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Choosing the Right Type of Business Bankruptcy

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business bankruptcy

Let’s say you are a small business owner trying to cope with mountains of debt. It occurs to you that filing bankruptcy is an option, but how do you know whether it is the best option for you? And what type of bankruptcy filing is most appropriate for your situation?

Business bankruptcy is much more complex than personal bankruptcy. The repercussions of filing can be wildly different depending on how your business is organized and the type of bankruptcy you file.

Read on to learn about the different types of bankruptcy filings and each business type’s potential ramifications.

The Type of Business Structure Matters

How your business is organized will dictate what bankruptcy options are available and help determine which options are best for you.

Sole Proprietors

Sole proprietorships are frequently used by small businesses, freelancers, consultants, and self-employed individuals. They are easy to establish, inexpensive, and have a simple management structure. However, this entity type is risky, as the sole proprietor is personally liable for all business debts and obligations.

If the business faces legal actions or incurs debts, the sole proprietor’s personal assets may be at risk of being used to satisfy these obligations.

For tax purposes, income generated by a sole proprietorship is reported on the owner’s personal income tax return. The business doesn’t file a separate tax return, and profits are taxed at the individual’s personal tax rate.

LLC, Corporations. Partnerships, Small Businesses

Limited liability companies, partnerships, corporations, and sometimes small businesses with a lot of debt file for Chapter 11 bankruptcy when they are in financial distress.

Chapter 11 is available for all types of business structures, including non-profits.

What Are Your Future Goals?

Do you plan to continue your business operations? Would you entertain selling your business and using the proceeds to pay off your debts? Are you personally liable for any business debt?

What you plan to do once your debt is discharged will help you decide whether bankruptcy is the best option and, if so, which type of bankruptcy you should file.

Chapter 7 Business Bankruptcy

Sole proprietors can file for personal Chapter 7 bankruptcy and use exemptions to safeguard their business assets. However, partnerships, LLCs, and corporations are not eligible for exemptions and can only use Chapter 7 bankruptcy to liquidate the company. If a business entity such as a corporation files under Chapter 7, it won’t be able to continue its business operations.

Chapter 7 bankruptcy for all types of businesses eliminates unsecured debts and allows the business assets to be sold by the bankruptcy trustee. However, if you are personally liable for any of your business debts, you won’t be protected by your business Chapter 7 filing.

After your business receives a discharge, you will still be liable for those debts, and you must file for personal bankruptcy to erase them and safeguard any personal assets with the available exemptions.

Chapter 13 Business Bankruptcy

You can use Chapter 13 bankruptcy protection if you are a sole proprietor. This program allows you to keep your non-exempt assets, renegotiate your secured loans, eliminate business and personal non-priority debts, and pay off priority obligations such as business and individual taxes.

Chapter 13 is a method of restructuring your debt. To be eligible, you must devise and execute a repayment plan that will last 3 to 5 years. Once you have completed the plan, you will be discharged from your debt.

Chapter 11 Business Bankruptcy

Sole Proprietorship Chapter 11

Chapter 11 is available to individual and business debtors but rarely filed by individuals because Chapter 13 is generally a much more attractive option.

LLP, LLC, Corporation Chapter 11

Chapter 11 is the only solution for companies organized as anything other than a sole proprietorship that wishes to continue business operations rather than liquidate.

This type of bankruptcy filed by major corporations and small businesses must follow most of the same rules and procedures. However, if you owe less than $2.5 million, you can file as a “small business debtor,” which fast-tracks the bankruptcy and releases you from some of the more onerous provisions.

Still, Chapter 11 bankruptcy is extraordinarily complicated. To file initially, you must produce your company’s most recent balance sheet, statement of operations, cash flow statement, and federal tax return. You must also:

  • Develop and have approved by the court a reorganization plan that shows how your business will recover
  • make monthly payments to creditors, the amount of which is determined by a complex formula and
  • be subject to strict oversight by a trustee during repayment.

Explore Your Options

After reading this, if you think filing under Chapter 11 is enormously complex, you are correct. While seeking qualified legal advice regarding any form of small business bankruptcy is advisable, Chapter 11 is truly in a league of its own, requiring an attorney’s experience and expertise.

Determining whether to file for small business bankruptcy and which type of bankruptcy to file is a complicated decision that should not be undertaken lightly. Consult an experienced business bankruptcy attorney who can help you sort through your options, file all needed documents, and ensure you do not experience unintended consequences.

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