Bankruptcy is a legal process whereby the court helps a business eliminate and repay debts. When a business enters bankruptcy, it usually has significantly lost the ability to pay back debts or other financial obligations. In some cases, bankruptcy can enable a business to not only repay their debts, but eventually return to yielding profits. Any business that files for bankruptcy will need to undertake a series of complicated steps to successfully make it to discharge – the last stage of bankruptcy.
Bankruptcy actually exists in several different forms. In the United States, bankruptcy courts process six types of bankruptcies, called “chapters”. As it relates to businesses, there are three important chapters of bankruptcy that should be considered – Chapter 7, Chapter 11, and Chapter 13. Each type has unique characteristics that apply to different circumstances.
Chapter 7 bankruptcy, otherwise known as “liquidation”, allows a business to sell its property and use the proceeds of the sale to repay debts. After non-exempt property has been liquidated, any individual debtors involved in the business receive a discharge relieving them of personal liability to the eligible debts left unpaid. The process is governed by the bankruptcy court and overseen more closely by a trustee. The trustee takes control of the business’s property and guides the sale and distribution to creditors and stock holders.
Chapter 11 bankruptcy often goes by the name “reorganization.” For a business, Chapter 11 bankruptcy is very different from Chapter 7. Rather than liquidating property, a Chapter 11 provides a business with a repayment plan. Eligible debts and payments are restructured so that the business has the ability to continue making payments. Under Chapter 11, the business may continue functioning while repaying debts and hopefully become profitable again.
Chapter 13 is a bankruptcy strictly for individuals, but used in some cases by businesses. To use a Chapter 13, a business must either be a sole proprietorship or partnership. Corporations and limited liability companies (LLCs) are ineligible. Sole owners or partners can file a Chapter 13 in their name and include debts of the business for which they hold liability. Similar to Chapter 11, Chapter 13 provides the individual with a repayment plan that restructures their eligible debts so payment of debts can continue.
The most important difference to understand between Chapter 7, Chapter 11, and Chapter 13 is liquidation versus reorganization. When a business uses a Chapter 7, property is lost and used to pay debts. When a business uses Chapter 11 or Chapter 13, it keeps property but has to repay a portion of its debts using profits from operation. Consequently, a business can stay active after a Chapter 13 or Chapter 11, whereas it could not after a Chapter 7.
Filing any form of bankruptcy can potentially be long, complicated, and overwhelming. Most businesses will require the help of a bankruptcy attorney to provide guidance and complete the filing. Bankruptcy attorneys have professional knowledge and experience that enables them to properly execute the steps involved in the bankruptcy process.
Any bankruptcy will firstly require credit counseling from an approved agency. Bankruptcy law requires that all filers have a certificate from an agency before they begin filing for bankruptcy. In each form of bankruptcy, the filer begins the process by submitting a “petition” along with other schedules and financial documents. Effective as soon as the petition has been processed, the court usually will issue an “automatic stay” preventing collection and repossessions.
In a Chapter 7, the trustee assumes control of the finances of the business and arranges a meeting between the business and creditors. At the meeting, the creditors can interview the filer about their finances and ability to pay back debts. If none of the creditors object to the bankruptcy, the business will be given a final hearing and a discharge that clears the business of eligible debts.
In both a Chapter 13 and Chapter 11, the process is mostly the same as in Chapter 7, with the addition of a few steps. For one, the business will need to negotiate and submit a repayment plan that defines payments and other terms of repayment. In addition, the business will need to fully complete their repayment plan before the court grants a discharge. When the repayment plan is complete and the court grants the discharge, the balance of debts covered by the bankruptcy will be cleared.
Businesses should first incur a financial hardship before choosing to file bankruptcy. Without a legitimate inability to pay debts, businesses might actually damage themselves financially by filing for bankruptcy. It is correct that a bankruptcy can clear a good amount of your debts as a business. But a bankruptcy can also stop your business from running altogether, stain credit history, or negatively impact profits. Some businesses experiencing financial hardships will benefit from alternatives such as financial planning or negotiation with creditors.
Eligibility is crucial to consider before choosing bankruptcy. To be eligible for Chapter 7, a business will need to prove it cannot pay its debts and cannot have a previous bankruptcy discharge within six years. To file a Chapter 13, a business will need to be able to comply with a repayment plan, have unsecured debts less than 269,250, and have secured debts less than 807,750. To be eligible for a Chapter 11, a business needs to be eligible to file a Chapter 7 and be able to comply with a repayment plan.