Bankruptcy vs Debt Settlement for a Business: 7 Factors That Decide It

Do you currently have a business that’s drowning in debt? Is your bankruptcy lawyer telling you to shut your doors and declare Chapter 7? Bankruptcy is a valid option, but in many cases, it’s not the right option. Especially for business owners. Instead, a debt settlement might serve your needs better.

Deciding Between a Debt Settlement and a Bankruptcy

Do you want to keep the business open or just close it down? This is the most important question to ask yourself when deciding between a debt settlement and a bankruptcy. If you want to close up shop and move on to something else, a business bankruptcy will probably be best for you. On the flip side, if you want to retain your business, then a settlement or Chapter 11 will probably be a better option.

When you declare Chapter 7, your business will almost always have to close it’s doors. This is because your business will have to go through a “liquidation process.” Which means that all of your nonexempt assets will be sold off. Then, the proceeds from those sales will be distributed to creditors that the company owes. You will not be able to choose who gets paid back. This may come as a surprise. Corporations and partnerships can file Chapter 7, but they don’t get the option of clearing the slate through a discharge. Obviously, this is not ideal if you want to maintain your business.

Under Chapter 7, a sole proprietor can keep some exempt property under federal or state law. Most debts get discharged under Chapter 7, but some are not, most notably certain taxes. Where a lien exists on property, Chapter 7 won’t remove the lien.

Now, there is another option for you: Chapter 11. A Chapter 11 business can reduce debts or stretch out payments, or find a way to reorganize more broadly. If your total debts are no more than $3,424,000, and at least half come from business activities, you might be able to continue operations in a “Subchapter V” Chapter 11 plan. The proposal must include all of your projected disposable income for at least three years, and as long as five. A sole proprietor might also qualify for Chapter 13.

Debt settlement is not court-monitored like bankruptcy. It’s an informal, out-of-court deal where you come to an agreement with your creditors. There’s no bankruptcy judge or trustee. The bankruptcy law itself highlights a settlement as an alternative to filing for relief.

Factors in Deciding

Are you getting sued? Can you afford to pay your bills? Do you have anyone hounding you daily? All of these are factors in deciding whether or not a business bankruptcy or debt settlement is right for you. If you have multiple creditors that are pushing extremely hard, a bankruptcy might be better. Filing triggers an automatic stay against most attempts to collect on a debt, meaning your creditors have to cease collection, enforcement, repossession and foreclosure actions. In theory, you get a little breathing room. But the stay isn’t automatic against everything, and there are exceptions. A settlement doesn’t come with that immediate court protection. If the pushing is not too bad at this point, a debt settlement might be a better route.

Did you sign a guarantee? If so, it means that you’ve taken on liability for the debt should your company fail to pay it back. If you sign as a guarantor, that means your business isn’t off the hook - but neither are you. A discharge forgives the debtor of liability for the debt, but not anybody who cosigned or guaranteed it. So if you signed personally for a business loan, you could still owe even if the business declared Chapter 7.

Did you pay any creditors in the last three months? If so, those funds may be “clawed back” by the bankruptcy trustee. The trustee could undo a lien that wasn’t properly perfected. There’s also the trustee’s power to undo transfers that creditors call fraudulent. If you’ve paid a creditor a big sum of money recently, bankruptcy might be a little trickier than just a settlement.

If you decide to file, be ready to fill out a lot of paperwork - you have to provide documents, such as a list of assets and debts, income, expenses and recent tax returns, just for starters. Expect a creditor’s meeting around 21-40 days after your filing. Don’t expect it to be fun.

Cost is a huge thing to consider in this. A Chapter 7 petition comes with a $245 filing fee plus a $75 administrative fee and $15 trustee surcharge. Chapter 11 costs $1,738. A benefit to debt settlements? The firms who handle them can’t charge a fee until after they’ve settled your debt.

After your debts get forgiven, the IRS usually considers the amount as taxable income. If the creditor forgives $600 or more, they generally have to report that amount to the IRS and you’ll get a 1099-C form. Note, though, that debt forgiven in bankruptcy is excluded from income, and so is debt forgiven when you’re insolvent, up to the amount you’re insolvent by. (That means you have to fill out a Form 982.)

A bankruptcy stays on your credit reports up to 10 years, and a charge-off or collection stays on for up to seven. The FTC warns that debt settlement programs that have you stop paying creditors are likely to lead to damage to your credit.

Do you want to keep the business open? Are you being sued? Can you afford to pay your bills? Have you signed a guarantee? Did you pay creditors in the past 90 days? How much paperwork are you willing to fill out? How much money are you willing to spend? Do you want to save your credit score? Asking yourself these questions can really help you in making the decision that’s right for you. Speak to your attorney before you make any definite decisions.