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Commercial Bankruptcy

What Is Business Bankruptcy Law? What Are Some Common Types of Business Bankruptcy?

Bankruptcy refers to a court process in which a person's debts are dismissed; meaning, they are no longer legally liable for repaying what they owe. Not all debts can be dismissed, but releasing what is able can help a person gain a fresh financial start when they are overwhelmed with debt.

Businesses can also file for bankruptcy. Generally speaking, if a business is filing for bankruptcy, they are filing under either Chapter 7 or Chapter 11. Regardless of which chapter of bankruptcy the business chooses to file for, creditors may not attempt to collect debts from the business when proceedings have been initiated. When filing for a Chapter 7 bankruptcy, not all debts may be discharged. 

This generally means that some of the debtor's assets will be repossessed and sold in order to repay the debts that cannot be discharged. Chapter 11, on the other hand, is considered to be a “restructuring” form of bankruptcy. What this means is that they will create a plan to repay their creditors in a way that is more manageable.

Each type of bankruptcy has its own advantages and disadvantages. Some examples of the pros and cons of a Chapter 7 bankruptcy include:

  • It is generally a more quick and simple process when compared to other chapters;
  • Only one court visit is required in order to file the petition for bankruptcy;
  • Some of the debtor's property must be sold in order to pay off creditors as much as possible;
  • A court appointed trustee is required to manage the bankruptcy; and
  • The business is not likely to continue its operations after the bankruptcy has concluded.

Some examples of the pros and cons of a Chapter 11 bankruptcy include:

  • The business is likely to continue its operations once the bankruptcy has concluded;
  • There is no need to sell off property in order to repay the creditors;
  • No court appointed trustee is necessary due to the fact that business will continue operating;
  • The process is longer and more complex than other chapters, such as a Chapter 7 bankruptcy; and
  • All debts must eventually be paid.

How Can a Business File for Bankruptcy?

The first step in a business filing for bankruptcy would be determining which chapter of bankruptcy would best suit your needs. As previously mentioned, Chapter 7 bankruptcy involves the liquidation of a business' property in order to pay off its debts. The process begins when the business files a petition with the bankruptcy court, which must list all of the business' property, debts, and recent financial history.

The court appoints a trustee responsible for selling off some of the business' property, as well as discharge some debts. Simply put, this means that the debts do not need to be paid. Other debts are not dischargeable, including:

  • Recent taxes;
  • Debts in prior bankruptcy proceedings; and
  • Penalties that are payable to the government.

Once all of the debts have been settled, the business will most likely close operations and cease to exist.

Chapter 11 bankruptcy allows a business to reorganize its finances with the goal of eventually paying off its debts in order to continue operations once the bankruptcy process has concluded. After filing a petition for Chapter 11 with the bankruptcy court, the business is then given 120 days in which they are to create a plan to reorganize their business in a more profitable way. In order to make the business profitable again, the plan could involve removing certain unprofitable parts of the business

An example of this would be discontinuing an advertising or research department. Additionally, the reorganization plan must detail how the business intends to pay off its creditors in the future. Finally, the reorganization plan must be approved by the creditors before the business can proceed.

If you are a small business owner and are overwhelmed with a large amount of debt, Chapter 7 bankruptcy may provide you with some financial relief. If you are a sole proprietor, or if your business is considered to be a general partnership, you are personally liable for your business's debts. What this means is that you may also be able to file a Chapter 7 bankruptcy in order to eliminate most or all of your debt. 

However, if your business is a separate legal entity such as a corporation or LLC, you will need to file for bankruptcy on behalf of the business. Although you may be able to file for Chapter 7 in such circumstances, you will need a lawyer to represent you throughout the process.

How Does a Business Chapter 7 Bankruptcy Compare To a Personal Chapter 7 Bankruptcy? Which Business Debts Are Discharged in a Chapter 7 Bankruptcy?

To reiterate, Chapter 7 bankruptcy is liquidation bankruptcy available to both businesses and individuals. However, there are some differences to the process if the debtor is a business rather than an individual. Some examples of these differences include, but may not be limited to:

  • Individuals are required to take credit counseling as a prerequisite to filing for bankruptcy, whereas if the debtor is a corporation or other non-individual business entity they do not;
  • If the debtor is a corporation or other non-individual business entity, they must be represented by a lawyer while individual debtors may represent themselves;

As previously mentioned, there are many business debts that can be discharged in a Chapter 7 bankruptcy, but not all. When a debt is discharged, the business owner is no longer personally liable for the debt. As such, they are no longer responsible for repaying the debt once the bankruptcy is complete.

Additionally, it is important to remember that a Chapter 7 personal bankruptcy only discharges the business owner's personal debt. If the business is an LLC or corporation, creditors are still allowed to pursue any debt that the business is liable for.

