Small business owners that are facing financial hardships may be able to use bankruptcy to help them get out of debt. Small business owners who are considering filing Chapter 7 bankruptcy or Chapter 13 bankruptcy must consider which option is better for them. To do this, business owners will need to consider the structure of their business, the assets in the business, and the amount of debt they have. The biggest question they will need to consider is whether they will plan to keep running the business, close their business? This article will discuss how Chapter 7 and Chapter 13 can impact these decisions for small business owners.
Who Qualifies for Chapter 7 Bankruptcy
Chapter 7 bankruptcy may be an option for individuals and small business entities. Business owners can use Chapter 7 bankruptcy to wipe out debts they are personally liable for. Business owners can also file Chapter 7 bankruptcy on behalf of their business. However, filing for Chapter 7 on behalf of the business does not get rid of any business debt. Individuals often choose to file Chapter 7 bankruptcy to wipe out business debt that they are personally liable for.
Why Should Small Business Owners File Chapter 7 Bankruptcy?
A Chapter 7 bankruptcy is a good option for sole proprietors and small businesses with little or no assets. Individuals who have business debt and personally guaranteed the debt can use Chapter 7 bankruptcy to eliminate their liability. When an individual personally guarantees their business debt, lenders can target their assets such as their car, home, and bank accounts. Filing for Chapter 7 relief can protect an individual's assets.
Many individuals end up personally liable for their business debts without even knowing it. Creditors often require business owners to personally guarantee their debt as an extra layer of precaution.
Most individuals must qualify under a means test to file Chapter 7 bankruptcy and to have their debt eliminated. The Means Test determines whether an individual has disposable income left over to pay their creditors. Individuals with disposable income left over must go into a Chapter 13 repayment plan. Individuals who have business debt are at an advantage because they don’t have to qualify under the Chapter 7 means test. The Court allows business owners to be exempt from the Means Test if their business debt is more than the personal debt. Thus, business owners who have a significant amount of debt and income can file Chapter 7 bankruptcy and have their debt eliminated.
Some individuals can continue to run their business and file Chapter 7 bankruptcy. This depends on whether the business has assets. Service-oriented businesses with little assets may be able to use bankruptcy exemptions to protect their assets and continue to operate the business. Since the individual is the main asset of the business, they can close their business, wipe out their debt, and open a new business after the bankruptcy is over. Individuals who have assets that can’t be exempt in a Chapter 7 bankruptcy run the risk of having the Trustee take the assets and selling them to pay back creditors. Many service-oriented businesses have tools that can be exempt in a Chapter 7 bankruptcy. Many State laws have exemptions for “Tools of the Trade” that can allow individuals to keep some of their assets and file bankruptcy.
Chapter 7 bankruptcy can allow corporations and limited liability companies a way to close their business and liquidate their assets. This can be advantageous to individuals who want to shut down their business and start anew.
Why Chapter 7 Bankruptcy May Not Be the Best Option for Business Owners
Only sole proprietors can get a discharge in a Chapter 7 bankruptcy. Thus, individuals who file a ‘business’ chapter 7 bankruptcy will still be liable for their debt unless they file a ‘personal’ Chapter 7 bankruptcy.
Some businesses have a lot of assets. Businesses that have a lot of assets with equity may not be able to use exemptions to protect them. When business assets are not protected under an exemption the Trustee can take those assets and sell them to pay off creditors.
Who Qualifies for Chapter 13 Bankruptcy
Chapter 13 bankruptcy is only an option for individuals. Business entities are not able to use Chapter 13 bankruptcy to get rid of their business debt. However, individuals may choose to file Chapter 13 bankruptcy to eliminate any personal liability from their business debt.
Chapter 13 Advantages
Unlike Chapter 7 bankruptcy, where individuals are not allowed to keep their assets, Chapter 13 bankruptcy allows individuals to keep all their assets and repay their debt through a Chapter 13 repayment plan. Chapter 13 allows individuals to protect their business assets and continue running their business by reorganizing their debt. How much the individual must pay back in their Chapter 13 bankruptcy will depend on the amount of equity in their assets. Individuals are required to pay back any nonexempt portion of their assets.
Chapter 13 bankruptcy can help small business owners by allowing them to pay some but not all their debt back. Individuals with credit card debts, utility bills, and unpaid invoices may not have to pay every creditor back in full. Any debt not paid in full through the plan will be discharged which means creditors won’t be able to collect from the individual or the business.
Chapter 13 also has some advantages for individuals who have tax debt and are behind on their mortgage payments. A Chapter 13 bankruptcy repayment plan allows individuals to catch up on their house or car payments. It can also allow individuals to catch up on some of their tax debt.
When individuals file for Chapter 13 bankruptcy their interest, fees, and penalties stop accruing. This can allow individuals with high credit card balances that were used for their business to catch up on their payments.
Another advantage of filing Chapter 13 is that individuals can cramdown their secured loans. A cramdown allows individuals to reduce the amount they owe to the actual value of an asset. A cramdown can significantly lower an individual's payment to their creditor. This can help individuals with business assets lower the amount that must be repaid.
Chapter 13 Disadvantages
As mentioned above, the biggest disadvantage for business owners considering Chapter 13 bankruptcy is that business entities are not able to file for Chapter 13 relief. Further, Chapter 13 takes much longer than a Chapter 7 bankruptcy. A Chapter 7 bankruptcy can be completed within a few months whereas, a Chapter 13 bankruptcy will take 3-5 years to complete.
Additionally, individuals who file Chapter 13 bankruptcy will be able to get a discharge, but the business will still be liable for the debt since only individuals can get a discharge in a Chapter 13 bankruptcy.
Speak with a Bankruptcy Lawyer
Small business owners who are thinking of filing bankruptcy should speak with a bankruptcy lawyer as soon as possible. Filing for bankruptcy with a business can be complicated. There are many laws and rules that individuals need to be aware of before filing their bankruptcy. Individuals are often unaware that certain things can/cannot be done before filing bankruptcy. For example, business owners cannot sell off all their business assets, and then file Chapter 7 bankruptcy. This can be a fraudulent transfer and can be problematic in a Chapter 7 bankruptcy. Moreover, businesses with assets need to take extra precautions. Filing the wrong chapter of bankruptcy can cause individuals to lose their assets.
Most bankruptcy lawyers provide free consultations. Business owners who are unsure of their financial future can start doing some bankruptcy planning to ensure they do not do anything they should not before filing bankruptcy.