Small Business Reorganization Guide: Helping Small Business Debtors Regain Financial Stability
“Bankruptcy” is one of the last things most small business owners want to consider, especially regarding their business. Despite its negative connotation, filing for business bankruptcy can be a smart way to regain financial stability.
In this article, we’ll tell you everything you need to know about Chapter 7 bankruptcy and how it can help you reorganize your business. So read on!
What Is Chapter 7 Bankruptcy?
Chapter 7 bankruptcy is also known as a straight or liquidation bankruptcy. It’s a type of bankruptcy that can clear different unsecured debts.
If your small business isn’t doing well and you are indebted to banks, suppliers, employees, or others, filing for Chapter 7 bankruptcy is a viable option. It can resolve debt issues by liquidating the company.
Chapter 7 business bankruptcy can be used for sole proprietorships, partnerships, and corporations organized as limited liability companies. Although it can be an intelligent strategy for sole proprietors, the downsides may outweigh the upsides for partnerships and corporate entities.
Chapter 7 for Sole Proprietors
Although different businesses can file for Chapter 7, sole proprietors might have the most to gain from it. It can discharge personal and business debt in the same case, which almost means you get a “two-for-one.”
Debt for Sole Proprietors
With Chapter 7, a sole proprietor can discharge several kinds of debt. They can do this whether it is consumer or business debt. Different kinds include:
- Medical bills
- Credit card balances
- Utility bills
- Past-due lease obligations
- Gym memberships
- And more
You can even discharge secured debts, such as mortgages and car payments, but you’ll have to return the property as collateral.
It’s important to note that bankruptcy doesn’t eliminate all obligations. Some nondischargeable debts include:
- Student loans
- Support obligations
- Tax obligations
- Fines and penalties owed to the government
- Debt incurred through fraud
Make sure to research deeply about which of your debts will be dischargeable under Chapter 7.
Property for Sole Proprietors
Sole proprietors won’t lose everything when filing for Chapter 7 bankruptcy. Unlike other business types that file, sole proprietors can hold onto a property covered by bankruptcy exemptions. These change depending on which state the bankruptcy is taking place.
However, they usually include items necessary for maintaining their home and job:
- Retirement account
However, excess luxury items will probably need to be given up.
Keeping Your Business
Whether or not you can keep your business will depend on the bankruptcy exemptions. If the trustee doesn’t sell crucial parts of the company or the company itself, you might be able to keep the existing business.
If your business is service only and you’re the only person who can supply the service, chances are you will be able to keep your business. Examples of this can include lawyers, gardeners, caterers, or nannies.
The trustee can sell your equipment, products, goodwill, or contact list. If you want to keep these things, they must be protected with a bankruptcy exemption. Most states will allow some things to be observed needed to operate the business.
Chapter 7 for Partnerships
A different legal entity that can file for Chapter 7 business bankruptcy is a partnership.
When a partnership files for bankruptcy, it is essential to note that there is no discharge of business debt. Also, no exemptions can be used to protect property. The trustee will shut the business down, and it or its assets will be sold to pay off creditors.
All partners are liable for business debt. If there aren’t enough business assets to pay off their debt, the trustee or creditors might go after the partners’ assets to finish paying it off.
Because of this, it might be a more innovative option for each partner to file for Chapter 7 bankruptcy individually after the business closes. This way, they can discharge personal and business debts independently.
Chapter 7 for Corporations and LLCs
Corporations and LLCs, like partnerships, will not receive discharges on their debt. The main benefit of filing a Chapter 7 bankruptcy for these larger companies is to get a simple liquidation. In this case, the burden of getting rid of assets and paying back creditors falls on the trustee rather than the owners.
Often the benefits do not outweigh the downsides of filing for this bankruptcy. Stockholders who cosigned for the corporate debt will still be on the hook for the debt.
In most cases, corporations might be better off selling their property and negotiating the debt with their creditors.
Pros and Cons of Chapter 7 Bankruptcy
There are upsides and downsides to declaring Chapter 7 bankruptcy.
Regarding the pros, Chapter 7 is a good option if you want to start a new business or explore other career options. It allows you to eliminate most of your unsecured debts. It usually takes around six months to take place.
The obvious downside is that your company will go out of business. Chapter 7 doesn’t relieve you of every kind of debt, including car loans and mortgages. Also, it can result in property loss if it is non-exempt.
Chapter 7 is not the best option for business reorganization, so if you’re looking to help your existing business, you might want to look at other options like Chapter 11 bankruptcy.
Lastly, a Chapter 7 bankruptcy will appear on your credit report for ten years, and you can’t file for Chapter 7 again for another eight years.
Should I File for Chapter 7 Bankruptcy?
Although people are mainly worried about losing property in bankruptcy, the most important question when choosing whether or not to file for Chapter 7 bankruptcy is if you’ll receive an overall financial benefit from the process.
You want to find if the total amount of discharged debt is significantly higher than the value of the property lost in bankruptcy. If it is, then filing for bankruptcy could make sense. If not, there might be better options out there for debt relief, like negotiating directly with creditors.
Let’s look at an example to clarify.
Let’s say you have $300,000 in total debt and you have the following assets:
- $400,000 in home equity
- A car worth $100,000 that you own
- A vacation property worth $200,000
With $700,000 in personal assets, it probably wouldn’t make sense to file bankruptcy because most trustees would sell most of your property at fire-sale prices to cover your debt. You also lose a percentage to the trustees for their fee.
Do I Qualify for Chapter 7 Bankruptcy?
Not everyone qualifies for Chapter 7.
First, your income must be low enough to meet the Chapter 7 means test (although there are exceptions to this). This test calculates whether or not you have the ability to pay back what you owe to creditors.
This test is meant to disqualify people who have high incomes. If you fail the test, you won’t be able to file for Chapter 7 but can file for Chapter 13 bankruptcy.
Chapter 7 Bankruptcy Procedure
There are several documents that the trustee will need to see for both business and personal financials. To begin the process, you’ll need a certificate that says you completed a credit counseling course. You’ll also need to file a bankruptcy petition.
After that, the trustee will require several documents that prove the numbers provided in the petition. These include:
- Both personal and business banking and retirement statements
- Your most recent tax return
- Paycheck stubs
- Profit and loss statements
- Proof of self-employment income
- Any other documents that the trustee asks for related to your financial situation
Next, you will need to attend a hearing where the trustee checks your ID and asks questions about your petition. Creditors that follow will also be able to ask questions as well. This is called the 341 meeting of creditors.
Lastly, you’ll need to attend a debtor education course and provide the certificate to the court.
After you finish all of these steps, you’ll be eligible for your debt discharge.
How Long Does a Chapter 7 Bankruptcy Case Last?
Most small business debtors can receive a debt discharge within three to four months. Because there are no repayment plans, Chapter 7 cases usually go faster than other types of bankruptcy.
What to Do Next to Regain Financial Stability
That’s a basic overview of how Chapter 7 bankruptcy can help you regain financial stability in your small business and personal finances.
When choosing a law office to help you through bankruptcy, selecting an attorney with specialized experience in bankruptcies is essential.
At the Bankruptcy Law Office of Richard A. Check S.C., we’ve completed over 10,000 bankruptcies and provided life-changing results for our clients. Call us for a free consultation today!