Choosing whether or not to file for bankruptcy is a serious decision. With all serious decisions, it is best to know all your options. Choosing the right chapter of the bankruptcy code to file under is a crucial part of the process, should you decide to pursue it.
The truth is that there is no “best option” when it comes to selecting the appropriate chapter to file under. In reality, the best choice can be determined by assessing a number of factors regarding your business.
This guide will walk you through Chapters 7 and 11 of the bankruptcy codes, detailing the pros and cons regarding different business types. By the end of this article, you will be more informed about your options. As always, it is in your best interest to consult with a professional bankruptcy attorney when making serious decisions regarding your business.
Types of Bankruptcy
The bankruptcy code, updated annually, is the official legislative authority that all bankruptcies are conducted under. This code applies federally, so no matter what state you or your business reside in, the law remains uniform. There are certain variations state to state but the rules set forth by the code are used federally.
Chapter 7 and Chapter 11 are the most common types of bankruptcy a business can file under.
Chapter 7 bankruptcies for businesses operate differently than Chapter 7 filed for individuals. With businesses, the entire business ceases operation and its management is handed over to an appointed trustee.
This trustee represents the business during the liquidation process, which seeks to systematically sell off the business’s assets to the creditors that are owed. This entire process is handled in court and follows the guidelines in the bankruptcy code to ensure that all parties receive the fairest outcome.
Unlike Chapter 7 filed for individuals, Chapter 7, when filed for a business, doesn’t allow the business to claim any exemptions – the entire business is available for liquidation at the discretion of the trustee.
Filing as a Business? – You Need a Bankruptcy Attorney
Another difference between filing personally or as a business is a need for a trustee. As an individual, you do not need an attorney – you can act on your own behalf. However, as a business, you must turn over management to a trustee.
What Types of Businesses Can File for Chapter 7?
Any corporation or sole proprietorship can file under Chapter 7. Additionally, some LLCs can file under Chapter 7. If you do not personally owe debts, then all debts will be satisfied during the liquidation process and you will walk away from your business personally owing nothing.
The Pros of Chapter 7 Business Filing
- Completely dissolves the business – ties up all loose ends.
- All business debts are paid off.
- For sole proprietors and certain LLCs, the owners are also cleared of debt.
- Pension payments and other continuing expenses can be discharged.
The Cons of Chapter 7 Business Filing
- The business is completely liquidated. This option is not ideal for those who wish to remain in operation.
- In the case that there are multiple owners, any individual owner who personally guaranteed business debt is still liable.
- Creditors have a say in the sale of assets.
- Business partnerships are not liable for chapter 7 bankruptcy.
Essentially, filing for Chapter 11 allows for debtors to renegotiate their debts while maintaining ownership of the company. This option means that a business can continue to operate during the bankruptcy process. It works with the creditors under the auspices of the bankruptcy court to restructure the repayment of the debt.
This is often the type of bankruptcy that gets the most press coverage. Big corporations like K-Mart, United Airlines and General Motors have all (very publicly) filed under Chapter 11, however, you do not need to be a big corporation to restructure your debt and remain in business.
Small Businesses Receive Special Provisions Under Chapter 11
A Chapter 11 bankruptcy proceeding takes time and money to successfully complete. Though it is the favored option for big businesses, there are some special provisions provided in the bankruptcy code that make this a palatable option for small businesses. As of April 1, 2019, if your total debt is less than $2,725,625, your small business is eligible for the following special provisions.
No Creditors Committee
A creditors committee is selected to represent the interests of the creditors during the court proceedings. The attorneys and specialists appointed to this committee are chosen by the creditors and paid for by the debtor.
This means the debtor is paying for the presence of their legal opposition – and it is an expense that lasts for the duration of the proceeding. A bankruptcy court can block the formation of a creditors committee under this special provision for small business owners.
Less Time to Plan
Under these special provisions, you must submit a Chapter 11 repayment plan to the court within 300 days of filing. Normally, there are no time limits imposed unless mandated by court order.
More Federal Oversight
The Department of Justice monitors bankruptcy proceedings through the United States Trustee’s office. This office is more involved in the process when small businesses are concerned. This is to ensure that smaller, more vulnerable businesses are being treated fairly during the proceedings
More Filing Paperwork, But No Disclosure Statement
Filing as a small business means you have to prepare more documents than a larger corporation would have to under Chapter 11. This is part of the increased federal oversight. Expect to have to include federal tax returns, cash flow statements, and balance sheets, to name a few.
However, unlike larger corporations, you do not have to prepare a disclosure statement, which is an extensive breakdown of your business’s assets and its plans for repayment. This must be approved by the court and then circulated to all affiliated parties, which takes time and costs money.
The Pros of Chapter 11 Business Filing
- Your business can continue to operate.
- You can negotiate with creditors and vendors to reach a repayment compromise.
- You can downsize and sell off certain assets to pay some of the debt.
- Access to special provisions.
The Cons of Chapter 11 Business Filing
- Creditors are not always happy to hear that they will not be repaid in full – this makes them less liable to cooperate.
- Regardless of the size of your business, this is a negotiation process and can take years to complete fully.
- This option is not always successful since it relies on negotiation. Sometimes Chapter 11 fails and the business has to refile for Chapter 7.
Consult with a Professional
You now are well-informed and ready to have an educated discussion with a bankruptcy attorney. Walking into your consultation with this prior knowledge means that you don’t need to spend time and, in some cases, money having the attorney break down your options for you.