3 Types of Business Bankruptcy

A sign that reads United States Bankruptcy Court

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Small businesses can fail for a variety of reasons, and many of these failing businesses find themselves faced with deciding if they should file for bankruptcy protection. Bankruptcy is a process you go through in federal court and is designed to help your business eliminate or repay its debt under the guidance and protection of the bankruptcy court. Business bankruptcies are usually described as either liquidations or reorganizations depending on the type of bankruptcy you take.

There are three types of bankruptcy that a business may file for depending on its structure. Sole proprietorships are legal extensions of the owner. The owner is responsible for all assets and liabilities of the firm. A sole proprietorship can take bankruptcy by filing for Chapter 7, Chapter 11, or Chapter 13. Corporations and partnerships are legal entities separate from their owners. As such, they can file for bankruptcy protection under Chapter 7 or Chapter 11.

Chapter 7 - Business Bankruptcy

Chapter 7 bankruptcy may be the best choice when the business has no viable future. It is usually referred to as a liquidation. It is typically used when the debts of the business are so overwhelming that restructuring them is not feasible.

Chapter 7 is also appropriate when the business does not have any substantial assets. If a business is just an extension of a particular owner's skills, it usually does not pay to reorganize it, and Chapter 7 is appropriate. Chapter 7 bankruptcy usually means that the business is dissolved.

In Chapter 7 bankruptcy, a trustee is appointed by the bankruptcy court to take possession of the assets of the business and distribute them among the creditors. After the assets are distributed, and the trustee is paid, a sole proprietor receives a "discharge" at the end of the case.

A discharge means that the owner of the business is released from any obligation for the debts. Partnerships and corporations do not receive a discharge.

Chapter 11 - Business Reorganization

Chapter 11 is a better choice for businesses that may have a realistic chance to turn things around. Chapter 11 is a plan where a company reorganizes and continues in business under a court-appointed trustee. The owner of the company may actually be the trustee.

The company files a detailed plan of reorganization outlining how it will deal with its creditors. From there, creditors will vote on the plan. If the court finds the plan is fair and equitable, they will approve the plan.

Reorganization plans provide for payments to creditors over some period of time which may exceed twenty years. Chapter 11 bankruptcies are exceedingly complex and not all succeed. It usually takes over a year to confirm a plan. 

Chapter 13 - Personal Bankruptcy

Chapter 13 bankruptcy is a reorganization bankruptcy typically reserved for consumers, though it can be used for sole proprietorships. You file a repayment plan with the bankruptcy court detailing how you are going to repay your debts.

The amount you have to repay depends on how much you earn, how much you owe, and how much property you own. If your personal assets are involved with your business assets, as they are if you own a sole proprietorship, you can avoid problems such as losing your house if you file Chapter 13 versus Chapter 7.

Consult with a good business bankruptcy attorney before deciding on which type of bankruptcy you will file or whether you need to file bankruptcy at all. There may be other options that could be explored first.