When Chapter 7 Is a Good Idea for a Business Bankruptcy

by Ragini Salampure
When Chapter 7 Is a Good Idea for a Business Bankruptcy

If you are a small business owner or a sole proprietor and are struggling, then filing for Chapter 7 may help give you a way to save service-related businesses or a way to close them. If you are a business filing for bankruptcy, there are some things to know about Chapter 7 bankruptcy. It’s rare for many types of businesses, such as partnerships, corporations, or LLCs, to file for Chapter 7 bankruptcy since it’s not usually beneficial.

In these cases, the business doesn’t receive a debt discharge and filing for bankruptcy can actually increase other liabilities and lawsuits. Instead, most people who have signed personal guarantees agreeing to pay for corporate or partnership business debt then choose to wipe out their own individual liability using Chapter 7 bankruptcy.

Who Is Accountable for Paying the Business Debt?

The answer to if Chapter 7 bankruptcy makes sense for you is if you are responsible for paying business debt. The answer will depend on the structure of the business and if you have signed a personal guarantee. This is an agreement that you pay the business debt yourself if the business doesn’t do so. If you sign this then you are liable for debt and the business structure won’t matter. If there is no personal guarantee signed, then it will depend on the business structure.

The Business Structure and Chapter 7 Bankruptcy

The business structure plays a big role in whether or not there are benefits to filing this type of bankruptcy.

Sole Proprietor

If you are the sole proprietor of your business, then you and the business are treated as one. You are then able to discharge qualified debt, both business and personal, by filing for Chapter 7 bankruptcy using your own name. If you have more business debt than personal debt, then you don’t need to worry about the income you make and you won’t need to pass the Chapter 7 means test. You are able to protect both business and personal assets using some bankruptcy exemptions. Using Chapter 7 for this type of bankruptcy means that it will be possible to wipe out the debt and still operate your business.

Most states will allow you to keep a certain amount of property so this works if you are service-based business, such as an accountant or personal trainer. Those who have a business with costly supplies, goods, or equipment, such as a store, may have a harder time keeping the business after filing for Chapter 7. The bankruptcy trustee to oversee the case should sell any nonexempt property, which may make it harder for you to continue the business. Sometimes the trustee may even attempt to sell the business entirely.

Partnership

When the partnership files for bankruptcy, there won’t be any discharge of business debt. Partners aren’t able to use exemptions to protect property. The trustee liquidates the business and sells the assets or the business itself to pay back creditors. All partners are personally responsible for the debt from the business and this can cause an issue if the partnership files for bankruptcy.

If the business assets aren’t sufficient to pay the creditors, then the creditors may go after each partner’s personal asset to pay for any outstanding debts. In the case of a partnership, it makes sense for each individual partner to file for Chapter 7 bankruptcy after the business closes. They should do so in their own names and not as the partnership. This will discharge both business and personal obligations. Many partnership agreements have a clause that if one of the partners files for bankruptcy, the business will dissolve.

Corporation

A corporation is similar to a partnership and while it can file Chapter 7 bankruptcy, it won’t discharge the debts. The only benefit of a corporation filing for Chapter 7 bankruptcy is that it places the burden of paying creditors and selling the assets on the bankruptcy trustee instead of the business owners. However, it is rare that the benefits outweigh the risks for this bankruptcy type. For example, a stockholder who has personally guaranteed or cosigned the corporate debt is still on the hook unless this person files for Chapter 7 bankruptcy using his or her own name.

Most corporations should sell the property at a higher price instead of the bankruptcy for sale prices and negotiate with creditors on debt. This leaves less financial burden for corporate debt. Filing for bankruptcy will give your creditors an easy way to claim that the officers didn’t follow corporate formalities. This is called piercing the corporate veil. This type of lawsuit will mean that shareholders are liable for the corporate debt.

LLC

A limited liability corporation works the same way a corporation does when it comes to debt liability and bankruptcy. You can liquidate the assets, but in order to wipe out business debt liability, you will need to file a personal bankruptcy. The same risks apply for an LLC as for corporations.

While Chapter 7 may not make sense for most businesses and is more designed for individuals, there can still be some help for a business that wants to file for bankruptcy. Chapter 11 bankruptcy may be able to help. Chapter 11 bankruptcy helps provide reorganization for corporations or partnerships.

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