What is Chapter 7 Bankruptcy for Small Businesses?

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.elementor-widget-text-editor.elementor-drop-cap-view-stacked .elementor-drop-cap{background-color:#69727d;color:#fff}.elementor-widget-text-editor.elementor-drop-cap-view-framed .elementor-drop-cap{color:#69727d;border:3px solid;background-color:transparent}.elementor-widget-text-editor:not(.elementor-drop-cap-view-default) .elementor-drop-cap{margin-top:8px}.elementor-widget-text-editor:not(.elementor-drop-cap-view-default) .elementor-drop-cap-letter{width:1em;height:1em}.elementor-widget-text-editor .elementor-drop-cap{float:left;text-align:center;line-height:1;font-size:50px}.elementor-widget-text-editor .elementor-drop-cap-letter{display:inline-block} Is your small business  facing an overwhelming amount of debt ? You’re trying your best, but there doesn’t seem to be a way out of this situation! Don’t worry if this sounds like you; several small businesses have faced a similar situation.  Hi! My name is AJ! I started Small Business Bonfire after selling my company for a  multiple seven-figure exit . Now, I aim to help entrepreneurs everywhere! Being a business owner, I understand how challenging it is to keep a business running . Understanding Chapter 7 bankruptcy is crucial for small businesses, as it can aid in resolving financial issues. What do I mean by Chapter 7?  Keep reading  to discover if filing for this type of bankruptcy is best for your situation!









Key Takeaways







Chapter 7 bankruptcy provides a lifeline for small businesses with debt by liquidating assets to pay off creditors.




Filing for Chapter 7 bankruptcy can help protect personal assets if the small business is a sole proprietorship.




The Chapter 7 bankruptcy process can result in the dissolution of the company.




Alternatives for a Chapter 7 filing include Chapter 11 and 13 bankruptcy. 












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Chapter 7 bankruptcy is a  liquidation bankruptcy.  Therefore, a trustee in a business bankruptcy Chapter 7 case  sells all its property  and divides the proceeds to creditors.  Typically, after a Chapter 7 bankruptcy process,  the business closes.  Some companies even shut down  during  the process.  Chapter 7 is the  quickest  and  most cost-effective  compared to other business bankruptcy processes! For instance,  Chapter 11 bankruptcy filings are time-consuming and complex , especially compared to Chapter 7.  Still,  each bankruptcy filing has its pros and cons , so it’s crucial to understand what will happen to your business, its assets, and your personal assets and liabilities after the process is complete. 





















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Pro Tip #1: Consult a bankruptcy attorney to ensure everything goes smoothly regardless of the type of bankruptcy filing your business demands. 
- AJ Silber









How Chapter 7 Works for Businesses



In the case of Chapter 7 bankruptcy,  a business declares that it’s unable to pay its debts  and opts for liquidation.  When a company opts for liquidation, it involves a  bankruptcy trustee  (the court appoints).  The bankruptcy trustee is  responsible for selling off the business assets.  Then, the company uses the funds it generates from the liquidation sale to  pay off the creditors and business debts. A bankruptcy case is a well-defined process involving the following things: Meticulous paperwork Compliance with the legal norms Settling business debts  Post the liquidation, the business (usually) ceases to exist. Therefore, filing for bankruptcy is a serious decision  you must make carefully.















