Although often perceived as a worst case scenario, bankruptcy can be an appropriate way for small businesses to recover from unmanageable debt by reorganization, reducing personal liability or liquidating business assets. Sometimes small businesses (or their owners) must turn to bankruptcy when cash flow slows or business expenses cannot be met.
There are three types of bankruptcy filings available. If you find yourself in the unfortunate position of considering bankruptcy, here are useful tips to help you determine a path toward solvency that fits your specific business needs.
Identify Your Liabilities
Some business owners are personally liable for their businesses’ debts. For example, creditors can seize the personal assets of sole proprietors and general partners. If your business is structured as an LLC or corporation, however, your personal assets cannot be seized unless you are a co-signer or guarantor of the debt. How your business is set up will determine whether you are personally liable for company debt. This can help you decide what type of bankruptcy makes the most sense for your business.
Typically, if you received an SBA Loan or business credit on credit cards, you did personally guarantee the debt and so you are likely considering a personal bankruptcy, rather than a business bankruptcy.
Know Your Options
There are three types of bankruptcy filings to choose from: Chapter 7, Chapter 11 and Chapter 13.
Chapter 7 bankruptcies liquidate assets to pay off the debt, but will also terminate the business entity, or if a personal Chapter 7, will terminate all of the debt. If you intend to keep your business going, consider a Chapter 11 or Chapter 13 filing, or a personal Chapter 7 bankruptcy.
Chapter 11 bankruptcies essentially reorganize the debt. Businesses (or their owners) are given a payment plan allowing them to repay debt over time, sometimes without additional penalties. Some remaining debts can even be discharged at the end of the repayment period. An LLC or corporation can file for a Chapter 11 while continuing to operate. Before considering a Chapter 11 bankruptcy, you likely would want to contact each of your individual creditors to determine if you can work out a direct repayment plan or renegotiation of the debt, usually at zero percent interest and a substantially reduced debt amount.
Under a Chapter 13 bankruptcy filing, assets are retained while business debts are restructured in order to pay them down over time. Again, some debts may be discharged if they are not paid in full at the end of the repayment period. Only individuals, such as sole proprietors, can file for Chapter 13 bankruptcies. Like with Chapter 11, if you are considering Chapter 13, negotiate with your lenders directly first.
One thing to note about negotiating debt with your lenders rather than using the bankruptcy process is that you could be liable to pay taxes on the amount of debt forgiven, as if the amount forgiven was income to you. When you file bankruptcy, debt forgiven is not taxed as income.
Deciding which bankruptcy option is right for your business can be difficult. You may need legal guidance during this critical time. If you want help navigating the bankruptcy process for your small business, contact us as your trusted legal advisor today. With the assistance of your Creative Business Lawyer®, you can learn about your options, get the help you need and make the best decision for you and your business.
This article is a service of A. J. Yolofsky, Creative Business Lawyer®. We offer a complete spectrum of legal services for businesses and can help you make the wisest choices on how to deal with your business throughout life and in the event of your death. We also offer a LIFT Start-Up Session™ or a LIFT Audit for an ongoing business, which includes a review of all the legal, financial, and tax systems you need for your business. Call us today to schedule.