Bankruptcy is a legal process overseen by federal bankruptcy courts. It’s designed to help individuals and businesses eliminate all or part of their debt or to help them repay a portion of what they owe. Bankruptcy may help you get relief from your debt, but it’s important to understand that declaring bankruptcy has a serious, long-term effect on your credit. Bankruptcy will remain on your credit report for 7-10 years, affecting your ability to open credit card accounts and get approved for loans with favorable rates.
Bankruptcy can be a complex process, and the average person probably isn’t equipped to go through it alone. Working with a bankruptcy attorney can help ensure your bankruptcy goes as smoothly as possible and complies with all the applicable rules and regulations governing bankruptcy proceedings. You’ll also have to meet some requirements before you can file for bankruptcy. You’ll need to demonstrate you can’t repay your debts and also complete credit counseling with a government-approved credit counselor. The counselor or an attorney will help you assess your finances, discuss possible alternatives to bankruptcy, and help you create a personal budget plan.
If you decide to move forward with bankruptcy proceedings, you’ll have to decide which type you’ll file. Chapter 7 or Chapter 13 types of bankruptcy can help you eliminate unsecured debt (such as credit cards), halt a foreclosure or repossession, and stop wage garnishments, utility shut-offs and debt collection actions. With both types, you’ll be expected to pay your own court costs and attorney fees. However, the two types of bankruptcy relieve debt in different ways.
Who Can File Chapter 7 Bankruptcy?
Both individuals and business entities can file for Chapter 7 bankruptcy. Small business owners have the option of filing Chapter 7 on behalf of their business or for themselves personally. If you’re a sole proprietor, both your business debt and your personal debt will be resolved in the same Chapter 7 bankruptcy case. Filing for Chapter 7 bankruptcy on behalf of the business doesn’t wipe out any debt whatsoever, however.
So many business owners choose to file an individual bankruptcy after a business closure because of the ability to erase the individual’s responsibility to pay a personal guarantee and other business debt.
What Type of Business Is It?
To know what will happen to your ownership interest in the company, you’ll start by looking at its formation.
• Sole proprietorship: If you haven’t incorporated your business, you probably own it as a sole proprietor. You own the assets of the company, such as the vehicles, lawn and gardening equipment, customer lists, and the company’s debts are your debts. When you file a bankruptcy case, you will list all of the company’s assets and debts as your own. You’ll include your personal debts and assets, too. The trustee will sell all nonexempt assets that you can’t protect with bankruptcy exemptions and use the proceeds to pay business and personal debt.
• Partnership: If you own your business with other people, but the business isn’t incorporated, you likely own it as a partnership. You’ll list all of your personal assets and the partnership itself as a business asset when filing for bankruptcy. As a caveat, filing bankruptcy when you own a partnership can affect all partners’ business and personal assets, even if they aren’t in bankruptcy. After selling the partnership property, the trustee will look to the personal assets of the business partners for payment of any remaining balances possibly even forcing the partners themselves into bankruptcy.
• LLC or corporation: If your company is incorporated, you own interest in the company, not the company itself. You might own 100% of the stock or share ownership with other stockholders. Even if you own 100%, the company owns its assets and is liable for its debts. When you file a bankruptcy case, you will disclose the stock as your asset, not the company’s assets or liabilities. (If you’re separately liable on company debt as a co-borrower or guarantor, you’ll include that debt).
Protecting Assets
You can protect some of the property that you own from the reach of the bankruptcy court and your creditors using the property exemptions allowed by your state. In most states, there’s no specific exemption for corporate stock; however, you might be able to use a wildcard exemption that allows you to protect any property of your choosing. Not all states have a wildcard exemption However, you might be able to protect a portion of the company’s assets as tools of the trade, if that exemption category is available. This exemption covers a certain amount of property that you need in your trade or profession.
