Business Bankruptcy 101: 5 Need-to-know Tips About Small Business Bankruptcy

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Closing down your business is tragic, especially when the action is prompted by an insurmountable debt problem. Not only do you have to grit your teeth through an unsettling array of emotions, but you must also seek protection from those persistent creditors. If you’re thinking about bankruptcy, here are five tips to help you understand what lies ahead.

  1. You may not be able to exclude your personal debts from the bankruptcy. If your business is a proprietorship, you cannot obtain bankruptcy protection solely for the business. The finances of your business are considered a subset of your personal finances; therefore, your bankruptcy filing would generally cover all of your debts—not just the ones related to your business.

    If your business is a corporation, limited liability company (LLC) or a partnership, the business can file its own Chapter 7 or Chapter 11 bankruptcy petition. This filing would not affect your personal finances.

  2. Your personal assets may be at risk if the business is a partnership. Although a partnership is a standalone legal entity, the court may sometimes use the partners’ personal assets to pay off creditors. Check your credit agreements for personal guarantees on the partnership’s debts, and get solid legal advice before proceeding.
  3. You may not have to shut down your business. You can reorganize your corporation, LLC or partnership under Chapter 11. If the business is a proprietorship, you can reorganize your personal finances, including the business, under a Chapter 11 or Chapter 13 bankruptcy. Reorganization is an option when the business’s primary problems are related to burdensome debt payments or other contractual obligations. A bankruptcy reorganization is not an option when sales and/or margins are too weak to support ongoing expenses.
  4. Reorganization isn’t always the best option, even when the business just needs to be reorganized. A Chapter 11 reorganization bankruptcy proceeding will sap a lot of your time and energy. Consider whether you able to meet the bankruptcy court’s demands while continuing to run your business effectively. Depending on the structure of the business, it might be more efficient to liquidate and start over. You would have to start with new money and, preferably, a new business name.
  5. Corporations, LLCs and partnerships do not get a discharge. Businesses that are legal entities have no “clean slate” option; they must either liquidate under Chapter 7 or reorganize. In a liquidation, the business is closed and the assets are sold to pay off creditors. In a reorganization, the debts and contracts are restructured so the business can pay back the money owed.

    A “clean slate” discharge is only an option in individual Chapter 7 cases. If you are a sole proprietor, your business-related debts could be discharged through Chapter 7—but this is because they are your personal debts in a legal sense.

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