Bankruptcy Basics for Small Businesses – Chapters 7, 11, and 13

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Your business is struggling, and you are wondering what to do about it.

Filing a bankruptcy petition may be the answer you are looking for, to either close up shop in an organized way, or reorganize your debt and move on.

If you are considering bankruptcy, know that there are two basic kinds:

1 – Liquidation case, where the business ceases operations and liquidates its assets for the benefit of its creditors.

2 – Reorganization case, during which the business negotiates with creditors to reduce or extend the term of the debt.

The question is what is best for your small business. Is bankruptcy something you should consider?

In this post, we will discuss your options, so you can make an informed decision.

Are you considering bankruptcy? Then, you must read this post to decide if filing for bankruptcy is needed for your small business. Understand the impact of filing Chapter 7, 11 or 13. These bankruptcy tips will help you.

What is Business Bankruptcy?

Business debtors most commonly file “Chapter 7” or “Chapter 11” bankruptcy petitions.

These forms of bankruptcy are named for the applicable Chapters in the federal Bankruptcy Code.
Whether you file under one or the other will depend primarily upon whether you intend to stay in business, or you intend to liquidate the business assets.

“Chapter 13” is also available to business debtors who are sole proprietors or single-member LLCs. It is not available to other types of business formations because a Chapter 13 debtor must be an “individual.” Chapter 13 is a plan of reorganization, like Chapter 11, with fewer procedural hurdles and restrictions.

How Does Chapter 7 Business Bankruptcy Work?

how to file for business bankruptcy

If your business files a bankruptcy petition under Chapter 7, you must resign yourself to ceasing business operations and liquidating your assets.

The Trustee oversees and assists with this, and creditors are paid an amount from the proceeds of liquidation that is in proportion to the business’ debt with them.

A business commences a bankruptcy case when it files a “petition.” Once the business files its petition, the “automatic stay” goes into effect, which stops or “stays” collection actions against your business, including repossessions and collection lawsuits.

When the business files its petition it will also file various “schedules” which set forth the business’ debts, revenue, expenses, and assets. Again, the Chapter 7 Trustee will seize the business assets listed therein and sell them for the benefit of your creditors.

How Chapter 7 Works for Sole Proprietors

If you are a sole proprietor or single-member LLC, you can file a Chapter 7 petition and discharge both business and personal debt.

However, this puts your personal possessions in danger of seizure by the Trustee.

Consult with an experienced bankruptcy attorney before you file anything, as applicable federal or state exemptions may help you protect your personal assets from seizure.

How Does Chapter 11 Business Bankruptcy Work?

business bankruptcy chapter 11

If instead of filing a Chapter 7 petition and liquidating you wish to remain in business, your business will file a petition under Chapter 11. In addition to filing a petition and schedules, your business will have filed a proposed repayment plan or a plan of reorganization.

In this plan, you will categorize secured and unsecured creditors into different classes, and propose the same treatment to creditors in the same creditor class.

This treatment could be to continue to pay as owed, to reduce the amount of debt owed, or to lengthen the payment term.

Your business will continue operations, and you will continue to run the business as the “debtor in possession,” however, you will be under the watchful eye of the Chapter 11 Trustee who will require periodic reports.

If the reorganization plan is successful and the business has caught up with its debt, the case closes.

Chapter 11 is by far the most expensive and the most complex form of a bankruptcy filing in terms of the procedural and paperwork requirements. There is a slightly more streamlined form of Chapter 11 available for small businesses, however, the requirements and expenses are still onerous for most. Chapter 11 is mostly used by major national corporations, like Toys-R-Us or Ford Motor Company.

If you are a sole proprietor or single-member LLC, you will be able to file under Chapter 13 instead and reorganize your debt that way.

How Does Chapter 13 Business Bankruptcy Work?

how does chapter 13 business bankruptcy work

Procedurally, you will still file a petition and schedules as well as a 3- or 5-year proposed repayment plan during which you can repay creditors in part and continue business operations.

You will make monthly payments to the Trustee, who in turn will pay your creditors according to your plan. When you have paid your plan in full, you will receive a discharge of the remaining unpaid unsecured debt.

A debtor has heightened powers in a Chapter 13 case, including “cram down” and “lien strip.”

In a Chapter 13 Case You Can “Cram Down” Your Car to Retail Value

If you have a car loan and the car is worth less than you owe on it, you can “cram down” the car loans to the retail value of the car and pay it off in your plan at a reduced interest rate of prime plus 1-3%. This gives you more time to pay off the car and in the long run, the car is less expensive.

Car lenders often object to the valuation of the car in a Chapter 13 plan, so you and your attorney may have to negotiate value and interest rate. However, if you use Kelley Blue Book or NADA to find a retail value as of the date of filing, and you can back that up with photographs showing condition, you should be successful in cramming your car loan down.

A note about car leases: Many car leases end with a balloon payment that you can tender to own that car. If you have such a lease and want to keep the car, know that you can put that balloon payment through your plan and get three or five years to pay it off.

In a Chapter 13 Case You Can “Strip Off” Liens on Real Property

If you have a mortgage on real property, and the property is worth less than the amount you owe on that first mortgage, you can “strip off” second and third mortgages, a line of credit, or a mechanics or judgment lien.

Often the creditor or lender subject to lien strip off will raise objections to your valuation of the property and will claim that the value is higher. If you have an appraisal or a real estate agents’ report including comps, you should prevail in stripping the lien off. Then, after you finish paying your plan payments, the lien as well as all unpaid unsecured debt is discharged as unsecured.

As a sole proprietor or single-member LLC, you will also be able to deal with your personal debt in a Chapter 13 case, because you and your business are considered the same entity.

Is Bankruptcy Right for your Small Business?

What happens when a small business files for bankruptcy?

Whether it is Chapter 7, Chapter 11, Chapter 13, or a workout with an individual creditor, there is a way to resolve your business’ financial difficulties.

Any business considering filing bankruptcy should consult with an experienced business bankruptcy attorney in order to select a course of action that will realize your business goals and avoid unintended personal or business consequences of filing a bankruptcy petition.

Your attorney will explain and help you choose among the available solutions.


 About the Author

Veronica Baxter is a legal assistant and blogger living and working in the great city of Philadelphia. She frequently works with David Offen, Esq., a busy Philadelphia bankruptcy lawyer.

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