Ara Betty is a freelance financial writer and speaker about personal financing. She helps people realize their goals on becoming debt free with the use of debt consolidation. She hopes to expand her knowledge more about loans and debt to be able to write a book.
When a business is near failing or so far in debt that it cannot continue to operate, its owners may need to file a Chapter 7 bankruptcy claim. Let’s look at Chapter 7 bankruptcy and what it can do for small businesses, corporations and LLCs.
What is Chapter 7 bankruptcy?
Chapter 7 is a liquidation bankruptcy designed to wipe out your general unsecured debts such as credit cards and medical bills. To qualify for Chapter 7 bankruptcy, you must have little or no disposable income. If you make too much money, you may be required to file a Chapter 13 bankruptcy.
When you file for Chapter 7 bankruptcy, a trustee is appointed to administer your case. In addition to reviewing your bankruptcy papers and supporting documents, the Chapter 7 trustee’s job is to sell your nonexempt property to pay back your creditors. If you don’t have any nonexempt assets, your creditors receive nothing. As a result, Chapter 7 bankruptcy is typically for low- income debtors with little or no assets who want to get rid of their unsecured debts.
How does it work?
The case begins by filing the official petition, schedules and statement of financial affairs. These forms prompt you to list all of your assets and all of your debts, along with some recent financial history. Keep in mind that this is the most important and most time- consuming part of a bankruptcy filing
It is important that every creditor is listed in the schedules with an accurate mailing address. You must list all of your debts, even if you intend to reaffirm the debt, or if the debt is nondischargeable.
The schedules also list your property, any debts secured by that property, and the sale value of the property. “Property” here means “assets” or “possessions”, not just real estate. Your choice of exemptions is made on one of the schedules.
The schedules are signed by the debtor under penalty of perjury. The schedules are filed with the bankruptcy clerk in the district in which you live, or have lived for the greater part of the last 180 days. For most purposes, the rights of the debtor and the creditors are those that exist on the day that the case is filed. All of the proceedings in bankruptcy after the filing relate to the situation as it was on the day the case was filed.
Chapter 7 bankruptcy for businesses
If you are a small business owner struggling to keep things together, filing for Chapter 7 bankruptcy for business may help save your company or provide a simple way to liquidate it. A personal Chapter 7 bankruptcy can also help you get rid of your personal liability for company debts.
Liability for small business debts
It depends largely on the structure of your business. If you are the only owner of the business and you did not form a specific business entity, you are probably a sole proprietor. A sole proprietorship is not a separate legal entity, which means you are personally responsible for all business debts and when you file for bankruptcy, you are actually filing a personal bankruptcy.
How does Chapter 7 bankruptcy work for small businesses?
When filing bankruptcy, an automatic stay goes into effect and prohibits most collection activities. A Chapter 7 bankruptcy trustee is appointed and charged with selling off the debtor’s non-exempt assets to pay off its creditors according to their priority.
In a personal bankruptcy, all dischargeable debts are wiped out so the debtor is no longer required to pay them. In a business bankruptcy, there is no discharge and no exemptions. As a result, all business assets are sold and the proceeds are distributed among creditors.
How can Chapter 7 bankruptcy help small business owners?
The answer depends on the business structure.
A sole proprietorship is not a separate legal entity, so it cannot file a Chapter 7 bankruptcy on its own. When a sole proprietor files a personal Chapter 7 bankruptcy, the business also files bankruptcy as a result. All business debts are treated as personal debts and get wiped out by the discharge. By using your exemptions, you can protect the assets of the business. So with a Chapter 7, you can wipe out your debts and continue operating the business.
A partnership is a separate legal entity and can file a Chapter 7 bankruptcy for businesses. As discussed earlier, there is no discharge or exemption in a business bankruptcy. So if your partnership files a Chapter 7 bankruptcy, the trustee will close and liquidate the business by selling all its assets to pay creditors.
The partnership’s bankruptcy does not affect the personal liability of its partners. If there weren’t enough assets to pay off all creditors, they can go after your personal assets if you were personally liable for the debt. The trustee can also sue the general partners to pay any remaining creditors. So if you were on the hook for the partnership’s debts, you may have to file a personal Chapter 7 bankruptcy to discharge your obligations.
Chapter 7 bankruptcy for LLCs and corporations
Filing for Chapter 7 bankruptcy is a good option for corporations and limited liability companies (LLCs) that are going out of business.
Corporations and LLC basics
In order to form a corporation or an LLC, you must file certain documents with the secretary of state and pay registration fees. When you incorporate your business or form an LLC, it becomes a separate legal entity. As an owner, you are considered a shareholder of the corporation or a member of the LLC. This means that the company has its own assets and debts that are separate from those of its owners.
- Liability for corporate and LLC debts
Corporations and LLCs are both liable for their own debts since they are separate legal entities. Usually, the owners of the company are not personally on the hook for the obligations of the business. As a result, forming a corporation or an LLC is a common way to shield your personal assets from business debts.
However, you may still be held liable for corporate or LLC debts under certain circumstances. You can voluntarily make yourself responsible for business debts by cosigning or personally guaranteeing the loan or by providing your personal assets as collateral. Alternatively, a creditor can go after personal assets by proving that the corporation or LLC was a sham or an alter ego of its owners. This is known as piercing the corporate veil.
How is chapter 7 bankruptcy can help a corporation or LLC?
Corporations and LLCs don’t receive a discharge by filing Chapter 7 bankruptcy. A business Chapter 7 is designed to liquidate the company’s assets and pay its obligations. Since exemptions are not available in a business bankruptcy, all assets of the corporation or LLC are sold and the proceeds distributed among its creditors according to priority.
The benefit of a Chapter 7 bankruptcy is the easy and orderly liquidation of the business. When the corporation or LLC files for Chapter 7, it becomes the duty of the bankruptcy trustee to sell off its assets and pay its creditors. This means that the owners don’t have to go through the hassle of settling debts with the company’s creditors.
What if you were personally liable for corporate or LLC debts?
Your corporation or LLC’s Chapter 7 bankruptcy doesn’t change your obligation to pay the debts you were personally on the hook for. If a business debt you were liable for did not get paid off in the bankruptcy, that creditor can now look to your personal assets to satisfy the obligation.
Usually, the simplest solution to this problem is to file a personal Chapter 7 bankruptcy yourself. Since you can discharge your debts in a Chapter 7 personal bankruptcy (unlike a business bankruptcy), your personal liability for business debts will be wiped out by the bankruptcy.
Disadvantages of Chapter 7 bankruptcy for corporations and LLCs
Filing a Chapter 7 basically, means the end of the business. You will no longer be able to operate it or negotiate its sale to a third party under more favorable terms. Further, you can usually sell your company’s assets at a better price than the bankruptcy trustee. So if you were personally liable for the company’s debts, you may be left with a larger personal liability than if you had negotiated with the creditors and sold the assets yourself.