Remaining Value
In every Chapter 7 case, a bankruptcy trustee appointed by the court will carry out a duty to liquidate the assets that you can’t exempt, and then distribute the proceeds to your creditors who file valid claims. Sometimes an asset isn’t exempt, but its value is so small that liquidating it would be a burden. In other words, selling it wouldn’t recoup enough to be worthwhile. Another business may lose its value if you aren’t associated with it any longer. In general, the trustee won’t have much interest in a sole proprietorship except for the assets that can be sold. If the business is incorporated, the trustee will be more interested in selling the stock if the company’s value doesn’t depend on your continued involvement.
Speak With an Attorney
When you own your own business, filing for bankruptcy is even more complicated than usual. Not only do you need to understand what will happen to your company, but you’ll likely have to provide financial information for you and the company. To ensure you’re doing what’s best, consider hiring a bankruptcy attorney experienced in handling business-related cases who can help you evaluate what you stand to lose, as well as discuss any alternatives available.
Benefits of Chapter 7 Bankruptcy for Small Business Owners
If you are a sole proprietor, Chapter 7 allows you to wipe out both personal and business debts in a single bankruptcy case. If your business debt exceeds your personal debts, you won’t have to meet the income requirements of the Chapter 7 means test. Also, you can use bankruptcy exemptions to protect your personal and business assets. So, in some cases—for instance, if you have a service-oriented business that doesn’t need much in the way of equipment or inventory, you can continue to operate the business after wiping out business debts in bankruptcy. If, however, you can’t protect all of the property you need to run your business, the Chapter 7 trustee will sell the nonexempt property, which could put you out of business.
If your business is a corporation, or limited liability company (LLC), Chapter 7 bankruptcy provides a way to close down and liquidate your company in a transparent manner. When you file Chapter 7 on behalf of your business, it becomes the bankruptcy trustee’s responsibility to sell off the assets of the business and pay its creditors. Keep in mind that Chapter 7 is rarely a good idea for partnerships because of the risk of the trustee paying debt with the personal assets of the partners. Keep reading for more drawbacks.
Drawbacks of Chapter 7 Bankruptcy for Small Businesses
Unless you’re a sole proprietor filing bankruptcy, your business won’t receive a discharge of its debts in Chapter 7. So, if you’re somehow responsible for the business debt. For instance, you signed a personal guarantee; you’ll still be on the hook unless you file a personal Chapter 7 bankruptcy. Also, a business entity can’t use exemptions to protect assets in business bankruptcy. As a result, the trustee sells all of the business assets to pay creditors, and the business gets shut down. In most cases, a business owner can get a better price for the business assets, and thereby pay down a more significant share of the business debt. This will leave less debt to be paid by the owners. Plus, putting a business in bankruptcy opens the door for creditors to lodge objections or to claim that corporate formalities weren’t followed and that the members or shareholders should pay business debt with personal assets.
Who Can File for Chapter 13 Bankruptcy?
Only individuals can file for Chapter 13 bankruptcy. Business entities such as partnerships, corporations, or LLCs cannot do so. However, if you are a sole proprietor, you can file a personal Chapter 13 to reorganize your personal and business debts. And sometimes reorganizing personal debt is enough to help a business owner keep the company afloat. A bankruptcy attorney with business-related experience can help you determine the best overall strategy.
Advantages of Chapter 13 Bankruptcy for Small Business Owners
In Chapter 13, you get to keep all your assets and pay back all or a portion of your debts through a repayment plan. If you are a sole proprietor with a lot of business assets, a Chapter 7 trustee may sell them if you don’t have adequate bankruptcy exemptions to protect the property. By filing a Chapter 13, you can protect all business assets and keep the business running while reorganizing your debts. Keep in mind, however, that you must pay the value of nonexempt assets (property you can’t protect with bankruptcy exemptions) through your repayment plan, which can pose a problem if your ownership interest in the business is substantial. Even if your business is a separate entity like a partnership, corporation, or LLC, you can reorganize (and potentially wipe out) your personal liability for business debts with a Chapter 13. Further, you can do things with a Chapter 13 that you can’t in Chapter 7, such as:
• catch up on a house, car, or equipment payment (any credit account wherein you used the property as collateral)
• pay off priority creditors, such as tax debt and domestic support obligations, and
• reduce some loans to the value of the property (called a “cram down”).
