Understanding Business Bankruptcy

In Bankruptcy, Business Tips, Business Transactions, COVID-19 by Larry DonahueLeave a Comment

Business bankruptcies can be an excellent tool to help businesses deal with unsustainable levels of debt

Depending on the severity of your debt, filing for bankruptcy could be the most sensible solution for keeping your business alive. It might allow your company to recover without the same burdens that nearly led to its demise or allow you as the owner(s) to proceed in life knowing that the business debts are resolved.

If you are considering this possibility, you must plan. Bankruptcy should never be rushed into, as the wrong type of filing or improper preservation of books and records or failing to adequately satisfy certain debts can have lasting negative consequences.

The outcome of the bankruptcy also depends on the type of bankruptcy filed for the business: Chapter 7, Chapter 11 (new Subchapter 5 also available), or Chapter 13. Each type offers its pros and cons, so this decision must be made very carefully.

Chapter 7 business bankruptcy is designed for businesses that cannot repay their debts because they are no longer able to maintain operations and earn revenue. The company shuts down so the court-appointed Chapter 7 trustee can liquidate its assets and repay the creditors in an orderly fashion according to code priorities.

Chapter 11 business bankruptcy is designed for businesses that are struggling with debt but not to the point where they cannot maintain operations. The filing allows them to negotiate new arrangements with creditors that must be approved by the bankruptcy court. To file Chapter 11, your business must prove that it is currently generates consistent revenue. You must also submit a reorganization plan that outlines your strategy for repaying your debts and when you expect each debt to be paid off or a negotiated amount. The bankruptcy court must approve your reorganization plan along with your creditors.

Subchapter 5 of the Bankruptcy Code will provide for a slightly more compact and ideally, easier version of Chapter 11 Reorganizations for Small Business Corporate and Individual Debtors. The purpose of this new section of the Bankruptcy Code is to allow business debtors and certain individuals with debts below $ 2.75 Million to reorganize their obligations under Chapter 11 without the need for obtaining the consent of a class of “impaired” creditors as required under basic Chapter 11. There are other advantages for filing under Subchapter 5 that should be discussed further with counsel.

Chapter 13 is used for sole proprietors. There are debt limits for Chapter 13. Those debt limits change periodically based on factors like inflation and the average cost of living. If you file for Chapter 13 as a sole proprietor, you must file under your name, as opposed to the business’s name. Sole proprietorship lacks the legal protection of registered business entities. There is no legal difference between personal assets and business assets in a Chapter 13. The Chapter 13 trustee will therefore review your personal assets when evaluating your eligibility for Chapter 13 as well as your reorganization plan.

Finally, we advise most small business owners to consider the factors set forth below before making any decision on if bankruptcy is right for their company.  These factors include but are not limited to:

  • Is the business salvageable through a reorganization of the debts? If so, then a thorough review of the provisions of Chapter 11 or the new Subchapter 5 Small Business Bankruptcy sections of the Bankruptcy Code is required.
  • Is the business a sole proprietorship? If so, then the same effect may be possible through an individual Chapter 13 filing with substantially fewer costs.
  • Have the non-dischargeable personal debts, i.e. employment taxes, sales taxes been paid down prior to closing? If not, these obligations are going to remain leaving the owner responsible and perhaps necessitate a personal bankruptcy.
  • How much of the debt has been personally guaranteed by the owner? These debts will also still be the responsibility of the owner and should be addressed at the beginning of bankruptcy planning with counsel.
  • Are the books and records in order? The proper preservation of records so a Bankruptcy Trustee can adequately review the finances of the business is essential and the failure to have them can be the cause of the dismissal of the bankruptcy itself.
  • Have there been improper distributions from the business (i.e. dissipation of assets) which have prejudiced the creditors from receiving their due share? Chapter 7 Trustees can sue on behalf of the bankruptcy estate and will not hesitate to sue the owner of the business to recover monies that have been disproportionately siphoned off from the business for personal expenses. 

Bankruptcy can be a remedy when a business fails, but a poorly considered, mis-timed or inadequately prepared bankruptcy filing can be fraught with consequences. Always work with competent counsel, start early, and plan ahead!

Is your business having a difficult time weathering COVID-19? Would you like to discuss your options with regard to Bankruptcy? Contact us today

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