Bankruptcy Options for a Small Business: 6 Paths and What Each Leaves Behind

If you are a small business owner, you have several bankruptcy options. You can reorganize through Chapter 11 or its small business section, known as Subchapter V. Or, you can liquidate under Chapter 7. If you are a sole proprietor, you can also file for Chapter 13. And, you could simply file a personal bankruptcy. Finally, you could make an assignment for benefit of creditors. Reorganizing helps keep the business running, while liquidating ends it. The assignment and the Chapter 7 bankruptcy close the business. For the rest, filing is simply a new way of dealing with the business’s debts. And for Subchapter V, you retain control and the business pays over time.

Even a company going out of business gets no discharge in Chapter 7. The owners remain liable on all personal guarantees, and those go away only if the business owner files personally to wipe them out. And businesses with employees have another set of concerns. Any taxes held back from payroll that have not been paid to the taxing agency become ”trust fund” debts for the officers who know about the nonpayment.

The question of reorganization versus liquidation is the first question. If the business is sound but burdened by debt, that calls for a reorganization, in which the debts can be partially paid and eventually resolved.

Subchapter V

The second decision is whether you are small enough to use the new, simpler, less expensive version of Chapter 11 - Subchapter V. It keeps control in the hands of the owner. A viable company that just has too much debt can consider a Subchapter V if it has debts of no more than a certain amount (now $3,424,000) when the case is filed. Subchapter V is available as long as more than 50% of the debt is from the business.

Unlike an ordinary Chapter 11, under Subchapter V only the debtor can propose a plan - the trustee and the creditors have no right to do so. The business owner has ninety days to put in a plan. A special Subchapter V trustee is appointed in every case to suggest steps to reaching a deal on resolving the debts. Among the reforms that went into effect with the creation of Subchapter V are the end of paying quarterly US Trustee fees.

Under Subchapter V, creditors holding unsecured debt could be forced to accept less than full payment, provided the plan is deemed ”fair and equitable,” meaning it pays all your projected disposable income for 3 to 5 years. The minimum repayment period is three years, although the court can make it longer - five years is the maximum in a Subchapter V - depending on the circumstances. But under the recently-revised bankruptcy law the owner may keep the business even if creditors object.

”Conventional” Chapter 11

If your business has debt that makes it too big to qualify for Subchapter V you could consider “conventional” Chapter 11, even though the overall costs are higher. In a Chapter 11, the debtor files a bankruptcy plan. The creditors vote on the plan, but the bankruptcy court must approve it. If creditors do not vote to approve the plan, it is still possible to do it by a procedure known as a ”cram down.”

Chapter 11 usually keeps the current management in place as a ”debtor in possession.” In a Chapter 11, the filing gives the debtor an ”automatic stay,” which is a wall, stopping most lawsuits and collection efforts. You can deal with your debt in Chapter 11 by rejecting bad leases or other onerous contracts. In bankruptcy, the deadline for dealing with your lease is usually 120 days. But the court can often add another 90 days. If it’s rejected, the lease is dissolved, and then the landlord has an unsecured claim, so a wise landlord may agree to lower the rent. Chapter 11 is often a way for businesses to shed leases and reduce loans, in cases where equipment or other collateral is not worth as much as the loan. The loan becomes fully “secured” by the collateral only up to its current market value. The rest of the debt becomes unsecured.

But Chapter 11 costs money. For example, the filing fee alone for a Chapter 11 is $1,738. There are also the fees for professionals you must hire to comply with bankruptcy rules. Preparing the plan and getting it approved can take years. The owners do not get to share unless the people they owe money to are paid in full first. As things unfold in the bankruptcy a committee of unsecured creditors may also form. It may oppose the owner’s plan.

Liquidate It Under Supervision of a Trustee

Not every business can go on. It’s not worth it to try to save a business if there is nothing to save. If there’s no way to reorganize a business, a Chapter 7 is a way to liquidate it under supervision of a trustee. The debts and taxes are paid from what the court allows the trustee to sell or liquidate. Trustees can run a going business for awhile if there is value in it that will be lost. The owners are last in line to be paid; they often get nothing. The company does not exist after Chapter 7 trustee’s sale of assets.

Only the filing of a personal bankruptcy, by an individual, wipes out personal guarantees made by a proprietor, partner or shareholder. So, check whether you, or anyone closely involved, has personally guaranteed any debt. One of the most draconian laws affecting business owners and people who work for them is about unpaid payroll taxes, which you withhold for the government. When payroll deductions for taxes get withheld from employee paychecks but are not paid over to the government, the government views the individuals in control as the people who should pay the unpassed taxes. If these taxes are willfully not paid, the IRS can charge a responsible person a penalty equal to 100% of the unpaid trust fund tax plus interest.

If you are a sole proprietor, Chapter 13 bankruptcy can help you reorganize business debts. A Chapter 13 is only available to individuals, not to corporations or other business entities. The amount of unsecured debt cannot exceed $526,700. The repayment period is at most 5 years.

Outside the bankruptcy system there’s a state procedure called an assignment for the benefit of creditors. The assignee takes the business’s assets, sells them, and pays the creditors in the order the state’s laws set for this type of proceeding.

Once you know whether the business should go on, or end, you know if you are trying to start over, or end a mess. Is it small enough to do Subchapter V? Is the business a corporation, LLC or partnership? What did you personally guarantee? Have you found a capable bankruptcy lawyer yet?