Many businesses are wondering if their business will survive the coronavirus slowdown or will have to shut down. Either way, they may be wondering about whether they should file bankruptcy, or be forced to do so.
“I am doing more and more phone consults with small business owners struggling with credit cards and unsecured loans they are on the hook for personally,” says Michael Bovee, founder of the Consumer Recovery Network. “These days, during our COVID-19 reality, many of these calls are focused on filing bankruptcy compared to settling with creditors for less than what is owed.”
Here are some common questions about small business bankruptcy, to help as you evaluate your options.
Please note, the material contained in this article is for informational purposes only, is general in nature, and should not be relied upon or construed as a legal opinion or legal advice.
How can bankruptcy help my business survive coronavirus financial problems?
Bankruptcy provides a legal framework for dealing with debts or financial obligations a small business can’t pay. It can be used either as a way to wind down a business, or as a tool to help a business restructure and (hopefully) survive the current crisis. There are two main types of bankruptcy that small businesses may file:
Chapter 7 Bankruptcy for Business
This form of bankruptcy is used by a business that plans to shut down. The assets of the bankruptcy estate will be liquidated by a trustee, and proceeds are distributed to creditors.
Chapter 11 Bankruptcy for Business
In Chapter 11, the business restructures debts under a plan approved by the court. The business will operate under the oversight of the bankruptcy court and U.S. Trustee. This process can be expensive and cumbersome, and is often out of reach for small business owners.
Recent changes to the bankruptcy law provide another option for relief under the Small Business Reorganization Act (see below).
What is the Small Business Reorganization Act?
In August 2019, Congress enacted the Small Business Reorganization Act (SBRA) which amends the Bankruptcy Code to provides a process under Chapter 11—“subchapter V (or “subchapter 5”)”—that makes it easier and less expensive for businesses with less than $2,725,625 million in debt to restructure their debt by streamlining the process. The CARES Act (Section 1113) temporarily raised the limit under the SBRA to $7.5 million in debt, provided that 50% or more of the business debts arise from business or commercial activities.
This change is expected to make it possible for more small businesses to use this form of bankruptcy to file bankruptcy under Chapter 11 subchapter 5 to restructure their business debts and remain in business.
How Can Bankruptcy Help A Business Survive?
When an individual or business files for bankruptcy, the “automatic stay” stops most creditors and debt collectors from trying to collect. Bankruptcy may allow you to restructure debts, including your business lease. It can give your business breathing room to survive a downturn such as the coronavirus crisis.
It may be a better alternative than going deeper into debt, provided you expect the business to be able to continue once the economy begins to recover.
What If I Shut Down My Business?
If you decide to shut down your business, bankruptcy can help by allowing debts to be “discharged” so you don’t have to worry about debt collection or lawsuits in the future. It can help you truly shut down your business once and for all, so you don’t have to continue to worry about future financial problems such as lawsuits.
What If I Signed Personal Guarantees?
Many business owners have signed personal guarantees or pledged personal assets such as home equity for their business. If you signed personal guarantees for business debts, filing for business bankruptcy won’t automatically protect your personal assets. However, personally filing Chapter 7 or Chapter 13 bankruptcy may remove personal guarantees from business debts. If you are operating a business as a sole proprietorship, if you are a single member LLC or, in many states, if you file for personal bankruptcy you can keep a certain amount of business tools or equipment.
If a debtor pledged home equity for the business, the SBRA may be used to help modify the mortgage against their home. (That doesn’t include a mortgage used to acquire their home though.) As one law firm points out, “The SBRA will make it harder for creditors to take away a business owner’s residence pledged as collateral to support the business.”
Can a sole proprietorship file for bankruptcy?
If you operate as a sole proprietorship, you and your business are essentially one. It is possible for a sole proprietorship to file under the SBRA but you may find it easier and less expensive to file personal bankruptcy under Chapter 7 or Chapter 13. Talk with an attorney to find out which type of bankruptcy may be appropriate for your situation.
Are there alternatives to small business bankruptcy?
It may be possible to walk away from business debts if you are not personally liable for those debts and there are no business assets creditors could try to collect if it sued you and won the lawsuit. (Make sure you know if you have signed personal guarantees; if you did, you may be personally sued.)
However, if you do decide to walk away, keep in mind that the Fair Debt Collection Practices Act, which prohibits debt collection harassment, does not apply to business debts. You (or your relatives) may get phone calls from debt collectors. They may even try to sue you.
Another option is to negotiate settlements with any businesses to which you owe money. Creditors may settle for as little as half of what you owe, and sometimes even less than that. Get any such agreements in writing and keep copies for your records in case they try to collect later. Settlement can be an attractive alternative to bankruptcy, especially if you don’t owe many creditors or filing for bankruptcy means you’d lose personal assets you want to keep. But remember that it does not provide the legal protection of the court.
What To Do Now
If you find yourself unable to pay your business debts, explore all your options. Just talking with a credit counselor, debt expert or bankruptcy attorney may help you get answers to questions that are keeping you up at night. And that can allow you to focus on helping your business survive.
Read: 11 Options If Your Small Business Can’t Pay Its Bills Due to Coronavirus
“Unless you are faced with the need to react to some type of collection event immediately, it is often better to hurry up and wait for things to even partially normalize before taking action,” advises Bovee. “In the meantime, get as informed about your options as possible!”