Disadvantages of Chapter 13 Bankruptcy for Small Business Owners
The first and foremost disadvantage to Chapter 13 is that business entities cannot file Chapter 13. Also, Chapter 13 takes much longer than Chapter 7 because you have to make monthly payments to a trustee for three to five years. If you have nonexempt assets property that you can’t protect with an exemption; you can keep the property, but you must pay an amount equal to its value to unsecured creditors which can increase your plan payments significantly. You might not have sufficient income to pay the required plan amount. Further, your discharge wipes out only your personal liability for business debts. The business itself will remain responsible for paying back its debts.
Bankruptcy Terms to Know As a Business Owner
Throughout bankruptcy proceedings as a business owner both individually or a cooperate owned business, you’ll likely come across some legal terms particular to bankruptcy proceedings that you’ll need to know. Here are some of the most common and important ones:
• Bankruptcy trustee: This is the person or corporation, appointed by the bankruptcy court, to act on behalf of the creditors. He or she reviews the debtor’s petition, liquidates property under Chapter 7 filings, and distributes the proceeds to creditors. In Chapter 13 filings, the trustee also oversees the debtor’s repayment plan, receives payments from the debtor and disburses the money to creditors.
• Credit counseling: Before you’ll be allowed to file for bankruptcy, you’ll need to meet either individually or in a group with a nonprofit budget and credit counseling agency. Once you’ve filed, you’ll also be required to complete a course in personal financial management before the bankruptcy can be discharged. Under certain circumstances, both requirements could be waived.
• Discharged bankruptcy: When bankruptcy proceedings are complete, the bankruptcy is considered discharged. Under Chapter 7, this occurs after your assets have been sold and creditors paid. Under Chapter 13, it occurs when you’ve completed your repayment plan.
• Exempt property: Although both types of bankruptcy may require you to sell assets to help repay creditors, some types of property may be exempt from sale. State law determines what a debtor may be allowed to keep, but generally items like work tools, a personal vehicle or equity in a primary residence may be exempted.
• Lien: A legal action that allows a creditor to take, hold and sell a debtor’s real estate for security or repayment of a debt.
• Liquidation: The sale of a debtor’s non-exempt property. The sale turns assets into liquid form cash which is then disbursed to creditors.
• Means test: The Bankruptcy Code requires people who want to file Chapter 7 bankruptcy to demonstrate that they do not have the means to repay their debts. The requirement is intended to curtail abuse of the bankruptcy code. The test takes into account information such as income, assets, expenses and unsecured debt. If a debtor fails to pass the means test, their Chapter 7 bankruptcy may either be dismissed or converted into a Chapter 13 proceeding.
• Reaffirmed account: Under Chapter 7 bankruptcy, you may agree to continue paying a debt that could be discharged in the proceedings. Reaffirming the account and your commitment to pay the debt is usually done to allow a debtor to keep a piece of collateral, such as a car, that would otherwise be seized as part of the bankruptcy proceedings.
• Secured debt: Debt backed by reclaimable property. For example, your mortgage is backed by your home, and for an auto loan, the vehicle itself is the collateral. Creditors of secured debt have the right to seize the collateral if you default on the loan.
• Unsecured debt: A debt for which the creditor holds no tangible collateral, such as credit cards.
Free Initial Consultation with Lawyer
It’s not a matter of if, it’s a matter of when. Legal problems come to everyone. Whether it’s your son who gets in a car wreck, your uncle who loses his job and needs to file for bankruptcy, your sister’s brother who’s getting divorced, or a grandparent that passes away without a will -all of us have legal issues and questions that arise. So when you have a law question, call Ascent Law for your free consultation (801) 676-5506. We want to help you!
8833 S. Redwood Road, Suite C
West Jordan, Utah
84088 United States
Telephone: (801) 676-5506
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