As a small business owner, you are likely to accumulate debt to keep your business running. However, these debts can easily overwhelm you. In such a scenario, you might lose your business and personal assets, depending on the type of business and the type of debts you have. Even with mounting debts that the business can no longer sustain, you can set yourself on the path to recovery by filing for bankruptcy. Filing for bankruptcy allows you some time to recover without the pressure from creditors. If you are a small business, you can apply for Chapter 7, 11, or 13 bankruptcy. The Los Angeles Bankruptcy Attorney explains the various options of small business bankruptcy you can apply, and their advantages and disadvantages.
Overview of Small Business Bankruptcy
Small business bankruptcy is a legal way of seeking relief for small businesses that cannot keep up with their debts and expenses. Bankruptcy does not absolve you from repaying your creditors. Instead, it allows you the freedom from the debt, and at the same time, ensures that creditors do not suffer losses.
If you feel that your business needs a second chance without the overwhelming debt, you have three options when filing for bankruptcy. The option you choose depends on the type of debts you have, personal and business assets, the type of business, and whether you want to close or continue doing business.
Most small businesses operate as sole proprietorships, which increases the likelihood of losing both personal and business assets in case the creditor liquidates your assets to repay the debt. Even in some types of partnerships, the partners can lose their personal assets to repay business debts.
Before filing for small business bankruptcy in California, you need to talk to a bankruptcy attorney to help you evaluate your situation and the best choice for you.
Here are the three types of bankruptcy available to small businesses:
1. Chapter 7 Bankruptcy
Chapter 7 bankruptcy is the best option for businesses such as sole proprietorships and general partnerships where the owners have liability for debts. By filing a Chapter 7 bankruptcy, you are relieved of both business and personal debts. This relief means that the creditors cannot take your personal assets to clear the business debt.
When you file a Chapter 7 bankruptcy, creditors will liquidate your business. So, if you feel your business is no longer viable, Chapter 7 bankruptcy is an ideal option.
Some of the advantages of Chapter 7 bankruptcy for small businesses include:
- Your debt will be discharged which gives you a chance to start afresh
- You can apply for any amount of debt unlike in Chapter 13 bankruptcy
- You do not have to come up with a repayment plan
- The process for filing for Chapter 7 bankruptcy takes a shorter time
However, Chapter 7 bankruptcy comes with several disadvantages, such as:
- The bankruptcy remains on your record for up to ten years, which affects your credit and ability to acquire a mortgage
- Any exempt property might be lost to recover the debts
- You will lose your credit cards but can restore these lines of credit after three years of filing the bankruptcy. You will also pay higher premiums for the same
- You cannot re-file for Chapter 7 bankruptcy until after six years
- You must pay child support, alimony, and student loans
- You may still have to pay some debts such as a mortgage liens
Not all businesses are eligible for Chapter 7 bankruptcy. You qualify if your debts exceed half your annual income, your income is below the median state income, and you lack a disposable income.
The court will also determine whether you can repay the debts in under five years and the effect of the debts on your relationships, family, and general life.
2. Chapter 11 Bankruptcy
Chapter 7 bankruptcy closes your business and is therefore ideal for a business that is not viable after the bankruptcy. However, if you wish to keep your business running, Chapter 11 bankruptcy is the best option.
Chapter 11 bankruptcy is a common choice amongst large corporations, but smaller businesses whose debts exceed the limits under Chapter 13 can apply for this form of bankruptcy.
Courts are likely to approve this type of small business bankruptcy if the business has a higher value in comparison to its assets.
Chapter 11 bankruptcy allows you to become a debtor-in-possession, meaning that your business operates under supervision. You must reorganize or restructure your business and finances and prepare a repayment plan on how to repay your creditors.
Filing for Chapter 11 bankruptcy gives your business a fresh start with relief from aggressive debt collection agents. While this form of bankruptcy allows you to keep your business, the bankruptcy court retains the authority of approving significant decisions such as:
- The sale of business assets
- Secured financing the business tries to access after filing for bankruptcy
- Breaking or entering into lease agreements
- Modifying or entering into business agreements
- Payment of attorney and other professional fees (even keeping such professionals on retainers)
- Expanding or closing business operations
Creditors have a say in the approval of your Chapter 11 bankruptcy petition. Creditors whom you owe secured debts may vote to support or oppose your petition for bankruptcy or your proposed repayment plans. You have to approach each creditor with your proposed repayment plan and request for their vote.
