Sometimes small businesses end up in bad financial situations and the only way out of debt is filing bankruptcy. Business owners who want to keep running their business and need help restructuring their debt may find some relief under Chapter 11 or Chapter 13 bankruptcy.
Chapter 11 and Chapter 13 bankruptcy are similar in some sense. Both provide ways for small businesses to restructure their finances and keep their assets. Both chapters provide ways for small business owners to modify the terms of their secured debt. For example, mortgage loans and equipment loans can be modified to allow individuals time to catch up on their arrears. The biggest advantage both chapters provide are ways for businesses to get out of paying certain unsecured creditors that cannot be repaid throughout the repayment plan. Lastly, businesses that can no longer stay afloat can use both chapters to allow time to liquidate their business assets and repay creditors. Business owners looking to restructure their debt, can find Chapter 13 and Chapter 11 as useful tools to get out of debt and start over financially.
Choosing Chapter 13 Over Chapter 11 Bankruptcy
Chapter 13 - Most small business owners choose to file Chapter 13 bankruptcy over Chapter 11 bankruptcy because of costs. Chapter 11 bankruptcy is extremely expensive and complicated. However, not everyone can file Chapter 13 bankruptcy. Chapter 13 is only available to individuals and sole proprietorships. Business entities such as LLCs, corporations, and partnerships are not able to find protection under Chapter 13 bankruptcy. Instead, they must file Chapter 7 or Chapter 11 bankruptcy, because they are considered separate legal entities. Chapter 13 bankruptcy is only a viable option for individuals who can afford to enter a monthly repayment plan. In a Chapter 13 bankruptcy, individuals repay their debts over a 3-5-year repayment plan. Thus, individuals that file Chapter 13 must have a steady income for the next 3-5 years to fund their repayment plan.
In Chapter 13 bankruptcy, the amount that an individual must pay back depends on their disposable income. The more disposable income that an individual has after their monthly expenses, the higher the amount the creditors must be paid. In some cases, not all creditors have to be paid back in full. Any debt that is not paid in full through the plan is discharged.
Further, individuals who file Chapter 13 are limited to certain debt limitations. Individuals who file Chapter 13 bankruptcy cannot have more than $1,257,850 in secured debt and $419,275 in unsecured debt. This figure changes periodically. Therefore, any individual looking to file Chapter 13 bankruptcy should speak with a lawyer.
Individuals are only eligible for Chapter 13 if they meet the requirements above and have not filed a Chapter 7 bankruptcy within the last four years. Any individual that has filed Chapter 7 bankruptcy within the last four years is not eligible for a discharge.
Under a Chapter 13 bankruptcy, an automatic stay is initiated when the petition Is filed. The automatic stay stops creditors from pursuing individuals. In Chapter 13 bankruptcy, the automatic stay protection extends to co-debtors. Thus, if two people are liable for a debt, creditors cannot pursue the debtor or the co-debtor. Although this does not eliminate the co-debtor's obligation to the creditor, it gives them time (3-5 years) to catch up on the debt.
In a Chapter 13 bankruptcy, a trustee is appointed to the individual’s case. The Trustee distributes the individual’s monthly plan payments to the creditors and oversees the entire process. The trustee ensures that the debtor stays up to date with payments and consents to the individual's plan confirmation.
Chapter 11 – Anyone can file a Chapter 11 bankruptcy. This includes individuals, partnerships, limited liability companies, etc. An advantage of Chapter 11 bankruptcy is there is no debt limitation. Thus, individuals with low or high debts can file. However, Chapter 11 bankruptcy can be very costly. Many individuals cannot afford the process. Thus, Chapter 11 bankruptcy is rarely used for small businesses. Individuals who are over the debt limitations under Chapter 13 must file under Chapter 11. Chapter 11, like Chapter 13, allows individuals to restructure their debt and continue operating their business.
In Chapter 11 bankruptcy the debtor submits a plan to the Bankruptcy Court that provides guidelines to how the individual will continue running its business and pay back creditors.
The reorganization plan that is submitted must be voted on by the individual’s creditors and confirmed by the Court to move forward. This can cause a roadblock in the process. Creditors who are not paid in full through the repayment plan can object to the plan and propose their plan.
In Chapter 11 the plan creates new terms between the debtor and his/her creditors. The Chapter 11 plan allows the business owner to catch up on past-due debts. In some cases, individuals do not have to pay back all their creditors. When this happens, the debt is discharged. Further Chapter 11 bankruptcy does not require that an individual’s disposable income be taken to pay back creditors.
Small business owners can also qualify to streamline the bankruptcy process in a Chapter 11 bankruptcy. Small business owners in a Chapter 11 bankruptcy do not have to follow everything that corporations do. A small business owner may qualify to streamline the process if the individual is engaged in commercial activity and meets certain debt limitations.
Key Differences Between Chapter 11 and Chapter 13
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Which Chapter Should A Small Business File
Small businesses that need help getting out of debt need to decide which Chapter is better for them. Chapter 11 usually makes sense for individuals or businesses that have high debts and cannot file a Chapter 13 bankruptcy. In February of 2020, the Bankruptcy Court implemented a new subchapter V under Chapter 11. Small businesses with high debt may be able to file under this new subchapter to streamline the process.
Small businesses that can file a Chapter 13 bankruptcy should file a Chapter 13. A Chapter 13 bankruptcy provides for a much less costly and complicated process.
Small business owners who are unsure what chapter they should file should speak with a bankruptcy lawyer. Business bankruptcies are complicated. There are certain things that business owners should be aware of before filing bankruptcy. Before filing bankruptcy, business owners should not be transferring assets out of their name, paying back friends or family, and taking their name off business assets. These types of actions can be deemed fraudulent. Small business owners who believe they will need to file bankruptcy within the near future can meet with a bankruptcy lawyer to do some pre-bankruptcy planning. During that meeting, the bankruptcy lawyer should give recommendations as to whether Chapter 11 or Chapter 13 is more suitable for the individual’s financial situation.
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