Types of Small Business Bankruptcy

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Key Takeaways







The most common types of bankruptcy include Chapter 7, 11, and 13. 




Chapter 11 bankruptcy is suited for large corporations and LLCs that act as separate entities from their owners. 




Chapter 7 bankruptcy is called "liquidation" because the court orders businesses to sell assets to repay creditors. 




Small business bankruptcy is when a company cannot pay its debts and must find a way to settle its obligations. 












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Small business bankruptcy is a  legal process  that a small business may undergo when it  can’t pay its debts.  Further, repaying debts involves the business or its creditors  filing a petition with the bankruptcy court.  Then, the company has  two options:  The business can reorganize its debts and create a payment plan to pay them off.  The company can liquidate its assets to pay off its debts.  Bankruptcy is a step most business owners don’t take lightly, but it can  provide a lifeline  for businesses  struggling with overwhelming debt. There are a few  types of bankruptcies  to consider, including the following:  Chapter 7  Chapter 11 Chapter 13  Each of the bankruptcy filings differs (which I’ll cover later).  Therefore, it’s helpful to understand the bankruptcy code, so you  choose what’s best  for your organizational structure and situation. 





















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Pro Tip #1: Consult with a bankruptcy attorney to discover the best way to undergo the filing process and avoid too much financial distress. 
- AJ Silber









How Does the Bankruptcy Process Work?



The bankruptcy process  starts when a small business owner recognizes they cannot repay their company’s outstanding debts  or obligations.  After that, the legal process officially begins with a  debtor filing a bankruptcy petition.  Sometimes, the petition is completed on behalf of creditors, but that isn’t common.  A court-appointed trustee  measures  and  evaluates  the business assets.  The business will  use the money  from selling its assets to  repay secured and unsecured debts.  Filing for bankruptcy serves as a  fresh start  for business owners.  Additionally, some forms of bankruptcy  allow businesses to remain open  while repaying their debt. 















Types of Small Business Bankruptcies 



There are  three main types of bankruptcies  small businesses must consider.  Depending on your company’s organizational structure, monthly earnings, and bankruptcy attorney, the type of bankruptcy that’s best for you differs.  Let’s look at how Chapter 7, 11, and 13 bankruptcy filings differ and who they’re best suited for! Chapter 7 Chapter 7 is the  most common type  of bankruptcy.  Another name for Chapter 7 is  liquidation bankruptcy.  Typically, Chapter 7 filings take between  four  and  six months.  Unlike other forms of bankruptcy, federal bankruptcy laws demand business owners still pay the following types of debt:  Alimony  Child support  Select taxes  Student debt (in most cases)  Liens on property  There are advantages and disadvantages of Chapter 7 bankruptcy (which I’ll cover later).  What is It? As previously mentioned, Chapter 7 bankruptcy is often called ‘liquidation bankruptcy.’ If you declare bankruptcy under Chapter 7, this option typically  results in your business closing  during or after the process.  Therefore, businesses that  cannot create a repayment plan  for their debts or  have no assets left  to sell will declare this type of bankruptcy.  In these cases, bankruptcy laws  require a trustee to sell or liquidate the company’s remaining assets  in order to repay secured and unsecured debt.  Once the trustee sells everything, they distribute the money among creditors.  If there is still debt remaining, the debts are discharged, meaning  the debtor is no longer legally required to pay them.  It’s important to note that although Chapter 7 can wipe out your debt, it  does not erase the credit history  of the bankruptcy itself, which can remain on your credit report for up to  ten years. Pros and Cons of Chapter 7 Bankruptcy There are certain  advantages  and  disadvantages  to Chapter 7 bankruptcy.  For example, some of the pros associated with this type of bankruptcy case include:  It relieves business owners from debt collectors  Most Chapter 7 filers have success in getting their debts discharged  You get to keep your property  Still, there are a few cons to know about with Chapter 7 filings, which include:  You can’t file for Chapter 7 if your income is over a certain threshold  The owners’ credit will take a hit  You can lose certain types of property and nonexempt assets  Chapter 11 Chapter 11 bankruptcy is a  type of reorganization bankruptcy.  Typically,  large corporations  and  LLCs  (or any business legal structure that operates separately from its owners) utilize Chapter 11.  Most small businesses don’t opt for Chapter 11 bankruptcy because it is:  Complex  Time-consuming  Expensive  When a company has too much debt but  still has disposable income and wants to stay in business , Chapter 11 is an excellent option.  What is It? Chapter 11 bankruptcy  allows the debtor to propose a plan of reorganization  to keep its business alive and pay creditors over time.  The process begins with  filing a petition in bankruptcy court , which should include the following things:   Detailed financial information about the company’s assets A description of the company’s liabilities Business Affairs If the court approves the bankruptcy plan, the business can decrease its debts by repaying some obligations and discharging others.  Also, the  debtor can terminate burdensome contracts and leases , recover assets, and rescale operations to become profitable again.  However, during this process, the debtor remains in control of its business operations as a debtor in possession, but it is  subject to the oversight and jurisdiction of the court. Pros and Cons of Chapter 11 Bankruptcy Like other forms of bankruptcy, Chapter 11 has its pros and cons.  For instance, some of the advantages include: Room for Recovery:  Chapter 11 bankruptcy allows businesses to restructure their debts and continue operating, which can be a company lifesaver. Control of Assets:  Debtors retain control of their business operations despite legal proceedings.  On the flip side, the disadvantages may include: Complex and Expensive:  The filing process for Chapter 11 bankruptcy is notoriously difficult and costly. Legal and administrative fees can pile up, which some small businesses cannot afford. Public Scrutiny:  During the process, the business’s financial information becomes a public record, impacting the company’s reputation and relationships with clients and suppliers. Chapter 13 Chapter 13 is  for companies with reliable disposable income  who wish to keep their business but must repay their loans.  Per the bankruptcy code,  businesses must follow a repayment plan  that lasts between  three  to  five years. If the business completes the repayment plan successfully, the following types of unsecured debt are discharged:  Personal loans  Medical bills  Credit card payments  This type of bankruptcy is  only available for small businesses that operate under sole proprietorships.  What is It? Chapter 13 bankruptcy, also known as a  wage earner’s plan , allows individuals and businesses with regular income to  develop a plan to repay all or part of their debts.  Under this bankruptcy petition,  debtors propose a repayment plan to pay creditors  over three to five years. If the debtor’s current monthly income is  less  than the applicable state median,  the plan will be for three years  unless the court approves a more extended period.  Further, if the debtor’s current monthly income  exceeds  the applicable state median,  the plan generally must be for five years.  The  law forbids creditors from starting or continuing collection efforts  during this period. Pros and Cons of Chapter 13 Bankruptcy Of course, there are advantages and disadvantages to filing for Chapter 13 bankruptcy.  For instance, some of the pros associated with this type of bankruptcy include the following:  Control Over Assets:  Chapter 13 bankruptcy allows business owners to retain control over their assets while paying their debts. Flexible Repayment Plan:  The repayment plans are based on the debtor’s income, allowing owners to repay their debts in manageable installments. Potential Discharge of Remaining Debts:  Some unsecured debts may be discharged after completing repayments. Regarding the disadvantages associated with this type of bankruptcy, one must consider the following things:  Long Commitment:  The repayment plans under Chapter 13 can last up to five years, requiring a long-term financial commitment. Impact on Credit:  Filing for Chapter 13 bankruptcy will remain on the debtor’s credit report for seven years. Limitations on Secured Debts:  There are limits on the amounts of secured and unsecured debt a debtor can have.  Consider these pros and cons carefully before proceeding with Chapter 13 bankruptcy! 















