If you’re thinking about filing bankruptcy for your small business, you’ll have plenty of questions about what kind of bankruptcy you’re eligible for and what might make the most sense for your business. This is a big decision to make, with lots of considerations. To help, here are answers to some pressing questions on this fraught subject.
Key Points
• Small business bankruptcy options include Chapters 7, 11, 12, and 13, each with specific eligibility and implications.
• Chapter 7 involves liquidation, allowing sole proprietors to address personal and business debts.
• Chapter 11 allows reorganization, suitable for LLCs, corporations, and partnerships to restructure finances.
• Bankruptcy can impact personal credit, especially for sole proprietors, affecting credit scores significantly.
• Business structure determines liability for debts; sole proprietors are liable, while LLCs and corporations generally protect personal assets.
What Are the Different Types of Bankruptcy for Business Owners?
The types of bankruptcy that apply are Chapters 7, 11, 12, and 13. There is a Chapter 9 bankruptcy, but that applies only to municipalities: cities, counties, school districts, and so forth. There is also a Chapter 15 bankruptcy, but that’s designed to facilitate the legal processes between courts in the U.S. and in other countries when bankruptcy proceedings filed in foreign countries involve U.S. financial interests.
You may also hear the term insolvency used when talking about these situations. This means a person is unable to pay debts due to lack of funds but may not necessarily be going bankrupt.
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Who Can File Chapter 7 Bankruptcy?
Here’s how to understand bankruptcy of this type. This Chapter of the Bankruptcy Code provides for “liquidation.” When you file for Chapter 7 bankruptcy, your assets will be sold (“liquidated”), and the money used to pay your creditors.
Individual people can file for Chapter 7 and so can businesses. Small business owners are able to choose whether to file on their own personal behalf or on behalf of the business.
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What Are the Pros and Cons of Filing a Chapter 7 Bankruptcy?
Pros when filing business bankruptcy, Chapter 7:
• A sole proprietor can handle both aspects within the same bankruptcy filing. Because a business Chapter 7 bankruptcy doesn’t erase any debt, many business owners who choose the Chapter 7 route file personally because of the protections that offers.
• Sole proprietors whose business debt is greater than their personal debt won’t have to meet income requirements for Chapter 7. Plus, there are bankruptcy exemptions that, in some cases, would allow them to continue to operate the business, post-bankruptcy.
• With an LLC or a corporation bankruptcy, Chapter 7 provides a transparent way to liquidate the company. The bankruptcy trustee is responsible for selling the business assets and using the funds to pay creditors.
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Cons of filing business bankruptcy, Chapter 7:
• Only sole proprietors have the opportunity to get rid of both personal and business debt under this structure.
• A business’ financial assets aren’t generally protected, which means that the bankruptcy trustee will sell the business assets to pay off creditors and, in many cases, the business closes.
• In most circumstances, if the business owners sold the assets and used the funds to pay down debt without filing for bankruptcy, they could usually get a better price for those assets than they would through bankruptcy.
Who Can File Chapter 11 Bankruptcy?
This may also be called a “reorganization” bankruptcy, since it means that, while you may stay in business, you will likely need to provide a plan for reorganizing your financial situation. This type of business bankruptcy is available for individuals, as well as for LLCs, corporations and partnerships.
What Are the Pros and Cons of a Chapter 11 Bankruptcy?
Pros when filing Chapter 11:
• There are no debt or income requirements.
• Extended payment terms are available for the business owner to pay back creditors, such as lenders for a small business loan.
• Disposable income does not have to be turned over to a trustee.
Cons of filing Chapter 11:
• This proceeding is complex.
• Chapter 11 bankruptcies are expensive.
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Who Can File Chapter 12 Bankruptcy?
Chapter 12 bankruptcy enables financially distressed family farmers and family fishermen to propose and carry out a plan to repay some or all of their debt.
Chapter 12 is similar to Chapter 13 (below) but is only available for those family farmers and family fishermen, giving them an opportunity to avoid foreclosure or liquidation.
Who Can File Chapter 13 Bankruptcy?
This form of bankruptcy allows individuals with a regular income to keep their property and pay off their debt over time, usually three to five years.