Chapter 7 Bankruptcy by Organizational Structure 



How does a business bankruptcy differ by organizational structure?  For instance, the bankruptcy process is different for each of the following legal structures:  Sole proprietor  Partnership  LLC  Corporation  Let’s look at these entities and how they handle business debt during a bankruptcy.  Sole Proprietor Files for Bankruptcy Service-oriented sole proprietors can  actually benefit from Chapter 7 bankruptcy ; here’s how! How Chapter 7 Works for Sole Proprietor  A sole proprietorship is  owned and operated by one person.  In this case, the individual and their business are considered as  one entity  in terms of legal liability.  When a sole proprietor files for bankruptcy under Chapter 7, it’s the  individual  who goes through the process  rather than the business itself.  The  trustee will still sell off any assets  that belong to the sole proprietorship (such as equipment or inventory).  Then, the owner uses the proceeds to pay off any business debts. If the business’s assets don’t cover the debt the owner owes to creditors, the bank relies on  personal liability  to cover the charges.  Advantages of Chapter 7 for Sole P roprietors   Many people think that when a business fails and files for bankruptcy,  nothing good  can come from it.  However,  that’s far from the truth!  Chapter 7 can be beneficial in some circumstances.  For example,  some advantages of Chapter 7 business bankruptcy  for sole proprietors include the following:  Owners can clear personal debts  Under some personal obligations, you don’t need to meet the income requirements for Chapter 7  Service-oriented businesses can survive because the bankruptcy trustee can’t take your talents away (meaning you can start another business later)  Disadvantages of Chapter 7 for Sole P roprietors   Although there are some advantages,  there are some downsides to know about  with this type of bankruptcy. For instance, some cons of this type of bankruptcy include the following:  It is a bad option if the business demands equipment or property to run their business  Not all states protect business property the same way or at the same amount The company (usually) ceases to exist once the process is over  Partnership Files for Bankruptcy Partnerships are another common business legal structure.  Let’s see  how a Chapter 7 bankruptcy case can impact partnerships! How Chapter 7 Works for Partnerships In a partnership business,  more than one person  owns and manages the operations.  The  partners are usually personally responsible for all debts  incurred by the business.  Therefore, when a partnership files for bankruptcy under Chapter 7,  each partner must file their own bankruptcy claim. Like sole proprietors, all of a business’s assets are liquidated and divided between creditors.  These cases involve a trustee responsible for selling the company’s assets and repaying all debts.  Advantages of Chapter 7 for Partnerships  A couple of upsides of filing for business bankruptcy include the following:  Compared to other bankruptcies, it’s a simple process  The process is orderly You can use assets to sell the business’s debts The debts are split between two or more people instead of one person taking on all the burden  Disadvantages of Chapter 7 for Partnerships Here are the disadvantages of Chapter 7 for partnerships:  It increases litigation risk It increases the likelihood of partnership disputes  Each partner’s personal assets are at risk  The most significant disadvantage of a Chapter 7 filing for partnerships is that it can  severely impact personal relationships  in the future.  Therefore, it’s helpful to  go into business with someone you trust.  Also,  discussing what happens  in the event of bankruptcy ensures no surprises! LLC or Corporation Files for Bankruptcy A corporation or LLC business bankruptcy differs from a personal bankruptcy because  the entity is separate from its owners.  How Chapter 7 Works for LLCs & Corporations Here’s how a Chapter 7 bankruptcy works for LLCs and corporations! The trustee  sells all  of the corporation or LLC’s  assets  and distributes the assets  based on priority rules.  Filling for Chapter 7 closes the business and doesn’t allow the entity to receive a debt exchange.  Therefore, a creditor can see payment under a personal guarantee! Advantages of Chapter 7 for LLCs & Corporations Some advantages of this type of business bankruptcy include the following:  Allows for a higher level of transparency (more accessible to prove the closure happened)  It might prevent a creditor from pursuing litigation  Many business owners don’t have to sell their personal assets themselves; a trustee does Disadvantages of Chapter 7 for LLCs & Corporations Some cons to this process include the following things:  Trustees may like the debtor’s assets for much less than what they’re worth  A trustee takes part of the proceeds from the sale Owners can’t negotiate their debt for an amount lower than what they owe

















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Pro Tip #2: In any bankruptcy, it's essential to understand which assets are exempt from liquidation.  
- AJ Silber









Personal Liability for Corporate or LLC Debts



Although LLCs and corporations are separate entities, the  owners can still be personally liable for certain business obligations.  Some situations that can cause personal liability include:  Trust fund taxes  Alter ego claims Fraud claims  Personal guarantees Trust Fund Taxes Trust fund taxes are  taxes withheld from an employee’s income.  Responsible parties like  officers  or  managing   members  are sometimes liable for these trust fund taxes.  Alter Ego Claims  According to bankruptcy law,  creditors can go after personal assets  if they can prove the corporation/LLC was  fake  or  an alter ego  of the shareholder.  This type of claim involves a lawsuit against the corporation that hides the shareholder’s private assets.  Fraud Claims  Typically, businesses use fraud to  hide money  from creditors.  Therefore, when creditors can prove fraud,  the individual must pay back all the money.  Additionally, the owner can  face criminal charges  for fraud claims.  Personal Guarantees  A personal guarantee is when an individual  agrees to pay off the business debt  by taking one of the following actions:  Cosigning a loan  Personally guaranteeing a loan Pledging personal assets as collateral  The most common personal guarantee is  putting valuable items up for collateral.  For instance, a business owner might put their speedboat or car up for collateral so the bank has something tangible to ensure debts are repaid. 

















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Pro Tip #3: Explore other debt management options before filing for bankruptcy. 
- AJ Silber









Chapter 7 Vs. Chapter 11 Bankruptcy 



Chapter 7 and Chapter 11  serve different purposes  and are chosen based on the individual situation of a business.  For instance, Chapter 7 is essentially a  liquidation bankruptcy.  Therefore, this type of business bankruptcy is  meant for companies with no viable future.  Further, Chapter 7 is a way to  turn assets   into  as much  money  as possible.  The owners then use the money to pay off the business debt.  On the other hand,  Chapter 11 is a reorganization bankruptcy.  Chapter 11 is for businesses that have  hit a tough spot  but still  have a chance of recovery.  Further, this type of bankruptcy allows the company to  restructure  its  debts  and  obligations .  Essentially, it  buys time for the business to bounce back  and become profitable again!















