How can a business enter bankruptcy?
Business bankruptcy focuses on liquidating available assets to pay off creditors, or to produce a plan that will ensure payment. Business bankruptcy is usually a complicated, lengthy process, especially for larger corporations. Most business owners would prefer to keep their company operating during bankruptcy procedures, and this complicates things. It’s difficult to keep a company running while resolving unmanageable debts, which is why business owners should seek guidance from a knowledgeable bankruptcy lawyer. Doing so will prepare the business owner for bankruptcy proceedings.
Businesses may file for Chapter 7, Chapter 11 or, in limited instances, Chapter 13 bankruptcy. The best choice for a particular company depends on whether the company’s owners want to keep the business in operation and how the business was formed. Sole proprietors, for example, have additional options in handling their bankruptcy case.
What does filing for business bankruptcy look like?
Bankruptcy is an involved process, and it will look slightly different for every company. A sole proprietor can file for Chapter 7, 11 or 13 bankruptcy, while larger businesses, including partnerships, limited liability companies (LLCs) and corporations, are limited to either Chapter 7 or 11 bankruptcy. This is what each version looks like for a company:
- Chapter 7 – Chapter 7 is also termed “liquidation,” and is usually reserved for companies that have little chance of remaining in business. Essentially, Chapter 7 marks the end of a business venture, unless the business is a sole proprietorship. This is because Chapter 7, when used by a sole proprietor, can wipe out both personal and business debts. Subsequently, some assets can be exempted from liquidation during individual Chapter 7, the sole proprietor can protect their business assets with these exemptions.For most companies, though, Chapter 7 is a quick and orderly method of shutting down operations, and the business, for good. Unlike with individual Chapter 7, when a business undergoes Chapter 7, their debts are not discharged. Instead, everything the business owns is sold off to pay creditors. This includes all cash and assets. Once everything owned by the company is liquidated and used to pay creditors as much as possible, the company is typically dissolved. This is almost always the case when an LLC or corporation files for Chapter 7, because the company’s owners are not legally liable for the company’s debts.
A bankruptcy trustee will be assigned to the company’s bankruptcy case. The trustee is responsible for discovering and selling off any of the company’s assets, and then paying back creditors.
- Chapter 13 – Chapter 13 bankruptcy is only available to sole proprietors, because only individuals can file for it. Chapter 13 bankruptcy allows sole proprietors to keep all of their assets, both personal and business-related. Nothing is liquidated in Chapter 13, but only a portion of debts are discharged. Most secured debts (mortgage, vehicle loan, etc.) must be paid back, as well as a fraction of unsecured debts (credit cards, for example). Chapter 13 is also a much more drawn out process, compared to Chapter 7. Where Chapter 7 takes only a few months to complete, Chapter 13 normally requires three to five years, from start to finish.In the end, people who file for Chapter 13 will pay less back than they would otherwise, but repayment is expected. The repayment plan is developed by the business owner and it must satisfy creditors and the court in its feasibility and fairness. If the repayment plan is accepted, it is put in place immediately and the debtor is expected to hold to it, or they risk having their assets liquidated instead.
An important note: Chapter 13 only discharges the business owner’s personal liability regarding their business debts. The business must still pay back its outstanding debts in full.
- Chapter 11 – Chapter 11 is the most complicated form of bankruptcy, and, with very few exceptions, only concerns businesses. Chapter 11 is also the most expensive version of bankruptcy, so it should only be considered if the company’s owners want to keep the business operating.During Chapter 11, the business may operate as usual and is run by the debtor (termed the “debtor in possession” for Chapter 11 purposes). There are a few exceptions, such as instances where fraud, gross incompetence or deception are present. In this instance, a trustee is appointed to manage the company’s operations.
Much like Chapter 13, when a company files for Chapter 11, it is required to provide a “reorganization” plan, which details how the company will pay back its creditors. This almost always includes some downsizing, so the company will specify what assets will be liquidated and what revenues generated to satisfy creditors. In most cases, a company has four months to develop this plan exclusively. If, at the end of this period, the debtor in possession can provide a good faith and feasible plan to reorganize the company’s operations, the creditors vote to accept the plan or not. If the plan is not accepted after four months, creditors can submit their own plans to be voted on. The overwhelming majority of the time, though, the accepted plan is provided by the debtor in possession. Rarely, the reorganization plan will set out terms to pay back all creditors, but usually, one or more creditors will only receive a portion of what they are owed.
Although the company can continue doing business during Chapter 11, it loses much of its power to make decisions, and the court gets the final say in many cases. For example, the court must approve any sale of assets (except for inventory), any attempt to enter into or break a lease, any attempt to borrow following the end of the Chapter 11 case, any attempt to shut down or expand business operations and any attempt to modify or enter into contracts or agreements with other parties. The debtor in possession is limited by Chapter 11, but it is the only option to keeping a troubled business functioning.
All forms of bankruptcy should be guided by a legal professional experienced in the area, particularly when businesses enter into the process. Given all the moving parts involved, bringing on an experienced bankruptcy attorney is mandatory.