It's a common fact of owning a small business: Small businesses fail all the time and for many various reasons, some of which are outside of the owner's control. If you're unable to pay the overhead and are falling deeper and deeper into debt by keeping your company open, sometimes the best business decision you can make is to shut down the business and cut your losses.
When it comes to closing a debt-laden business, bankruptcy is one option that can allow you to stop bleeding money and get a fresh start. However, there are certain considerations for filing for certain types of bankruptcy, and filing a Chapter 7 business bankruptcy has its own benefits and drawbacks. As a sole proprietor, Chapter 7 lets you wipe out both personal and business debt in a single filing. There are some exceptions that apply and an experienced bankruptcy attorney can guide you in the right direction. And even though your personal assets will be included in the bankruptcy estate, you can use exemptions to protect some—and maybe even all—of your property. In a Chapter 7 business bankruptcy, the trustee is responsible for selling your assets and paying your creditors. A chapter 7 business bankruptcy may be the easiest way to go if you want to put the failing business behind you and move forward with a new beginning.
This pandemic has forced a lot of small business owners to consider filing a Bankruptcy. It can be an extremely confusing process to discern the difference between filing a personal Chapter 7 Bankruptcy or a Business Bankruptcy. Make sure you hire an experienced Bankruptcy attorney to help you navigate this minefield. Hallaq Law Firm is always available for inquiries.
What are your options?
When a business is failing you have the following options:
- Do nothing.
- Wind the business down according to State law.
- File a Chapter 7 liquidation Bankruptcy for the business.
- File a Chapter 11 reorganization Bankruptcy for the business.
- File a State Court receivership for the business.
- File a Sub-Chapter 5 Bankruptcy for the business.
None of these options preclude filing a personal Bankruptcy case, however, you need to talk to an experienced Bankruptcy attorney about the timing of a personal vs. business Bankruptcy case because there are advantages of filing one type of Bankruptcy prior to filing the other type of Bankruptcy.
Why would you file Bankruptcy for a business?
In some states, there is no advantage to filing a Business bankruptcy as the business can simply dissolve and the effect would be the same without needing to file a Bankruptcy case. Because of this, many attorneys simply never consider this option for their clients.
There may be advantages, however, based upon State law to filing a Bankruptcy for an LLC. For example, here in Washington State, there are state-specific statutes that would apply to an LLC that owes money to the government. Normally upon LLC dissolution that debt would drop down to the individual members of the LLC and would NOT be dischargeable in a Ch. 7. There is a State-specific statute, however, that says that if the LLC declares Bankruptcy and is subject to liquidation, the debt would not fall onto the individual members if the individual member files a subsequent Ch. 7 Bankruptcy.
Because of this, it is important that attorneys verse themselves in the various options and strategies for closing down businesses or reorganizing businesses, and not simply ignore the potential advantages that Bankruptcy has to offer.
Things to consider.
When you are closing down a business it is very important to carefully assess the situation and preserve as many of your records as possible. It is also important to maintain clear lines of communication with your creditors, especially those creditors that have options such as lienholders and landlords. You don't want a situation where your important records are in a building locked by your landlord, or where your files are kept on a device that has been repossessed due to a UCC filing.
You should also make all efforts to coordinate with your tax preparer so that you will have access to sensitive tax information necessary to file final tax returns. Oftentimes these taxes are critical in offering important losses that you can apply to older tax liability. It is not unusual for businesses to also owe their tax preparer and so it is important to have copies of your original source documents, as oftentimes tax preparers will hold your original documents until their unpaid invoices are paid in full, which can seriously affect the winding down process.
Receivership vs. Bankruptcy.
Receivership is a state court process where an independent third party is assigned by a court (a receiver) operates the company to help meet the goals of creditors and shareholders. This was oftentimes a good option for companies that needed to reorganize but could not afford the relatively expensive option of a Ch. 11 Bankruptcy and did not want to liquidate the assets of the business in a Ch. 7 Bankruptcy.
Sub-Chapter 5 Bankruptcy.
In the personal Bankruptcy world, a Ch. 13 Bankruptcy (wage earner plan) adds significant advantages for some debtors over a Ch. 7 Bankruptcy, but there was no equivalent in the Business Bankruptcy context. Recently Congress has created a new Subchapter 5 Bankruptcy which is intended to bridge the gap between Chapter 7 and Chapter 11.
In a Subchapter 5 Bankruptcy (sometimes called “Subchapter V), if your business has regular income, you can spread your debt repayment out over 3 to 5 years, during which time the business must propose to use its disposable income for paying creditors. Unlike a Ch. 11 Bankruptcy, where the administrative expenses of filing the case (which can be substantial) must be paid fairly early (upon plan confirmation), in a Subchapter 5 Bankruptcy, the administrative costs can be spread out over the repayment term (3 to 5 years) similar to a Ch. 13.
A great advantage of a Bankruptcy filing over a receivership is that the business owners retain control over the business during the administration of the case, however, a Trustee will be appointed in a Subchapter 5 Bankruptcy who has the authority to investigate the financial affairs of the business and ensure that a feasible repayment plan is finalized by the court.
There are some limits on who can file a Subchapter 5 Bankruptcy, including the nature of the business income and the debt limits, so you should have your business evaluated by an experienced Bankruptcy attorney to assess your options under Subchapter 5 Bankruptcy.
Personal Liability from Business Obligations.
For most small businesses, the owners of the business needed to personally guarantee most loans and extension of credit for a business, especially at the start of the business. This means that notwithstanding the winding down of the business, or a Bankruptcy case, the individual owners may remain obligated on Business-related loans. It is very important to sit down with your attorney and list all of the business debts and make sure to identify which loans were personally guaranteed. It is also common that many business owners do not know, or do not recall which loans may have been personally guaranteed. If the original loan documents are not available, you should assume that the loan was personally guaranteed until you can verify that it was not. Making the opposite assumption could lead to an unfortunate surprise later on during the case.
More critically some business loans (especially loans from the Small Business Administration) can be secured by the personal assets of the business owner. For example, it is not usual for some lenders to extend credit to a business in exchange for a lien on the business owner's personal residence. These types of loans can complicate the analysis when closing down a failing business, and it may make filing for Bankruptcy a more advantageous option.