This article was reviewed and updated on August 24, 2020
Small 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 probably have about bankruptcy.
Even if you are familiar with consumer bankruptcy, realize that, as a small business owner, business bankruptcy law may be slightly different. You still have access to the same types of bankruptcy: Chapter 7 and 13, and you may also have other types, including Chapter 11 bankruptcy and Chapter 12. Not to worry; we’ll cover them all in this article.
Frequently Asked Questions About Business Bankruptcy
As we said at the start: business bankruptcy law is similar in many ways to consumer bankruptcy, but there are key differences, and you likely have questions like the ones below.
Are you personally liable for your business debts?
If you run a sole proprietorship, 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 to make payments on debts owed. (State laws restrict what property a creditor can try to access, however.)
Owners of limited liability companies and S-corps may be liable for some debts; for example, if you are an owner of a limited liability company or corporation but you personally guaranteed a specific business debt like a loan, you’d be liable. In most bankruptcy cases, including Chapter 11 bankruptcy cases, the LLC and S-corp business entity owners are personally off the hook for the debts of their business for which there is no personal guarantee.
In addition it’s not uncommon to pledge personal assets like home equity in conjunction with a business loan. Filing for bankruptcy may allow you to protect that home equity or other assets from creditors.
Do you want to keep the business open?
Filing a Chapter 7 business bankruptcy means closing up shop usually, though if you run a corporation or LLC with others, there may be options to keep your business running. If you want to continue operations, you’ll often need to look at Chapter 11 bankruptcy (or Chapters 11 and 13 if you’re a sole proprietor).
Do you have co-signers that you want to protect?
Do you 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 negative impact on your personal credit. If you file under Chapter 13, the bankruptcy will stay on your pesonal credit for up to seven years from the bankruptcy filing date, and under Chapter 7 bankruptcy, it can remain for up to 10 years. The same goes for Chapter 11 bankruptcy.
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 can’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.
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, can take into account the owner’s personal credit as well as business credit; thus a personal bankruptcy may have an effect on the score.
How Does Bankruptcy Affect Credit?
Unfortunately, filing bankruptcy can have a pretty nasty and long-lasting impact on your credit. You may find it difficult to get approved for credit from an unsecured creditor right after your bankruptcy, though taking out secured debt can be a good way to start repairing your credit.
Where most personal and business credit cards are unsecured debt, meaning you don’t have to put down collateral to qualify, after a bankruptcy, you may need to work with a secured creditor who will issue you a secured debt (credit card or loan) but require you to put down collateral or even cash to get access to the funding.
If you’re putting down cash…what’s the point of taking out financing? Well, actually, there is one because you need to work on rebuilding your credit right after your bankruptcy so that, over time, your credit scores will rise, and eventually you will qualify for the best business loans.
What You Need to File a Business Bankruptcy Petition
To start the bankruptcy proceedings, 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 individual debtor)
- A list of your property
- A list of living expenses
If you’re working with a bankruptcy attorney, he or she will help you understand what documents you’ll need.
What Are the Different Types of Bankruptcy for Businesses?
If you’re familiar with consumer bankruptcy, two of the following will sound familiar. Then you’ll see that business bankruptcy also has two other options for you to consider.
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. Chapter 7 usually requires you to close your business, however, there are exceptions for sole proprietors.
If you are a sole proprietor, you’ll be filing for personal bankruptcy. You won’t necessarily lose everything: each state has a list of “exempt” property protected from creditors. A bankruptcy trustee will be appointed to sell all of your non-exempt assets to use the cash to pay back as many of your creditors as possible. 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 bankruptcy 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 a bankruptcy option for staying in business if you are a corporation, partnership, or LLC.
Under Chapter 11 bankruptcy, a reorganization plan must be submitted and approved by the bankruptcy court. The reorganization plan will usually involve modifying payment terms for existing debts, debt restructuring, or selling assets to cover the cost of some debts.
Chapter 11 Subchapter 5
The Small Business Reorganization Act (SBRA) is a new form of bankruptcy enacted by Congress in 2019. It creates 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 debt. 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 new type of bankruptcy is already making it possible for more small businesses to restructure their business debts and remain in business.
Chapter 12: Debt Adjustment for Family Farmers or Fishermen
Chapter 12 of the bankruptcy code is very specific, as it’s only an option for family farmers or family fishermen who want to set up a payment plan to repay their existing debts over the next three to five years. In most cases, businesses are asked to repay the debt within three years, but there are bankruptcy cases where a five-year repayment plan will apply.
Chapter 12 was created specifically for family farmers and family fishermen because the nature of their business makes 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 corporate bankruptcy. 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 may be 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 three to five 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.
For detailed information on all available options for business bankruptcy, please visit the Bankruptcy Basics page on the U.S. Courts website.
Nav’s Final Word: Business Bankruptcy
Certainly you’ll want to explore all your debt relief options if you are considering bankruptcy. You may be able to settle debts through negotiation, for example. But one of the advantages of bankruptcy is that, once you file, the automatic stay will prevent creditors from collecting on debts while the business reorganizes (or closes).
If it turns out filing for bankruptcy —whether that’s Chapter 11 bankruptcy or another option—is truly your best path to solvency as a business owner, consult a a bankruptcy lawyer. Bankruptcy code can be complicated and you want to minimize your trips to bankruptcy court. Working with a professional will expedite the process and ensure you choose the best type of bankruptcy for your situation.
*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.
This article was originally written on March 5, 2018 and updated on January 26, 2021.