Bankruptcy can offer a struggling small business a way to stay afloat or close quickly. But not every business can file, or benefit from, each bankruptcy type. This article discusses the options available.
Unfortunately, many businesses don’t survive in the long run, with some data suggesting that only 30% of small businesses will survive 10 years. Many businesses that are unable to make it in the long run look for the options available to limit liability as they are shutting down, or looking to continue in some form or fashion. One option that’s out there for businesses when it isn’t looking like they will survive is bankruptcy. Bankruptcy is a federal court process a business can look into that may help eliminate or repay debt. So even a business declaring bankruptcy in Virginia would be subject to the general terms that apply across the board in bankruptcy court. Typically, business bankruptcies are described as liquidations or reorganizations. There’s more than one type of bankruptcy to consider.
There Are 3 Types of Bankruptcy.
There are three different types of bankruptcy that may be available to a business, depending on how it’s structured - meaning, is the business set up as a sole proprietorship, a partnership, and LLC or a corporation.
Chapter 13: Adjustment of Debts for Individuals With Regular Income.
Chapter 13 bankruptcy is a reorganization bankruptcy typically reserved for individuals. It can be, and is, used with sole proprietorships, since businesses structured this way are indistinguishable from their owners. Small businesses that are sole proprietors use this option as a way to reorganize as opposed to liquidate and completely shut down. The business (basically the individual in this case) would file a repayment plan with the court detailing how all debts and obligations would be repaid. The amount that must be repaid will depend on how much you earn, how much you owe and how much property you own. Since your personal assets are tied to, or inseparable from, your business assets in this situation, you can avoid some issues around the loss of a home, making this advantageous if you qualify for Chapter 13.
You’ll essentially get to keep some assets and only pay back a portion of the liabilities, keep running the business and re-organize your debts. One thing to keep in mind is that you likely won’t be able to protect all of your assets, anything that is a nonexempt asset, you’ll have to pay the value of as part of your repayment plan, which could get expensive.
Chapter 7: Liquidation.
Chapter 7 bankruptcy may be the best option for your business if it has no viable future. Commonly called liquidation, it’s when the business has so many debts that it is not feasible to restructure them and continue on. This option is on the table for sole proprietors, partnerships, LLC’s and corporations. It’s also commonly used when a business doesn’t have any substantial assets - think about an LLC or sole proprietorship where the entire business is basically built around the skills and abilities of a single person.
Before a Chapter 7 bankruptcy is approved you must meet the income requirements of a “means” test in order to qualify for a Chapter 7 bankruptcy. Basically, that means if your income is too high, you aren’t going to qualify and will probably need to look at Chapter 13 bankruptcy.
Under Chapter 7, the bankruptcy court will appoint a trustee to take possession of the business assets and then distribute them accordingly among the creditors of the company. If you’re a sole proprietor, Chapter 7 will allow you to wipe out both personal and business debts in a single bankruptcy case, which can provide some level of convenience.
Chapter 11: Business Reorganization.
Chapter 11 bankruptcy is a good place to start looking for a business that may have a chance to turn things around and continue operations. It’s typically used by businesses that are set up as formal business entities, but it’s also used by sole proprietors whose income levels are too high to qualify for Chapter 13 bankruptcy.
Under Chapter 11, a plan is developed where a business reorganizes and continues to operate under a court appointed trustee. The business files a plan of reorganization which details how it will handle all the creditors. Often there is some combination of terminating contracts or obligations, recovering assets that may be available and repaying some portion of the debts that are owed in order to work towards being a profitable business. Under the reorganization plan businesses are usually able to provide repayment of debts over time, which give a company more options to continue the business. Chapter 11 bankruptcy can be complicated and time consuming, so while it’s an option to consider, you’ll need to realistically assess your ability to keep the business going under a reorganization.
You’ll have to be generating regular revenues in order to qualify for Chapter 11, but it will allow management to remain in control and make decisions for the company.
How Does a Small Business Declare Bankruptcy?
The first step will be deciding which of the three types of bankruptcy you’re going to file for. There may be some criteria you don’t meet or restrictions that apply which will prevent you from pursuing some of them.
Once you’ve determined the option that works best for you, you’ll start your bankruptcy by filing an official bankruptcy petition in the jurisdiction where your business is located. Bankruptcy proceedings are regulated by the U.S. Bankruptcy Court, and there are 94 jurisdictions.
You’ll then need to complete all the necessary bankruptcy forms, there will probably be quite a bit of paperwork that goes along with the bankruptcy. Each type of bankruptcy has its own business forms that will vary depending on how you’re organized. If you’re going to reorganize, you will have to formally disclose your plan and explain to the court how it will work.
In reorganization you will then need to get your creditors to approve the plan, and have a confirmation hearing to discuss the plan. The court will either accept or reject your plan. If it’s accepted you’ll move forward, updating the court along the way that you’re complying. If you’re liquidating, a trustee will take possession of your assets, liquidate them and use the proceeds to pay back your creditors.
Small Business Reorganization Act of 2019
In August 2019 the Small Business Reorganization Act of 2019 (SBRA) was signed into law. This law added a new subchapter under the Chapter 11 bankruptcy, which seems to favor applicants of Chapter 11 in order to strike a balance between Chapter 7 and Chapter 11 bankruptcies for small business debtors.
The SBRA lowers the costs and streamlines the plan confirmation process which means small businesses should be better able to survive a bankruptcy and continue operations. All of this was part of an effort to combat what has long been considered the high costs and complexities of using Chapter 11 bankruptcy. These issues often made it too difficult for small businesses to take advantage of a reorganization, basically forcing many into a Chapter 7 liquidation. The SBRA streamlines confirmation of the reorganization process, relaxes the requirement to conform to a plan and all around lowers the costs and time associated with this option.
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