Business Debt and Bankruptcy

Even the most well-managed businesses can fall on hard times. The COVID-19 pandemic and its economic impact caused financial strain on people and businesses. Many small business owners took on more debt to keep their operations afloat. As pandemic-era government relief expired, personal bankruptcy filings rose 16% in 2023. Business bankruptcy filings rose more than 40% in 2023 over 2022.

If you are facing significant business debt, you may consider filing for business bankruptcy. Bankruptcy doesn't always signal the end of your business. This section offers information for struggling businesses that are considering bankruptcy.

Businesses have many bankruptcy options. If you are unsure which type of bankruptcy is right for you, talk with a bankruptcy attorney.

Business Bankruptcy Basics

Bankruptcy is a legal process offering debt discharge or restructuring for businesses and people overwhelmed by debt. Bankruptcy can offer a fresh start by lifting the burden of heavy debt.

There are two types of bankruptcy: Liquidation and reorganization.

Liquidation bankruptcy, or Chapter 7, closes your business operations. A bankruptcy trustee oversees the sale of all non-exempt business assets. These proceeds get distributed to your creditors. Chapter 7 does not discharge your personal debts when filed for a business. If you used personal credit cards or took out personal loans to help your business, those debts remain your responsibility.

Reorganization bankruptcy is available under Chapter 11 and Chapter 13. Chapter 13 bankruptcy is primarily for individuals and some sole proprietors, while Chapter 11 is for businesses. Chapter 11 allows the business entity to remain open. The business undergoes restructuring and devises a repayment plan. Some business creditors may settle your debt for less than owed.

Once a business files for bankruptcy, an automatic stay is in place. This stay stops creditors from trying to collect payment and halts foreclosure actions and repossessions while the bankruptcy case moves through the court.

What Type of Business You Have Matters

How you set up your business can affect what type of bankruptcy you qualify for or which might be most appropriate.

You are personally liable for business debts if you have a sole proprietorship or a general partnership. Creditors can pursue your personal assets to meet business debts. Bankruptcy, in this instance, will likely affect your credit score.

Corporations and limited liability companies (LLCs) are not personally liable for business debt but are responsible for paying them.

Chapter 7 Liquidation

Consider Chapter 7 bankruptcy if there's no way of reaching profitability and you must close your business. To qualify, you must meet a means test. If your monthly income over the prior five years is not less than:

• 25% of your nonpriority unsecured debt, or
• $9,075, whichever is greater; or
• $15,150

In Chapter 7, an appointed U.S. trustee takes possession of the company's assets. The trustee arranges a meeting of creditors, called a "341 meeting." You will discuss the company's assets, liabilities, income, and expenses at the meeting. The trustee arranges for the sale of all assets, and the proceeds get distributed to the creditors. Unsecured debts typically get paid first, followed by secured debts and, lastly, any stockholders.

Chapter 7 is available to individuals and sole proprietors. Partnerships, LLCs, and corporations generally won't qualify but are eligible.

Chapter 11 Bankruptcy

Consider this type of bankruptcy if you want to stay in business and do not qualify for other related bankruptcy chapters.

In Chapter 11, your company becomes the "debtor in possession" with a right to keep its property. A U.S. trustee oversees your bankruptcy case. In cooperation with their seven largest unsecured creditors, the business debtor will develop a reorganization plan to provide for payment to creditors over a reasonable period. Any debts and liens not included are eligible for discharge when the court confirms your restructuring.

As a debtor in possession, you are responsible for adhering to the reorganization plan and filing tax returns and monthly operating reports to the court as required.

All businesses may file for Chapter 11 bankruptcy, and individuals may file if they exceed the debt limits of Chapter 13.

Subchapter 5 in Chapter 11, the Small Business Reorganization Act of 2019, is for small businesses that want to reorganize under Chapter 11. It simplifies the payment process for profitable but underwater small businesses affected by the COVID-19 pandemic. This provision for small business bankruptcies is set to expire in June 2024.

Chapter 13 Reorganization

Chapter 13 reorganization bankruptcy is for individuals and sole proprietorships. Sole proprietorships that want to stay in business can reorganize through a Chapter 13 bankruptcy. You must undergo credit counseling as part of your case.

While a trustee gets appointed, they do not take possession of the company's assets. Typically, Chapter 13 will reorganize business and personal debts, as sole proprietorships are personally liable for the business's debts. You may exempt certain property, such as your home, from the proceedings.

You and your creditors examine the business's position during a 341 meeting. You and your creditors examine the business's position during a 341 meeting. You must file a plan within 15 days of the bankruptcy petition. The plan must devote all your disposable income to payments under a three-to-five-year plan. Creditors do not vote on the plan. The court must confirm if the plan complies with the Bankruptcy Code. The rest is eligible for discharge when the debtor completes the plan payment. Creditors do not vote on the plan. The court must confirm if the plan complies with the Bankruptcy Code. The rest is eligible for discharge when the debtor completes the plan payment.

Chapter 12 Bankruptcy for Family Farms and Fisheries

Chapter 12 is also a reorganization bankruptcy specifically for family farmers and fishermen who want to create a plan to repay their debts. It must be a closely held family business that does not trade stock. You must be actively involved in the operation of the company.

Federal bankruptcy law streamlined the Chapter 12 process, making it faster and easier to file bankruptcy. You must undergo credit counseling and receive regular income from the farm or fishery.

Chapter 9 for Municipalities

Insolvent public entities have the option to file for Chapter 9 bankruptcy. This bankruptcy is like Chapter 13. But it addresses different issues municipalities, towns, villages, school districts, or other taxing districts face. Municipalities and public entities aren't forced to sell their assets. But they may choose to settle some of their debts.

Life After Bankruptcy

Bankruptcy is a daunting process, often done as a last resort. But it can also be a helpful tool. Relief from crushing debts should afford you a fresh start, whether you continue your business or not.

Restructuring bankruptcy can help businesses that struggled during the COVID-19 pandemic overcome the financial strain. The company can even become a stronger, more profitable one.

Questions About Business Debt and Bankruptcy? Contact a Bankruptcy Attorney

Bankruptcy is a complicated process. Deciding to file for bankruptcy and which type is appropriate for your business will raise many questions. A bankruptcy lawyer can guide you through the process. Contact a qualified bankruptcy attorney to discuss your options.