Business Bankruptcy — What Options Are Available?

Business Bankruptcy — What Options Are Available?

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Business bankruptcy is serious, but it doesn’t necessarily mean the end for your business. It does present some tough decisions and a good amount of paperwork, however, so you need to know what you’re getting yourself into. Let’s take a look at a few questions you’ll want to answer before we dive into the bankruptcy code.

Frequently asked questions about business bankruptcy

Are you personally liable for your business debts?

If you are a sole proprietor, your business is not a legal entity—in fact, you and your business are the same entity. Thus, you are liable for your business debts. This means that creditors may come after your personal assets if your business is unable make payments on debts owed.

Owners of LLCs and S-corps may be liable for some debts; for example, if you are an owner of an LLC or corporation but you personally guaranteed a specific business debt, you’d be liable. In most cases, however, LLC and S-corp owners are personally off the hook for the debts of their business.

Do you want to keep the business open?

Filing a Chapter 7 bankruptcy means closing up shop. If you want to continue operations, you’ll need to look at Chapter 11 (or Chapters 11 and 13 if you’re a sole proprietor).

Do you have co-signers that you want to protect?

Have a spouse or friend that co-signed your loan that you don’t want to take down with you? If you’re a sole proprietor, you may be able to protect co-signers with a Chapter 13 bankruptcy. Corporations and partnerships that qualify under Chapter 12 also have the opportunity to protect any co-signers.

How will the bankruptcy affect your personal credit?

If you are operating as a sole proprietor, a business bankruptcy will have a significant effect on your personal credit. If you file under Chapter 13, the bankruptcy will stay on your credit for up to seven years from the filing date, and under Chapter 7 bankruptcy it can remain for up to 10 years.

If you are operating as an LLC or corporation, a business bankruptcy under Chapter 7 or 11 should not affect your personal credit. However, there are exceptions. As mentioned above, if you signed a personal guarantee for a debt, you will be liable for that debt if the business doesn’t pay it. Pay the debt on time and your credit will be fine. If it goes unpaid, or you miss payments, however, it can have an impact on your personal credit.

How will the bankruptcy affect your business credit?

If you choose to file for bankruptcy and keep your business open, your business credit score may be affected.

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Your D&B PAYDEX Score, for example, will not be affected, but the bankruptcy may show up as a derogatory mark on your Dun & Bradstreet business credit report.

Bankruptcies account for about 5 -10% of your Experian Intelliscore Plus, so a bankruptcy could have a significant effect on your business credit score from Experian.

If you filed for personal bankruptcy and own a business, the personal bankruptcy could also have an effect on your business credit score if the scoring model takes both business and personal credit scores into account. The SBSS score by FICO, for example, takes into account the owner’s personal credit as well as business credit; thus a personal bankruptcy will have an effect on the score.

What you need to file a business bankruptcy petition

To start the bankruptcy process, you’ll need to file a petition with your local bankruptcy court. Gather the following statements to file your petition with the court, as they pertain to your business:

  • Schedules of assets and liabilities
  • A schedule of current income and expenditures
  • A statement of financial affairs
  • A schedule of executory contracts and unexpired leases

Depending on the Chapter you’re filing under, you might also need:

  • A list of all creditors, what you owe them and what it’s for
  • Amounts and sources of income for you (the debtor)
  • A list of the your (the debtor’s) property
  • A list of living expenses

What are the different types of bankruptcy for businesses?

Chapter 7: Liquidation business bankruptcy

A Chapter 7 bankruptcy is a common form of bankruptcy for individuals who cannot make regular payments towards their debts. A Chapter 7 usually means closing up shop for a business, however there are exceptions for sole proprietors.

If you are a sole proprietor, you’ll be filing for personal bankruptcy. A bankruptcy trustee will be appointed to sell all of your non-exempt assets to use the cash to pay back your creditors. Once your debts are gone, you can continue to operate your business.

The difference if you are incorporated is that there are no non-exempt assets, so all business assets are liquidated by the bankruptcy trustee and the business is closed. Thus, if you are an incorporated business and plan to keep running your business, Chapter 7 is not for you.

Chapter 11: Reorganizing a business

Chapter 11 is usually best suited for larger corporations and is used to restructure a business. Smaller businesses generally don’t aim for this option because it is expensive and complex, however it is the bankruptcy option for staying in business if you are a corporation, partnership, or LLC.

Under Chapter 11, a plan of reorganization must be submitted to and approved by the bankruptcy court. The plan will usually involve modifying payment terms for existing debts or selling assets to cover the cost of some debts.

Chapter 12: Debt adjustment for family farmers or fishermen

Chapter 12 of the bankruptcy code is an option for family farmers or family fisherman to set up a payment plan to repay their existing debts over the next 3 – 5 years. In most cases, businesses are asked to repay the debt within 3 years, but there are cases where a 5 year repayment plan will apply.

Chapter 12 was created specifically for family farmers and family fishermen because the nature of their business make both Chapters 11 and 13 an imperfect fit. For example, Chapter 12 is cheaper and less complex than Chapter 11, which is generally meant for corporations. Chapter 12 also accounts for the seasonal nature of farming and fishing businesses, whereas Chapter 13 is available to wage earners or self-employed individuals with regular income.

Chapter 13: Wage-Earner’s and Sole Proprietor’s Bankruptcy

A Chapter 13 bankruptcy is a good option for sole proprietors who don’t want to liquidate all of their assets.

It is generally used by individuals with regular income to develop a plan to repay all or part of their debts over a period of 3 – 5 years. Unincorporated businesses can use this option to restructure their debt to be paid over the course of up to five years. The length of time you have as an individual or business to pay back your debts will depend on your monthly income.

Additional protection offered by a Chapter 13 bankruptcy includes an automatic stay, which prevents creditors from collecting on their debts while the debtor is formulating a payback plan.

For detailed information on all available options for business bankruptcy, please visit the Bankruptcy Basics page on the U.S. Courts website.

*Disclaimer: The content on this page is for educational purposes only. The author is not an attorney or tax professional. Before proceeding with a bankruptcy, find a business bankruptcy attorney to assist you with the process.

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About the Author — Lydia serves as Content Manager for Nav, which provides business owners with simple tools to build business credit and access to lending options based on their credit scores and needs.

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