Among small businesses, only sole proprietors can file for Chapter 13, so this avenue is not an option for corporations or LLCs. That said, in some instances, filing personally may provide enough leeway for a business owner with an LLC or corporation structure to keep his or her company going.
What Are the Pros and Cons of Chapter 13 Bankruptcy?
Pros when filing Chapter 13 bankruptcy:
• Assets can be kept while the business owner repays some or all of the debts via a repayment plan of up to five years.
• The business owner can pay down prioritized debt; potentially refinance some loans; and use this restructuring to catch up on other qualifying payments.
Cons when filing for Chapter 13 bankruptcy:
• This plan is not available for business owners other than sole proprietors.
• The payments under the repayment plan may be challenging to make.
• Payments will be required for three to five years.
Chapter 7 vs. Chapter 11 vs. Chapter 13 Bankruptcy
Below is a chart that sums up some of the important features of the three most common types of bankruptcy so that you can see them all together.
| Chapter 7 | Chapter 11 | Chapter 13 | |
|---|---|---|---|
| What Does It Do? | In a “liquidation” bankruptcy, your assets will be sold (“liquidated”) and the money used to pay your creditors | In a “reorganization” bankruptcy, you may be able to stay in business, but will need to provide a plan for reorganizing your finances and repaying your debts | Also called a “wage earner’s plan,” this bankruptcy allows individuals with a regular income to keep their property and pay off their debt over three to five years |
| Who’s Eligible? | Individuals and small businesses | Individuals, LLCs, corporations and partnerships | Individuals and sole proprietors |
| Pros? | Sole proprietors can handle both personal and business bankruptcy in one filing. For LLCs and corporations, the trustee provides a transparent way to liquidate | No debt or income requirements. Extended payment terms are available Disposable income does not have to be turned over to a trustee | Assets can be kept while you repay some or all of the debt. You can pay down prioritized debt, reduce some loans, and use this restructuring to catch up on other qualifying payments. |
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The Takeaway
When a small business struggles–and sometimes can’t even service its debt–it’s understandable that an owner would wonder about filing for bankruptcy. That can be a viable way to best protect the business and reorganize financial obligations. But it has risks as well. And it’s very important to choose the type of bankruptcy that fits with your needs and priorities.
If you’re seeking financing for your business, SoFi is here to support you. On SoFi’s marketplace, you can shop and compare financing options for your business in minutes.
FAQ
Are you personally liable for your business debts?
The answer depends on what kind of business structure your company has. If you are a sole proprietor, you can be held liable for your business debts. If your company is an LLC or corporation, you are generally separated from the company and cannot be held liable. In partnerships, general partners are typically liable, while limited partners typically are not, but this can vary by state.
How will the bankruptcy affect your personal credit?
If your business is an LLC or a corporation, it should be legally separate from you, so the business’s bankruptcy should not affect your personal credit (unless you have signed a personal guarantee). However, if you are a sole proprietor, there is no separation and bankruptcy, which can stay on your credit report for seven to 10 years, depending on what type it is, can lower your personal credit score significantly.
How will this affect your business credit?
If your business survives the bankruptcy, there will still be a negative impact on your business credit score.
What happens if a business files for bankruptcy?
If a business files for Chapter 7 bankruptcy (liquidation), the company’s assets will be sold by a trustee, the proceeds will be disbursed to the creditors, and the business will cease to exist. If the business files for a Chapter 11 bankruptcy, it will be able to keep doing business but will have to pay off some or all of its debts according to a structured repayment plan.
Who can file for Chapter 7 bankruptcy?
Individual people can file for Chapter 7 and so can businesses. Small business owners are able to choose whether to file on their own personal behalf or on behalf of the business.
Who can file for Chapter 13 bankruptcy?
Individuals with a regular source of income. Among small businesses, only sole proprietors can file for Chapter 13, so this is not an option for corporations or LLCs.
Who can file for Chapter 11 bankruptcy?
This type of business bankruptcy is available for individuals, as well as for LLCs, corporations and partnerships.
Photo credit: iStock/elenaleonova
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