Each chapter or type of bankruptcy defines who is eligible to be a debtor in its definition. Some of the chapters are reserved solely for individuals, some can be used by individuals or businesses. The most common forms of bankruptcy are Chapter 7, Chapter 13, and Chapter 11. An individual or business can be a debtor in a Chapter 7 or Chapter 11; however, a business cannot be a debtor in a Chapter 13.

The next layer in deciding what chapter applies to the business is understanding the structure of the business. Corporations, LLC, and Partnerships are separate legal entities and are liable for its own debts, meaning the owners are generally not personally liable for the debts of the business. If the business is one of these type of organizations and is in a financial position where it needs a bankruptcy, that particular business will have to file either a Chapter 7 or Chapter 11.

On the other hand, if the business is a sole-proprietorship or DBA (doing business as) then the business is not a separate legal entity, which means the assets and liabilities of the business are owned by the owner — they are linked. In this case the owner would have a choice between filing a Chapter 7, Chapter 13, or Chapter 11. The decision would depend on the value of assets the individual owned, the type of debt that is owed, the amount of debt that is owed, and the goal the owner is trying to accomplish. The strategies involved in deciding which Chapter can best effectuate the goals of the business should be discussed with a qualified attorney.

This article will discuss the advantages of a bankruptcy for a business that is organized as a partnership, corporation or LLC, for a discussion on advantages of filing a personal bankruptcy read one of our other articles or visit our website.

It is important to remember that the bankruptcy code does not allow a business to receive a discharge of its debts, so the question does become why would a business file a bankruptcy.

CHAPTER 7

If a business is in financial distress to where it is no longer profitable and it cannot afford its debts, filing a chapter 7 is an easy way for the owners to move on from the business without having to deal with the headache of selling its assets to settle its business debts.

The Trustee assigned to the case will take over the administration of the estate; the Trustee will sell the businesses assets and use the proceeds to satisfy the businesses debts. Basically, it is a transferring of the burden of selling the assets and paying creditors on to someone else so the owner or owners can move on to their next venture.

Often times the Trustee will sell the assets for less than what could be received if sold by the owner so that is a factor for a business owner to consider.

Because businesses do not receive any exemptions, which is the way property is protected in a bankruptcy, all of the businesses assets are available for the Trustee to sell.

At the end of the bankruptcy, creditors could attempt to collect from the owner if they were personally liable on the debt. In a corporation or LLC, an owner would be personally liable if he or she co-signed on a loan or personally guaranteed a debt. The only other way an owner of a corporation or LLC would be personally liable is if it were determined they pierced the corporate veil, which means the owner took some illegal action that destroyed the distinction of the business being a separate entity (think fraudulent activity).

If the company is a partnership, and after the Trustee sold all of the business’s assets and there was not enough to satisfy the debts, the Trustee can go after the owner’s personal assets to satisfy the debt. Moreover, the Trustee can sue any general partners to pay any remaining creditors.

If an owner is exposed to any type of personally liability associated with the business, the owner often times will have to file a personal bankruptcy along with the business in order to discharge the debt.

Chapter 7 marks the end of the corporation or LLC; therefore, the practical effect of the liquidation is,after the Trustee sells and pays the creditors what is available, the business no longer owes any remaining debts.

CHAPTER 11

Most of us are familiar with businesses filing a Chapter 11 reorganization. This is when a business in financial distress uses bankruptcy to reorganize its debts in order to restore itself to a profitable state so the business can survive.

Similar to a chapter 7, the business will not receive a discharge of its debts. In some cases, however, some business debts can be forgiven through a tactic called a cramdown. The debtor in a chapter 11 will offer a plan to a creditor’s committee, as a part of  the plan the debtor can eliminate some debts in order to pay others. The plan may be approved by the Judge is the debtor, through negotiation, can get the creditor’s to agree. Chapter 11 allows flexibility in its restructuring in order to find a solution that benefits both the debtor and the creditors.

Different from a chapter 7, Chapter 11 does not mark the end of the business, it is meant to be a tool that ensures the business’ survival.

If you are a business owner and are contemplating filing a bankruptcy, you should consult a bankruptcy attorney in order to get the best advice surrounding your business’ situation.