How Bad Is Filing Bankruptcy? 6 Consequences Measured Honestly

Bankruptcy is worse than its defenders admit and better than its reputation, and the difference between those two statements can be measured in years, in dollars, and in the specific things other people are forbidden to do to a debtor. The measuring is the useful part. Asked in the abstract, how bad is filing bankruptcy has no answer; asked about a particular owner with a particular set of guaranties, it has several.

The six consequences below apply whether the question is how bad it is to file chapter 7 or how bad chapter 11 bankruptcy would be for a company that intends to keep operating, though the weight of each shifts with the chapter. The last one is the consequence of doing nothing, which is the comparison most people leave out.

1. The Credit Entry Lasts Ten Years, and Sometimes Longer

A consumer reporting agency may not report a bankruptcy case whose order for relief is more than ten years old, under 15 U.S.C. 1681c. That limit applies to individuals: a sole proprietor, or an owner who files personally. An LLC's or corporation's own case is not a case about a "consumer," a word the statute defines as an individual.

The same section lifts the limit when the report is used for credit of $150,000 or more, life insurance of that size, or a job paying $75,000 or more. An owner rebuilding a business may meet that exception sooner than expected, to the extent a personal report pulled for business credit counts as a consumer report, which is itself an unsettled point.

2. The Docket Is Public and Stays Public

Section 107(a) makes the papers filed in a case "public records and open to examination by an entity at reasonable times without charge." Schedules list what the debtor owns and owes. Anyone curious enough to open an account on the federal courts' electronic system can read them.

This consequence is permanent. It is also, for most small businesses, read by almost no one.

3. The Law Forbids Some Punishment, and Only Some

In 1971, before the current Code existed, the Supreme Court decided Perez v. Campbell, and the Senate report on section 525 describes the section as codifying that decision. The text provides that a governmental unit "may not deny, revoke, suspend, or refuse to renew a license, permit, charter, franchise, or other similar grant" to a person "solely because" that person is or has been a debtor, was insolvent before or during the case, or has not paid a dischargeable debt. A business license or a professional permit sits inside the protection, so long as the bankruptcy is the only reason given for the denial. Private employers may not terminate or discriminate in employment against an individual on the same grounds.

The protection has edges. The word "solely" leaves room for a government to consider "other factors, such as future financial responsibility or ability," in the words of the Senate report that accompanied the section. The private-employer clause, section 525(b), omits the words "deny employment to" that appear in the governmental clause, and whether a private employer may therefore decline to hire someone because of a past case is a question the text raises without settling. Private lenders are not bound by section 525 in their credit decisions at all; a lender may consider the filing, and SBA's own procedures direct lenders to discuss past bankruptcy filings in the credit memorandum.

A statute that protects the debtor's license and leaves the debtor's credit application exposed is, if one is being fair to Congress, a statute about the state's own conduct. It was never a promise about the market.

4. Some Debts and Some Obligors Walk Out of the Case Untouched

For a company, the most significant limit is that its case does not reach its owner. An LLC in chapter 7 receives no discharge, and section 524(e) leaves any other entity liable on the debt, which describes every personal guarantor. The funder stayed as to the company may sue the guarantor the following week.

For an individual, certain debts survive the discharge. Withheld payroll taxes for which the owner is responsible are excepted through sections 507(a)(8)(C) and 523(a)(1)(A). A creditor who proves the debt was obtained by fraud, or by a materially false written financial statement it reasonably relied on, may have it excepted, though only by asking the court. Liens survive too; the Supreme Court in Johnson v. Home State Bank (1991) described a discharge as extinguishing "only one mode of enforcing a claim," the personal action, while the creditor's rights against the property itself continue.

A bankruptcy that leaves the guaranties, the trust-fund taxes and the liens in place is like a fire door installed in a building with no walls: sound engineering, attached to less than the owner assumed.

5. The Filing Starts Clocks for the Next One

An individual who receives a chapter 7 discharge cannot receive another in a chapter 7 case filed within eight years of the first, under section 727(a)(8). Chapter 13 has its own intervals in section 1328(f). A person with a case dismissed within the prior year receives a shortened stay in the next case, and a person with two such dismissals may receive no automatic stay at all without asking the court for one. Chapter 11 carries costs of its own, including quarterly fees to the United States Trustee in cases outside subchapter V and professional fees the court must approve.

6. Not Filing Has Consequences Measured the Same Way

A civil judgment may be reported for seven years from entry, or until the statute of limitations expires if that is longer. In New York a judgment creditor's attorney may issue a restraining notice without going back to a judge, and a served bank must hold the debtor's property. Outside bankruptcy there is no automatic stay, no court to bind a holdout creditor, and no discharge. A business with four advances and one funder refusing to negotiate has none of the tools a petition supplies.

You add up the costs of filing and then you add up the costs of the lawsuits, and only the second list keeps growing. Whether that makes bankruptcy the better choice for a given company is a question worth sitting with before anyone answers it for you.

Where a Settlement Review Stands in This Comparison

Delancey Street negotiates merchant cash advance and related business debt outside court. It is not a law firm, does not file petitions, and cannot provide the stay or the discharge that only a court supplies. What it offers is a no-cost, confidential first review of whether the company's advances and the owner's guaranties can be resolved by agreement, with independently licensed counsel coordinated for legal matters. Some businesses need bankruptcy counsel instead, among them a company facing a funder that will not negotiate, or an owner whose guaranties exceed anything a negotiation could reach.

Bankruptcy's reputation was built on the ten-year entry. The real cost usually lies in what the filing leaves standing.