Some creditors may seek to renegotiate the terms or vote down the proposal. In some cases, you can request the judge to approve your petition for bankruptcy, regardless of the creditor who refuses to support the plan. If approved, the creditor will have to accept the repayment offer.
A repayment or reorganization plan is similar to a proposed budget. It outlines the creditors (both secured and unsecured), and equity shareholders. The plan outlines the obligations owed to each party and the priority with which the business will repay each debt.
You can modify the plan before confirmation, or have the court evaluate its fairness to all creditors during a hearing. If the creditors had cast their votes, and the judge determines that the modifications are unfair, the voting process will start again.
The court has to approve the reorganization plan once it meets several requirements such as:
- The plan is likely to succeed based on the proposed revenue, income and debt repayment plan
- The plan must be proposed in good faith
- Creditors have a higher chance of recovering their debts (the minimum repayment must be equal to that of a discharge under Chapter 7 bankruptcy
- The plan is fair and equitable, especially where some creditors vote against the plan
If you owe unsecured debt such as credit card debt, a bankruptcy trustee will appoint an unsecured creditors committee to represent the unsecured lenders. The committee will speak for the lenders to ensure that their interests are considered in the bankruptcy proceedings.
When creating a repayment plan, the secured creditors get top priority than unsecured creditors with higher amounts.
The bankruptcy court will give you four months within which to create a reorganization plan. A reorganization plan allows you to create a financial and operational plan. The goal is to downsize your operations and reduce expenses to have enough left over to repay your debts. In some cases, the court can extend the reorganization period up to 18 months if you provide good cause. Chapter 11 bankruptcy takes more time between the petition and approval. The process for Chapter 11 bankruptcy takes between 6 months and two years to complete. You will need a bankruptcy lawyer to guide you through the process.
The greatest advantage of Chapter 11 bankruptcy is that it allows viable businesses to keep running while paying their credit obligations. Other advantages include:
- You can reorganize your debts to repay an amount the business can afford
- You enter into an automatic stay on your debts, meaning creditors cannot ask you to pay unless with a court order
- You may renegotiate for lower interest rates and repayment with the creditors (creditors are receptive to reorganization as it allows them to receive more payment than they would under Chapter 7 bankruptcy)
However, it comes with several disadvantages, including:
- You are not in full control of the business operations
- You have to submit monthly reports to the bankruptcy court and the US Trustees
- You have to attend status conferences as the court determines
- You must open new bank accounts and books for the business when you request for bankruptcy
- Filing for bankruptcy can be expensive for a business that is already struggling
Generally, the laws surrounding Chapter 11 bankruptcy are complicated, and the costs for the same are high for the client. While it offers a lifeline to a business that wishes to stay afloat, Chapter 13 is a more cost-effective option for your small business.
3. Chapter 13 Bankruptcy
Chapter 13 bankruptcy is similar to Chapter 11 in that it allows your business to reorganize its debt without the pressure to repay these debts. Chapter 13 bankruptcy allows businesses with an income to repay their debts within 3 to 5 years.
Not all small businesses can file for Chapter 13 bankruptcy. Technically, Chapter 13 bankruptcy is available only to individuals. However, if you are a sole proprietor, you can file under your name (a sole proprietorship is an extension of the owner). The eligible businesses must meet the eligibility requirements, such as:
- Have a disposable income
- Your unsecured debts must not exceed $394,725, and secured debt should not exceed $1,184,200
- You have not received Chapter 13 discharge in the last two years, or a Chapter 7 or 11 discharge in the last four years
- You have not had a Chapter 13 bankruptcy dismissed within the last six months for violating a court order or failing to appear
- You must have up-to-date tax records, expenses, and income statements
When filing for Chapter 13 bankruptcy, you need to:
- Pay the filing and administrative fees of at least $300
- Provide a list of all the creditors and the amount you owe them
- Disclose the source and amount of your income
- Provide a list of your property, contract, and leases
- Disclose your monthly living expenses which include the necessities
This form of bankruptcy eliminates unsecured debt and allows you to keep most of your assets, especially your home. However, you will have to spend your disposable income on repaying your debts.
