If a company’s obligations outweigh its assets or it runs out of cash, it faces an existential danger. Both issues may be resolved, but if there is no other option, you might consider filing for bankruptcy. Small Business Bankruptcy halts debt collection efforts and may result in the cancellation of certain obligations.
Bankruptcy used to signify insolvency, and the term is still used colloquially to denote such. However, “bankruptcy” is a legal word that refers to the process through which a court of law takes over the administration of an insolvent commercial company. A bankrupt business is insolvent; nevertheless, a business may be insolvent without being bankrupt.
Being a company owner is not for the faint of heart. A lot of things can go wrong. The most serious of them is a lack of clients, but a lack of cash is a close second. It’s easy to believe that something will never happen to you. However, knowing what to do if your company confronts an existential danger is much more reassuring than praying it never does.
Table of Contents
Business Bankruptcy Types
Chapters 7, 11, and 13 are the three basic forms of commercial bankruptcy, each with its own set of regulations and remedies.
Bankruptcy under Chapter 13
Individuals (sole proprietorships) are the only entities that may file.
Stay on autopilot
Debt limits apply.
It is necessary to have a consistent source of income.
It is significantly less expensive than a Chapter 11 filing.
Plan approval occurs significantly more quickly than in Chapter 11.
If a small company owner wants to stay in business while being in grave financial problems, they may file for Chapter 13 bankruptcy. Chapter 13 provides creditors with a reprieve, and it may be feasible to turn things around during this period. When you file for Chapter 13, an automatic stay is immediately imposed. However, in order to qualify for the Chapter 13 relief, a small firm must fulfil specific criteria
Individuals are the only ones who may use Chapter 13. As a result, only a company with no independent legal existence from its owner, such as a single proprietorship, is eligible to utilise the action.
A repayment plan of three to five years must be included in a Chapter 13 filing. This must be done even if the repayments are insufficient to pay off all of the obligations. As a result, the company’s income must be consistent. However, any discretionary money must be devoted to the repayment plan. It cannot also owe more than $419,275 in unsecured debts and $1,257,850 in secured obligations. If it does, it must file for Chapter 11 bankruptcy instead. If the filer’s household income is less than the state median, the plan will last three years. Otherwise, the plan is for five years.
If the payment plan is properly followed, any outstanding sums of qualified debts will be forgiven at the end (discharged).
Bankruptcy under Chapter 11
All lawful business organisations are welcome.
Stay on autopilot
There is no income criterion.
There are no debt limits.
More expensive than a chapter 13 bankruptcy
A Chapter 11 bankruptcy petition is beneficial when a company’s financial troubles are transient and the company can overcome these challenges if given some breathing room. It may also be preferable to continue running the firm if it is expected to be worth more than if it were liquidated in a Chapter 7 bankruptcy and the assets auctioned off piecemeal. Furthermore, the debtor—the business’s owner—is permitted to retain control.
Any form of business organisation, including a sole proprietorship, partnership, corporation, or limited liability company, may file a Chapter 11 petition (LLC).
Chapter 11 takes far more paperwork than Chapter 13 and is significantly more expensive. A trustee is not often appointed, but creditors may petition the court to appoint one. In such scenarios, the trustee assumes day-to-day administration of the company to the degree that they believe is appropriate under the circumstances.
The 2019 Small Business Reorganization Act
The Small Business Reorganization Act (SBRA), which went into effect in February 2020, added a new subchapter of Chapter 11 — Subchapter V — to make it simpler for small firms suffering financial difficulties to get back on track. The debtor retains ownership of the company, but his activities are monitored by a trustee. The debt maximum has been increased to $2,725,625, and the court may approve a repayment plan even if creditors protest.
The CARES Act makes it easier to file for bankruptcy.
The CARES Act broadens eligibility for Chapter 11 subchapter V aid by redefining a “small business debtor.” The maximum has been increased from $2,725,625 to $7,500,000 till March 26, 2021.
Bankruptcy under Chapter 7
Chapter on Liquidation
Stay on autopilot
It is appropriate for solo proprietors, partnerships, and corporations.
There are no minimum or maximum debt limitations.
When it makes no sense to keep a small firm running, Chapter 7 bankruptcy is acceptable. Any form of business entity, including a sole proprietorship, partnership, corporation, or limited liability company, may utilise the chapter. When you file for Chapter 7, an automatic stay is immediately imposed.
The company is dissolved after a Chapter 7 petition is approved. The court will next appoint a trustee to seize the assets, liquidate them, and distribute the money to creditors. A single owner obtains a discharge, which releases them from accountability for the debt, after all of the asset revenues have been dispersed and the trustee has been paid.