Chapter 7 Vs. Chapter 13 Bankruptcy



Another type of bankruptcy is  Chapter 13.  Again, Chapter 7 and Chapter 13 are two kinds of bankruptcy that serve different purposes and are suited to varying circumstances.  Chapter 7, as we’ve discussed, is essentially liquidation bankruptcy.  Chapter 7 bankruptcy suits businesses that see no feasible future  and wish to cease operations, liquidate their assets, and use the proceeds to repay creditors.  However,  Chapter 13  bankruptcy is a  repayment  or  reorganization  bankruptcy. The bankruptcy court  designed this type of bankruptcy  for individuals with regular income who can  repay a portion of their debts  through a repayment plan.  Unlike Chapter 7, which  wipes out business debts entirely  after assets are sold, Chapter 13 allows individuals to  restructure their debt  payments over a period of three to five years.  Further, the Chapter 13 structure  enables business owners to retain their property and assets  while they work on fulfilling their repayment responsibilities. As you can see,  Chapter 13 bankruptcy is more lenient  than Chapter 7, especially if the business owner still has regular income sources. 















Alternatives to Chapter 7 Bankruptcy



Although a Chapter 7 bankruptcy filing is the best option for some companies,  other small business owners need an alternative.  Fortunately, there are  two alternatives  to Chapter 7 you should consider! Let’s see when the business chapter should use Chapter 11 or 13 bankruptcy! Chapter 11 Bankruptcy for Small Businesses  Chapter 11 bankruptcy is a form of reorganization bankruptcy.  Typically, these types of bankruptcies are:  Expensive  Time-consuming  Complex Because of these factors,  small businesses usually don’t file for bankruptcy under Chapter 11.  Instead, larger, more organized businesses file for this type of bankruptcy.  However, Chapter 11 is  beneficial for small businesses if they want to restructure  and  continue operating  when it’s a partnership.  Also, Chapter 11 is a great option for small businesses if they  owe a lot of money to secured or unsecured creditors.  In cases where companies owe lots of money, Chapter 11 is the only way to file for bankruptcy and stay in business.  How does Chapter 11 bankruptcy work?  Typically, these cases are for businesses that suddenly find themselves in a  tight financial situation  (due to the economy or downturns).  After a company files for bankruptcy under Chapter 11, an “automatic stay”  prevents (most) unsecured and secured creditors from pursuing their money.  For example, the automatic stay temporarily stops the following things:  Payment requests Evictions  Foreclosures  Collections trials  Bank levies, till taps, and property seizures Other collections processes  Then, the person who filed for bankruptcy must  create a payment plan  through a bankruptcy court.  These payment plans can include details like:  Modified interest  Different payment due dates  Erasure of debts  Consulting a  bankruptcy attorney is the best way  to determine whether this type of filing is best for your company and situation!  Chapter 13 Bankruptcy for Small Businesses  Another Chapter 7 bankruptcy alternative is a  Chapter 13 filing.  With a Chapter 13 filing, business owners can  keep their assets  while reorganizing and  paying off their remaining debt.  Typically, a Chapter 13 repayment plan lasts between  three  and  five years.  When your payment plan is complete, the  bankruptcy court discharges your remaining unsecured debts.  Further, this type of bankruptcy can also help you  protect your assets from repossession or foreclosure  by creditors.  In certain circumstances,  Chapter 13 is a better option than Chapter 7  for small businesses since it lets them restructure and keep their assets.  However, it’s not ideal for every company.  For instance,  sole proprietorships can’t file for bankruptcy under Chapter 13.  Also, business filings under Chapter 13 have  lower debt limits  than those filed for personal finances. Similar to a Chapter 11 filing,  consulting with a bankruptcy attorney is the best  way to determine if this type of bankruptcy is right for your small business.















Final Thoughts on Chapter 7 Bankruptcy for Small Businesses 



Chapter 7 bankruptcy can be a viable path  for small businesses that have reached an insurmountable financial hurdle.  However, it’s critical to remember that this option ultimately means  closing your business.  For those who  see the potential for recovery , exploring alternatives such as  Chapter 11 and Chapter 13  bankruptcies might be more beneficial! What additional questions do you have about Chapter 7 bankruptcy?  Let us know in the comments section  below!  And if you’re pursuing a Chapter 7 bankruptcy, good luck selling assets and settling debts!




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