Other Types of Bankruptcies



The bankruptcy code includes other types of bankruptcies, including:  Chapter 12 Chapter 15 Chapter 9  Let’s see how these bankruptcies function and who they’re best suited for! Chapter 12: For Family Farmers and Fishermen Chapter 12 bankruptcy is specifically designed for  family farmers  and  fisheries .  Under this bankruptcy protection, farms and fisheries can  reorganize their business while maintaining ownership.  Typically, Chapter 12 cases involve a bankruptcy trustee who helps the company devise a  repayment schedule  to  settle their debts.  Individually   and   corporation-ran farms and fisheries qualify  for this type of bankruptcy. Chapter 15: For Foreign Creditors Chapter 15 bankruptcies  involve more than one country.  In 2005, the federal government created Chapter 15 bankruptcies to offer  cooperation between United States courts and foreign debtors.  Chapter 15 filings intend to  reduce the risk  for creditors and stakeholders of foreign companies.  Put simply,  Chapter 15 aims to make a bankruptcy proceeding go as smoothly as possible  when it involves the United States and a foreign country.  Chapter 9: For Municipalities Lastly, there’s Chapter 9 bankruptcy.  The government created Chapter 9 bankruptcy for  financially distressed municipalities.  Further, Chapter 9 protects certain entities from creditors by  developing a resolution for outstanding debts  between creditors and the municipality.  Some  examples of Chapter 9 entities  include the following governmental entities:  Cities/towns  Counties  Townships  Municipal utilities  Taxing districts  School districts  Chapter 9 filings are slightly different from other bankruptcy types.  For instance, when school districts have outstanding debts, the  creditor cannot force the municipality to liquidate its assets. 

















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Pro Tip #2: Consider the long-term impacts of the bankruptcy filing you choose, as some can significantly impact your credit score and ability to receive loans. 
- AJ Silber









How to Choose Which Bankruptcy Option is Right for You?



The best way to resolve your company’s secured or unsecured debt is to  consult a bankruptcy attorney.  Still, understanding the basics of bankruptcy courts helps.  For instance, Chapter 13 is  only available for sole proprietorships  and  some  partnerships.  LLCs and corporations cannot apply for Chapter 13 bankruptcy.  Further, Chapter 11 is  best for larger corporations  because the process is more complex.  Chapter 7 bankruptcy is suitable for any type of business.  However, Chapter 7 will most likely result in the closure of the business in question. 















Closing Thoughts on the Types of Business Bankruptcy Filings



Whether your business is struggling with finances or you’re an individual in need of bankruptcy protection, understanding the different types of bankruptcy and debt relief is essential. There are numerous bankruptcy types, but the options depend on your unique situation.  Some types of bankruptcy forgive your medical bills or child support payments!  Still, it’s always smart to consult with an attorney when you owe money to several creditors.




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