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What Is Business Bankruptcy?

accounting sheets of business next to calculator

A harsh reality for most new small businesses is that they do not survive and are often faced with whether they should file some form of business bankruptcy. Between 2005 and 2017, only about one-fifth of new small businesses survived more than one year and only about half of those that survived continued for up to five years. With an economy gripped by the COVID-19 pandemic, it is unsurprising that many small businesses are considering bankruptcy.

Business bankruptcies go through federal bankruptcy court usually in the form of either liquidations or reorganizations. Depending on the entity’s structure, the entity may file for Chapter 7, Chapter 11, or Chapter 13 bankruptcy. Sole proprietorships operate as legal extensions of the owner, so the owner is responsible for all assets and liabilities of the firm. Corporations and partnerships are business entities separate from their owners. They can file for bankruptcy protection under Chapter 7 or Chapter 11.

Chapter 13 bankruptcy is a repayment plan typically reserved for individuals but since sole proprietorships are extensions of the owners, sole proprietorships may also use Chapter 13. The business will essentially just file a repayment plan with the bankruptcy court detailing how you will repay your debts. Chapter 13 allows the sole proprietor to stay in business and repay its debts as it continues to operate.

Chapter 7 business bankruptcy, also known as liquidation, is often the best choice when the business has no viable future. Usually when the debts of the business are so overwhelming that restructuring or setting up a repayment plan is not feasible, Chapter 7 bankruptcy will be used. Before a Chapter 7 bankruptcy is approved, the applicant must pass a “means test”. Essentially, if the applicant’s income is over a certain level then their application will not be approved. However, if the application is approved, the business is dissolved, and a trustee will be appointed by the bankruptcy court to take possession of the assets of the business and distribute them among the creditors. After the assets are distributed and the trustee is paid, a sole proprietor receives a “discharge” at the end of the case but partnerships or and corporations do not receive a discharge.

Chapter 11 bankruptcy, also known as reorganization, is a better choice for businesses that see a likelihood that their business will improve in the future. Chapter 11 business bankruptcy is typically used for partnerships and corporations but may also be used for sole proprietorships whose income levels are too high to qualify for Chapter 13 bankruptcy. Chapter 11 bankruptcy is a plan where a company reorganizes and continues to do business under a court-appointed trustee. The company will file a detailed plan of reorganization which will entail how it will pay out its creditors. The business may terminate contracts and leases, recover assets, and repay a portion of its debts while discharging others in effort to bring the business back into the green. The plan will be presented to the creditors for a vote and upon the creditor’s approval of the plan, the court will then determine whether the plan is fair and equitable. If so, the plan will be approved by court. Due to the complexity of Chapter 11 business bankruptcies, it often takes over a year for a court to confirm a plan.

Whether you are considering bankruptcy for your business or some other avenue, it can be exceedingly difficult to determine what the best path is forward. Regardless of your business’s organization or future goals, the lawyers at Cantafio & Song PLLC can advise you of how to best structure your business’s next steps.