Partnerships, corporations, and limited liability companies, on the other hand, do not get this form of liability release. Although a business is dissolved upon acceptance of a Chapter 7 filing, it continues to exist for the purposes of winding up.
Why Would a Company Declare Bankruptcy?
The major reason a company may declare bankruptcy is because its present level of income is insufficient to pay creditors and cover operational expenditures. If there is no chance of things improving, the company may file for Chapter 7 bankruptcy. If you own a sole proprietorship, a Chapter 7 filing allows you to discharge your personal and commercial obligations at the same time. Indeed, if the company obligations exceed the personal debts, the single owner is exempt from the “means test” as non-business persons are.
The means test is intended to guarantee that persons with sufficient wealth will not be able to utilise Chapter 7 to totally discharge their obligations. Such people will have to rely on Chapter 13. A Chapter 7 petition that is accepted reduces debt responsibility immediately. With a Chapter 13 petition, a debtor must diligently complete the repayment plan before being discharged of any remaining obligations.
Filing for bankruptcy under Chapters 7 and 13 instantly initiates a “automatic stay,” which halts any legal action initiated by creditors. The duration of the stay varies. Stays in Chapter 7 cases often last three to four months, although stays in Chapter 13 cases might extend five or more years.
How to Declare Bankruptcy
The basic stages for filing for bankruptcy under Chapters 13, 11, and 7 are the same for all kinds of business companies. However, before filing for bankruptcy, sole owners must complete a credit counselling course, and the certificate of completion must be provided at the time of filing. They must also finish a debtor education course within 60 days of the first date established for the creditors’ meeting.
The following are the stages of a bankruptcy case:
Filing a petition with a bankruptcy court in the region where the firm is situated is the first step.
Submit asset and liability schedules, current income and expenditures, executory contracts and unexpired leases, financial statements, tax reports, and a list of creditors.
A schedule of “exempt” property is also presented in Chapter 7 cases.
File a reorganization/repayment plan (Chapters 11 and 13) as well as a written disclosure (Chapter 11)
Fees must be paid
The Problem of Automatic Stay (Chapter 7 and 13)
Appointment of a case trustee (Chaps. 7 and 13)
Meeting of Creditors (usually between 21 and 50 days after the petition is filed)
The disclosure statement has been approved (Chapter 11)
Confirmation hearings and reorganization/repayment plan approval (Chapters 11 and 13)
Discharge Order Is Issued
What Happens When a Company Files for Bankruptcy?
What Happens to Your Assets After You File for Bankruptcy?
The destiny of company assets after a bankruptcy filing is determined by the form of bankruptcy. Any assets that are transferred to the bankruptcy estate as a result of the filing of a Chapter 7 petition are transferred to the bankruptcy estate. This gives the trustee the authority to liquidate the assets and distribute the money to the creditors. In a Chapter 11 or Chapter 13 proceeding, the assets stay in the hands of the debtor-in-possession (i.e., the business owners).
How Bankruptcy Affects Your Personal and Business Credit
Bankruptcies filed under Chapter 7 remain on customers’ credit records for 10 years from the date of filing. Bankruptcies filed under Chapter 13 remain on customers’ credit records for seven years from the date of filing. A strong credit score, paradoxically, will suffer a larger “blow” than a bad one. A credit score of 780 or higher is likely to decrease 200 to 240 points, although a score of 680 may only lose 130 to 150 points.
After Filing for Bankruptcy, How to Start a New Business
There is nothing that prevents someone who has declared bankruptcy from launching a new firm. The failure of the first endeavour may have produced vital insights that, when put into practise, helped to make the second venture a success. Use legal methods to establish a company to guarantee that the firm is independent from its owners and that the owners are protected by “limited liability.”
Starting a comparable firm requires caution so that the whole arrangement does not look to be a deceptive ruse to get previous creditors off one’s back. Otherwise, a creditor of the old firm may be able to collect from the new business by claiming it is really the old business disguised as a new one.
Obtaining a Credit Card Following Bankruptcy
Obtaining a new credit card after bankruptcy may not be as tough as you believe. Credit card businesses have created two sorts of products for post-bankruptcy consumers. They provide secured credit cards, which are credit cards that are backed by some type of collateral, generally a cash deposit. There are other unsecured credit cards accessible. They often feature a minimal credit limit, as well as a high interest rate and fees.
Is It Difficult to Get a Loan After Filing for Bankruptcy?
It may be challenging, but it is not impossible to get a personal or company loan after filing for bankruptcy. Your best chance is usually a loan backed by some collateral, so that the lender may use this asset if the borrower is unable to make the instalments.