Schedule Your Free Consultation
bankruptcy clock

Which Bankruptcy Chapter Is Best for a Small Business?

More than 17,000 businesses have filed for bankruptcy so far in 2021. The current commercial bankruptcy rate is lower than for the same period in 2020 and considerably lower than 2019 when almost 40,000 commercial bankruptcies were filed, according to the American Bankruptcy Institute.

The news is far from all rosy. Some experts believe an upcoming surge in bankruptcies will occur after federal stimulus money for small businesses is exhausted. Every day, many business owners struggle to keep their heads above water even in the best of economic times. Some of these owners want to figure out how to keep the doors open, while others look at ways to close without also crushing their finances personally.

The legal structure of the business, the amount of debt and cash flow, and the mindset of the owner all factor into which type of bankruptcy is most appropriate.

Liquidating a Small Business

Most small businesses that open are the realization of a long-held dream. Whether you are selling a product or service, being the boss and charting the direction of a company can be exhilarating. Unfortunately, ownership can also be exhausting and sometimes lead to deep debt.

There are times that for financial and mental reasons, closing the doors is the right call. For those with a backlog of business debt they are struggling to pay, Chapter 7 can provide a clean slate.

The business closes and some debt goes away, but bankruptcy filers may also lose some assets. All business and personal property become part of the bankruptcy estate. Chapter 7 does exempt some assets (some equity in a home, retirement accounts, some equipment needed for your profession, and some personal goods). The nonexempt assets are sold by the Chapter 7 bankruptcy trustee to pay off as much of the outstanding debt as possible.

Since a trustee can’t sell future services, a service provider such as a yoga instructor, a freelance writer, or accountant, may be able to continue working under Chapter 7. Liability insurance and other stipulations might be required.

Restructuring Debt in a Small Business

Congress recognized that not all small businesses want to shut their door. Some business owners want to restructure and stay open, but the only option was a complicated and expensive Chapter 11 that’s better suited for larger businesses. To rectify this, Congress passed the Small Business Restructuring Act of 2019, also known as Subchapter V under Chapter 11. This option went into effect in February 2020.

Under this option, a company can negotiate with creditors for better terms and in some cases dismiss debt. Subchapter V is far simpler and less costly than traditional Chapter 11. Businesses with less than $2.73 million in debt are eligible. Unlike traditional Chapter 11, a judge can enforce a restructuring plan even if creditors don’t like it. A Subchapter V trustee, not a creditors’ committee, keeps the reorganization on course.

With the impact of COVID-19, Congress wanted to expand the number of businesses that could use Subchapter 5 to restructure their debt. As part of the CARES Act, the eligible debt level was increased from $2.73 million to $7.5 million. That expansion was recently extended until March 27, 2022. At that time, the level will most likely return to $2.73 million.

Like all bankruptcies, creditors can no longer hound you about the debt. Creditor collections are halted while the business owner negotiates a restructured debt and payment program, which usually lasts three to five years.

In certain circumstances, Chapter 13 can restructure business debt. This bankruptcy chapter is available only for sole proprietors. Corporations, businesses, and LLCs are not eligible. Sole proprietors can restructure both their personal and business debt through Chapter 13. They will need to pay the value of nonexempt assets (what cannot be protected) through a repayment plan, usually over three to five years.

Understanding Your Business Bankruptcy Options

If your business wrestles with debt and struggles to pay creditors, talk to one of our knowledgeable lawyers at Licata Bankruptcy Firm. We have the experience and compassion necessary to guide you through your options. We will focus on your current situation as well as your future goals.

Explore your options in a free consultation. We will evaluate your situation and discuss possible next steps. Call us today at (417) 213-5006 or use our convenient online form.