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Home/ Business Bankruptcy

Small businesses and bankruptcy relief

Your business is in trouble: how do you determine if bankruptcy is necessary or helpful for your situation?

First, is the business a corporation, a partnership, or a proprietorship?

  • Corporations, limited liability companies and partnerships are legal entities separate from their shareholders or partners.  They can file Chapter 7 or Chapter 11  bankruptcy in their own right.

bombshell    Bombshell for partnerships in Chapter 7

  • Proprietorships are just an extension of the owner:  they can't file bankruptcy alone: the proprietor must file bankruptcy, since the assets and the liabilities of the business are really just one form of assets of the proprietor.  The individual owner may file Chapter 7, Chapter 11 or Chapter 13  (if the debt limits are met). See  Chapter 13 eligibility standards.

Should the business be reorganized or liquidated?

To answer this question, you have to know what has caused the problems the business now faces and what are the prospects for change:

  • Reorganization can't create a market; increase gross revenue, or make up for a poor fit between the skills available and the skills required to run the business. 
  • Reorganization could free up cash from servicing the old debt to permit current operations;  permit rejection of leases or contracts that are no longer advantageous (an expensive facility lease or improvident equipment purchase); or prevent the loss of vital assets or cash to creditor collection actions.

In between Chapter 7 liquidation and reorganization, a  liquidating Chapter 13 or Chapter 11 could provide a breathing space for the owners to sell the business  as a going concern or or its assets in something other than a fire sale.  

The resulting proceeds could pay taxes or unpaid salaries; sale of the business could provide ongoing jobs for the work force under new ownership.  The bankruptcy could then be converted to Chapter 7 or dismissed if bankruptcy protection is no longer needed.  The court will probably condition dismissal of the case on payment to creditors of the sale proceeds. 

bombshell.gif (1081 bytes)   Possible pitfalls for management 

Does management have the resources and desire to engage in the reorganization process?

Bankruptcy reorganization in Chapter 11 requires significant time on the part of the owners and managers to comply with the requirements of the bankruptcy system, interface with counsel, and negotiate with creditors.  It is usually expensive as well.

The "bankruptcy bargain" is that, in exchange for the protection of the automatic stay and other bankruptcy protections, the debtor provides full disclosure of its financial condition to creditors and the court, both at the beginning of the case and on a monthly basis thereafter,  and operates as a fiduciary for its creditors while the bankruptcy is ongoing.  

A reorganization can drain an already stressed organization of management's time to participate in bankruptcy proceedings and money since the legal expenses are significant.  

Most reorganizations fail, usually for lack of a real plan to solve the problems.

Is the business one that the owners could start up again after a liquidation of the current business?

Businesses that require little capital, have few assets, or are really just extensions of the owner's skills and personality are ones that it may not pay to reorganize.  The owners may be better off liquidating the business, in or out of bankruptcy, and starting over in a fresh entity.  

This can be a complex issue and requires good professional advice to do correctly.  Thoughts on finding a lawyer.   

When Chapter 7 is best

A Chapter 7, whether for the individual or a corporation, may be the best choice when 

  • the business has no future, 
  • it has no substantial assets or qualities that cannot be reproduced after bankruptcy,  or 
  • the debts are so overwhelming that restructuring them is not feasible.

Individuals can get a discharge of the dischargeable debts and a chance to start over. 

Corporations don't get discharges, so a corporation won't get a fresh start in a Chapter 7, the way an individual does. Nonetheless, a Chapter 7 can provide an orderly liquidation under the direction of the trustee and at no expense to the shareholders.  Creditors are assured that they will be paid to the extent of the assets available and the priority of their claim.  Former management is assured that the assets that are available go (after the expenses of the Chapter 7) to pay taxes for which the individuals may be liable. 

blueedgedbulltet.gif (1080 bytes)  More on the liability of "responsible individuals" for the corporation's taxes.

  Planning for Chapter 7

  When to file a bankruptcy for a corporation

  Liquidate in bankruptcy or on your own

                                                                 Legal issues and bankruptcy questions are frequently complex and individual.  The information contained here is intended to be educational only:  it is not intended to be legal advice nor does it create an attorney client relationship between the viewer and the firm.  You should consult with a bankruptcy attorney licensed to practice in your state for advice about your particular situation.  See Law on the Internet 


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