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Small Business Bankruptcy



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Filing Bankruptcy when you own a Small Business

With all the risks, financial constraints and competition that small businesses can face, it's not surprising that 35,000 or more U.S. small businesses file for bankruptcy each year. Bankruptcy may feel awful to a small business owner, but it may be the smartest financial choice for a business that can't control its financial situation. A bankruptcy allows you to either keep operating while you restructure and manage your debt, or dissolve your business, get rid of debt and start fresh. Depending on the situation and the type of business, small businesses are eligible for Chapter 7, Chapter 11 or Chapter 13 bankruptcies.

Sole proprietors run businesses that haven't been legally incorporated. Bankruptcy law treats them just as it would an individual; they are eligible for Chapter 7, Chapter 13 or Chapter 11 bankruptcies. But because of this, sole proprietors are legally liable for their businesses' debts; a trustee in any type of bankruptcy may take the individual's eligible assets to pay off debt.

Corporations, LLCs (limited liability companies) and partnerships are eligible for Chapter 7 or Chapter 11. However, individual partners in a partnership are legally liable for debt that the partnership's assets don't cover in a Chapter 7 liquidation. That is, the law allows a trustee in a partnership's Chapter 7 bankruptcy to sue the individual partners for money to cover the partnership's debts. For that reason, partnerships interested in a bankruptcy are strongly advised to talk to a bankruptcy attorney before taking any action. Partners in a Chapter 11, and other types of incorporated business owners involved in a bankruptcy, are not legally liable for most of the business's debt.

However, the IRS may hold owners of any type of business personally liable for payroll taxes. You will also be personally liable if you've pledged any personal assets as collateral for your business, if you've treated the business like a sole proprietorship and neglected things like shareholder meetings. If you're in this type of situation, you should consider a personal bankruptcy as well as a business bankruptcy, or at least pay off your debts strategically. Contact a bankruptcy attorney for help choosing the best options available in your situation.


How Chapter 11 Bankruptcy Works

Chapter 11 is available to businesses and to individuals with too much debt to qualify for Chapter 13. In a Chapter 11, the debtor restructures and reorganizes the debt, just like a Chapter 13, and may continue to operate the business for the benefit of creditors. However, a Chapter 11 is a bit more complex than a Chapter 13, because it's overseen by a committee of large creditors appointed by the U.S. Trustee's office. (None of these creditors may be insiders to the business; that is, if your business owes your spouse back wages, the spouse may not be a trustee.) All creditors get a chance to approve a Chapter 11 bankruptcy plan; a business may force a plan against their approval only if the plan meets certain legal requirements.

The advantage of filing a Chapter 11 is that it gives the business time to keep operating while owners try to sell it or its assets. It can also get a business out of unfavorable contracts, like a lease on property that's not being used anymore. However, Chapter 11 is time-consuming and incurs a lot of legal fees, draining time and resources that the business's owners could be using to build profits. And because creditors are in charge of approving a reorganization plan, Chapter 11 is often more expensive than other types of bankruptcy.


Which Type of Bankruptcy Is Best?

In general, which type of bankruptcy you choose depends on the circumstances that led you to a bankruptcy in the first place.

A liquidation (Chapter 7) is best when the current incarnation of the business isn't viable. That would be true if your business has too much debt to restructure, if it's facing bankruptcy because the market wasn't there for your products or services, or if financial mismanagement is part of the problem. Liquidation may also be a good choice for businesses that would be fairly easy to start all over again. That is, if your business requires little startup capital and doesn't have a lot of assets outside of the owner's skills, starting over may be a better use of your time, money and energy than a long-term reorganization.

A reorganization (Chapters 11 or 13) is best when debt is holding back an otherwise viable company. If you've got debt that's keeping your company from meeting its full potential, a reorganization can help you discharge that debt and pay off creditors. However, a reorganization isn't a fast process like a liquidation; in either Chapter 13 or Chapter 11, you will likely face several years of repayment and management by a trustee. Furthermore, a Chapter 11 -- the only type of reorganization available to incorporated businesses -- can incur lots of expensive attorney fees. But if your business can still be profitable with a little financial restructuring, a reorganization may make the most sense for you.

An experienced bankruptcy attorney can give you more detailed advice on choosing between these options during a free initial consultation. Bankruptcy attorneys can also help business owners arrange their finances in the most advantageous way; protect personal assets; and outline the likely costs of a bankruptcy. Call us today or fill out our online case evaluation to find a skilled bankruptcy lawyer in your state.