Some examples of the types of debts that are discharged in a Chapter 7 personal bankruptcy include, but may not be limited to:

  • Credit card debts;
  • Lawsuit judgments;
  • Medical debt;
  • Unsecured business debt that owed by the business owner; and
  • Personal loans, as well as promissory notes.

What if There Are Bankruptcy Issues Related to COVID-19? 

It is important to note that COVID-19 has impacted the landscape of bankruptcy law. As of the signing of the CARES Act on March 27, 2020, and the signing of the COVID-19 Bankruptcy Relief Extension Act on March 27, 2021. With both Acts, there were changes to the definition of the word “income” in the Bankruptcy Code for both Chapter 7 and 13 debtors, which excluded COVID-19 federal payments for the purposes of filing bankruptcy. 

Additionally, there were additional protections given to individuals in an ongoing Chapter 13 plan. Thus, if there are bankruptcy issues related to COVID-19, it is important to seek a local attorney knowledgeable in bankruptcy to inform you of any further relief that may be present under the two Acts. 

Is Filing for Bankruptcy Right for My Small Business?

For a business, the purpose of a bankruptcy is to save your business from closing, wipe out any of the owner's personal liability to the debts owed, or to sell the business. Filing a small business bankruptcy or an owner's personal bankruptcy can achieve these goals.

Will Bankruptcy Wipe Out My Debt Liability?

This depends on how your small business entity was created and who owns the business. Generally, if you are the sole owner of the small business, then you are personally liable for the debts where the small business does not have enough money to cover the debts. If a few individuals own the small business and you are the general partner, again, you may be liable. But if you are only a limited partner, you may not necessary be liable unless special circumstance arise.

What if My Business is a Corporation or LLC?

Many people file for a Chapter 7 bankruptcy when they are a corporation or LLC because it is a valuable option for them. When a small business owner runs a business as a LLC or corporation, the LLC or corporation becomes a separate entity. This means that the small business owner would not be personally liable for the debts and liabilities of the corporation. As a result, Chapter 7 liquidation would only sell off the corporation's assets and not the small owner's personal assets.

Can I Keep My Business After I File for Bankruptcy?

This depends on what type of bankruptcy you plan to file as a small business owner. If you want to file for bankruptcy, but keep your business, a Chapter 7 bankruptcy would not be a good option. In most cases, a small business owner will not be able to operate their business after they file for a Chapter 7 bankruptcy.

When you file a Chapter 7 bankruptcy, a bankruptcy trustee is appointed to liquidate or sell all of your non-exempt assets that have value, which would then be used to pay the debt owed to the creditors. If you are a sole proprietor, the assets that will be sold are all your business assets. One of those assets will include your business property.

What Happens to Business Assets in a Chapter 7 Bankruptcy?

If you run your business as a sole proprietor, the business assets legally belong to you. You must list all your personal assets and debts on your bankruptcy papers. Since you personally own the business assets, you must also list these assets on the bankruptcy papers you file. In the liquidation process, these debts will be sold to repay the debts you owe to the creditors. Any business assets of value that you cannot claim as exempt will be sold to repay these debts.

Can Small Business Tax Debt Be Discharged in a Chapter 7 Bankruptcy?

If you are a small proprietor, your business tax will not be discharged in a Chapter 7 bankruptcy. As a small business owner, you are personally liable for all of your business debt, including your business tax debt. Even though a Chapter 7 bankruptcy discharges most business debt, taxes will not be discharged.
In some cases, taxes can be discharged in bankruptcy. Tax debt can be discharged in bankruptcy if:

  • The tax debt is more than three years old or
  • The tax debt was assessed at least 240 days before the bankruptcy filing, and
  • The tax return was filed at least two years before the bankruptcy, and
  • The taxpayer has not committed tax fraud or tax evasion

In other words, a tax debt must be more than three years old or assessed at least 240 days before filing for bankruptcy; you only need one or the other, but not both. However, the remaining two requirements must still be met. 

Do I Need to Hire a Lawyer for Help with Business Bankruptcy Issues? 

If you own a business and are considering filing for bankruptcy, you should consult with an experienced and local bankruptcy lawyer before taking any action. Bankruptcy, while a process meant to bring relief, is complex and can have lasting implications such as remaining on your credit report for up to ten years. Additionally, each state has its own laws regarding bankruptcy and which chapter you can apply for as a business owner. 

Further, COVID-19 and the signing of the two federal relief Acts, added additional protections and new interpretations of the Bankruptcy Code. Thus, an experienced and local attorney will be best suited to helping you understand your state's specific laws and how they will affect your legal options. Your attorney can guide you throughout the entirety of the bankruptcy process, as well as advise you in terms of which chapter to file for. Finally, an attorney can also represent you in court, as needed.

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