Filing for Bankruptcy When a Small Business Can’t Pay its Debt

April 8, 2019

There are many reasons small businesses fail.  Some are beyond the owner’s direct control. Sadly, not every new business will last and even well established companies fall on hard times.

Bankruptcy can be an option when a business is overwhelmed with debt and, as a result, it is failing.  It’s not always the best choice.  In the event that it is the correct solution there are multiple types of bankruptcy filings and each type has its own advantages and disadvantages.  Michael J. Duffy, who specializes in bankruptcy and business law, was asked by The Intuit Small Business Blog to help sort through the do’s and don’ts of filing for bankruptcy.

Stressed Out Business Owner

Are Your Assets at Risk?

According to Mr. Duffy, small-business owners should only consider bankruptcy if their personal assets are at risk. “If only a limited-liability business entity were suffering financial trouble, the best thing to do is just close the doors and walk away,” he says. “There’s no need to go through any bankruptcy process if the only recourse is against the business.”

Mr. Duffy usually recommends that new business owners organize their enterprise as a corporation, LLC, or other limited-liability entity to help protect their personal assets from business creditors. (Businesses that operate as sole proprietorships or partnerships expose their personal assets to greater risks.)  However, just because you set up a limited-liability structure for your company,  doesn’t mean your personal assets may not still be in jeopardy.  According to Mr. Duffy, this depends on how you run your business.

One big failure to protect your business is  by improperly separating your personal and business finances. If that happens, according to Mr. Duffy, “The court will find that there was no separate business entity, disregard it, and ‘pierce the corporate veil,’ putting the owner’s personal assets at risk.”

Another typical reason: If the business fails then the creditor won’t have sufficient means for recovering its money which makes banks and other creditors reluctant to offer financing to new limited-liability entities.  Therefore most significant credit lines like startup capital, commercial leases, lines of credit, and so on — usually require a “personal guarantee,” meaning the owner must put his or her personal assets at stake to get approved for financing. “The [business owner’s] assets are then just as vulnerable as if there was no corporate entity,” Duffy says. “In many cases, the financing is also secured by personal collateral, such as a home.”

The Types of Bankruptcy for Businesses

Bankruptcy may be the best way to protect personal assets (like a home, for example) from creditors. Knowing which type of bankruptcy to file for is complicated because each state has different laws and there are dozens of other variables, according to Mr. Duffy.  However, grasping the basics can help remove some of the fear and misconception surrounding the process.

Myth:  Chapter 11 is the most common form of bankruptcy filed by businesses.

“You’ve probably heard of Chapter 11, but that’s generally only useful for larger-scale operations, particularly publicly traded companies,” Duffy says. It  It takes a massive amount of time and it’s expensive for all parties involved. “In most cases, if a business is failing, creditors, such as banks, want to cut their losses and liquidate. They’re not interested in going through a complicated and expensive process of reorganizing the company.” (Mr. Duffy does state that there is one reasonable exception: Chapter 11 may provide the best outcome for business owners who have a high personal net worth and regular income.)

Typically small business will either file for Chapter 7 or Chapter 13, he says. Simply stated, Chapter 7 effectively marks the end of the business and results in the liquidation of any capital or assets.  Alternatively, Chapter 13 involves structuring repayment plan that could allow the business to stay open and find success in the future.

The debtor’s income, assets, amount owed, and financial goals are key qualifiers when choosing between Chapter 7 and Chapter 13. Sometimes the court may choose for you.  If you have low income and asset value combined with a large amount of debt then Chapter 7 seems more likely; However, higher income and asset value combined with having a lower amount of debt makes Chapter 13 the more likely scenario.

Avoiding The Situation

Mr. Duffy gives some suggestions for avoiding having to contemplate bankruptcy:  If at all possible don’t use your personal assets to start or operate your business. If your business does face challenges then consider scaling sown rather than “doubling down.”

“It’s better to retreat and regroup than go big and be wiped out,” Duffy says.

Unquestionably, according to Mr. Duffy, you should Write a business plan. According to Duffy, “So often the losses that lead to bad financing decisions can be easily avoided if there is a proper business plan that is followed.”f

If you are facing bankruptcy, whether personal or business then give us a call at Clemmons Law Firm.  843.448.4246 or Click HERE to schedule a FREE Bankruptcy Case Evaluation / Consultation.  We serve the Mrytle Beach and Grand Strand Area and can help you not only make the right choice but also guide you through the process smoothly while protecting YOUR interests.

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