there would be no remaining assets to reclaim.
Important Information that Businesses and Individuals Need to Know
Although, most of the corporations liabilities would be settled; personal liabilities are NOT INCLUDED in Chapter 7 proceedings. When a corporation files for Chapter 7, in most cases there are no personal liabilities to address. However, if a situation arose that led to a corporate officer or partner to sign a personal guarantee for a corporate debt, i.e. obligating themselves for a trust fund portion of payroll taxes, etc., then unless all debts are settled to the satisfaction of that particular creditor, that person would be held liable for that debt.
Therefore, that individual would have to file for personal bankruptcy protection separate from the corporation. In the case of partnerships filing for bankruptcy protection, their options are considerably more complicated.
General Partners are considered liable for ALL of the partnerships debts. Therefore, personal protection of Chapters 7, 11, or 13 would be their only options. As far as limited liability companies (LLC’s), they are by definition not responsible personally for any debts accrued by their business.
An LLC would also benefit from filing Chapter 13 or Chapter 7, depending on their particular needs. Any of these options would be contingent upon their consultation with a bankruptcy attorney. Only a properly licensed attorney could explain to them all the advantages and disadvantages of their particular circumstances.
An attorney could also assess if they would be able to avoid bankruptcy. In the end, the final decision would be determined by their individual circumstances. While there are options to retain their business, consulting with a qualified attorney can help them to determine what would be best for their needs.
Filing for bankruptcy protection is often times both difficult and complex due to the ever-changing bankruptcy laws. They would need to research their state and federal laws and then determine the right counsel for their needs. There is always a glimmer of hope even in the most dire times.
Sources
Uscourts.gov, *"Bankruptcy Basics" (accessed March 1, 2010).
Lawyers.com, *"Small Business Bankruptcy Relief" (accessed March 1, 2010).
Korie Schmidt - I am a former High School and Middle School English Teacher that decided to stay at home after the birth of my second child. I am a ...