The unique features of Chapter 13 bankruptcy are the protection of your assets not available for Chapter 7 bankruptcy and forgiveness of some debts. Chapter 7 bankruptcy liquidates your business, and you may lose assets that the law does not protect. However, with a Chapter 13 bankruptcy, you can protect your assets from repossession and foreclosure.
However, to be fair to creditors, the court will require that you pay at least a sum equal to the value of the non-exempt property. Non-exempt property is that which could have been sold if your business filed for Chapter 7 bankruptcy. The court distributes the value within three to five years, to allow you to make these payments comfortably. Once the repayment period expires, the court will discharge any outstanding debts.
Chapter 13 bankruptcy is a safer option compared to Chapter 7. It allows you to keep your business and protect your assets. Other advantages of filing Chapter 13 bankruptcy include:
- It allows you more time and flexibility in repaying your debts
- The means test is not mandatory in Chapter 13 bankruptcy
- Chapter 13 bankruptcy stays on your credit report for a shorter period compared to Chapter 7 bankruptcy
The disadvantages include:
- It is more expensive to file than a Chapter 7 bankruptcy
- It takes longer to repay your debts
- You will not have any disposable income until the repayment period expires
- The bankruptcy appears on your record for seven years, which makes it hard to acquire credit, or you have to pay higher interest rates
- You will lose your credit cards
- Getting a mortgage becomes harder
- You have to wait six years after the date of filing before filing for Chapter 7 bankruptcy
- You still have to repay debts such as employee wages, alimony, child support, student loans and taxes
- You have to explain the reasons you are filing for bankruptcy
Before filing for Chapter 13 bankruptcy, you have to evaluate your business situation to ensure that you can keep up with the payment if the court confirms your petition. Failure to repay these debts can lead the court to dismiss your petition, which exposes your property to repossession and foreclosure.
A bankruptcy trustee is a court-appointed official who oversees the bankruptcy estates, receives income from the debtor, and allocates it to various creditors. Bankruptcy trustees may have different obligations depending on the type of bankruptcy you file.
In Chapter 7 bankruptcy, the trustee's roles include:
- Rounding up your property
- Selling the property
- Challenging claims from the creditor
- Distributing the proceeds from the property sale to creditors depending on the priority and nature of the debts
- Objecting to the bankruptcy based on the circumstances in each case
The court does not appoint a trustee in most bankruptcies under Chapter 11. However, it may be necessary to have one if fraud, mismanagement, dishonesty, and incompetence are present.
Chapter 13 bankruptcy trustees have the responsibility and power to:
- Review the proposed repayment or reorganization plan and making relevant objections
- Receiving or collecting payments from the debtor based on the reorganization plan
- Distributing the income to creditors
The trustee appointed to you may require you to provide information under oath. He or she will review your financial documents, tax forms, income statements, and loan statements. He or she may also confirm your identity and social security number.
A trustee has the power to speed up your bankruptcy petition or have it dismissed. However, you also have a role to play in cooperating with your trustee. You have to provide him or her with the correct and truthful information.
If the trustee uncovers any fraudulent activities such as transferring income to avoid repaying debts, he or she may have your petition dismissed, which means you have to repay your debts and may lose your property.
Find a Los Angeles Bankruptcy Lawyer Near Me
Filing for bankruptcy can be a strategic move for your business. While it has a lasting impact on your credit, repossession and defaulting on your loans have an even bigger negative effect. You can reduce the burden of your business debts by choosing the best bankruptcy plan for your small business. The first step towards choosing the right plan is getting a qualified and knowledgeable bankruptcy attorney. Such an attorney should be familiar with the bankruptcy laws both at the federal and state level to help you adequately. The Los Angeles Bankruptcy Attorney helps clients like you in navigating the bankruptcy laws and keeping as many assets as is legally possible. The attorney examines your financial situations and the possible weaknesses or actions that could affect your bankruptcy case. Contact us at 424-285-5525 for a free consultation.