Filing for Business Bankruptcy: Pros and Cons of Chapter 7, 11 and 13

Is bankruptcy the right move for your business?

Bankruptcy is not a solution for every business’s financial situation. If you have one or two outstanding debts, working with your creditors is a far better solution than bankruptcy. However, if you have several red flags in regards to your finances or a business that is just not viable, then filing for bankruptcy could make a good deal of sense.

Read on to discover what bankruptcy can and can’t do for your small business and when a business should consider alternatives to bankruptcy prior to filing.

What Is Bankruptcy?

Bankruptcy isn’t merely being broke. Bankruptcy is the legal process in which people or businesses that cannot repay debt seek relief for some or all of their debts to creditors. An important aspect of the bankruptcy process is that the debtor — the person or business filing for bankruptcy — gains what they often call a “fresh start,” while the creditors are treated in a fair manner in regards to the debt owed to them.

Why File for Business Bankruptcy?

A good way to figure out if bankruptcy makes sense is to assess your financial situation. This involves some self-reflection and asking yourself key questions about your business, such as:

  • Are you only making minimum payments on your credit cards?
  • Are you using credit cards to pay for necessities?
  • Are you thinking about debt consolidation?
  • Are you uncertain of how much money you owe?
  • Are collections agencies calling you?

Answering “yes” to just one of these is an issue, but not one to be solved with bankruptcy. If, however, you’ve answered “yes” to several of these questions, then you may want to consider filing for bankruptcy as an option.

Perhaps the biggest benefit to filing for bankruptcy is the sense of relief, or clean slate, that the debtors feel afterward. Declaring bankruptcy is a scary prospect, but it can be a necessary and good solution if your finances are in such bad shape. Bankruptcy laws exist in the U.S. both to assure creditors but also to enable debtors to admit they can’t do it alone and seek help without completely destroying their livelihoods.

Read: Why Your Business Needs a SWOT Analysis

Types of Bankruptcy for Small Businesses

In business bankruptcy, a business that can’t repay its debts files for bankruptcy and, under the guidance and protection of the bankruptcy court, either eliminates the debt or restructures how it is repaid. Business bankruptcies are often described as liquidations or reorganizations.

For small businesses, there are three applicable types of bankruptcy:

  • Chapter 7
  • Chapter 11
  • Chapter 13

Each type pertains to certain business circumstances, so they differ from one another in key ways. Keep reading to learn more about each type of bankruptcy to determine which type is best for your situation.

What Is Chapter 7 Bankruptcy for Businesses?

Chapter 7 bankruptcy is a four- to six-month liquidation process, by which the business — or you if you are sole proprietorship — discloses all assets, income, debt and expenses. If unexempt, business assets are sold by the Trustee and the proceeds used to satisfy or partially satisfy creditors. The business or sole proprietor is discharged of their debts. Chapter 7 bankruptcy is usually best for businesses that have no viable future. It is also sometimes called “straight bankruptcy.”

Pros of Filing Chapter 7 Business Bankruptcy

Review these pros to filing Chapter 7 bankruptcy for businesses:

  • A short four- to six-month process
  • Individuals can deal with their personal and business debt if they are a sole proprietor
  • Can liquidate business assets if wishing to cease business operations

Cons of Filing Chapter 7 Business Bankruptcy

Review these cons to filing Chapter 7 bankruptcy for businesses:

  • Businesses cannot continue operations
  • If individuals gave their personal guarantee for any business debt, they are still liable

Read: What Your Dun & Bradstreet Rating Is and Why It’s Important

What Is Chapter 11 Bankruptcy for Businesses?

Chapter 11 bankruptcy is primarily a reorganization plan. Businesses filing under Chapter 11 can restructure debt as long as they can have their plan approved by the court. Chapter 11 bankruptcies are very complex and, since the debt is restructured and not discharged, you still have to pay back what you owe.

Pros of Filing Chapter 11 Bankruptcy

Here are some pros to filing Chapter 11 bankruptcy for businesses:

  • Businesses continue operations
  • Some unsecured debt may be paid in part and the balance discharged
  • Secured debt can be renegotiated

Cons of Filing Chapter 11 Bankruptcy

Here are some cons to filing Chapter 11 bankruptcy for businesses:

  • Chapter 11 is very complicated procedurally
  • Most businesses must operate under the strict supervision of the Trustee
  • Many secured creditors will have the right to be paid in full and if not, the right to the collateral

See: 9 Ways to Increase Business Profits

What Is Chapter 13 Bankruptcy?

Chapter 13 bankruptcy is a three- or five-year process by which the debtor deals with debt in the Chapter 13 plan. This type of bankruptcy is sometimes referred to as “personal bankruptcy.” It usually involves the reorganization of debts for consumers rather than businesses. The debtor pays a sum monthly to the Chapter 13 Trustee, and the Trustee distributes funds to creditors in order of priority. When the plan is complete, the debtor receives a discharge of all unsecured debt.

Because Chapter 13 bankruptcy is usually reserved for consumers with personal debt, Chapter 13 bankruptcy is available only to individual business owners like sole proprietors. Other types of business structures, such as corporations, LLC, or partnerships, cannot file bankruptcy under Chapter 13.

Related: What Is an LLC?

Pros of Filing Chapter 13 Bankruptcy

Chapter 13 is a powerful tool, with a debtor being able to reap the following pros:

  • Surrender a car, home or other property secured by debt and have that debt discharged
  • “Cram down” a car
  • “Strip off” second and third mortgages as unsecured, and have them discharged
  • Force a car lender or mortgage lender to accept monthly payments on loan arrears

Cons of Filing Chapter 13 Bankruptcy

There are also some cons to Chapter 13 bankruptcy, such as:

  • Available to sole proprietors only, who file an individual petition to deal with business and personal debt
  • Chapter 13 debtors must have sufficient income to fund the plan and make monthly payments to the Trustee
  • Certain debts are not dischargeable, such as alimony or child support, student loans and many types of taxes, fees and fines

See: How to Write a Business Proposal to Bring in New Business

Bankruptcy Alternatives for Small Businesses

If there are only one or two debts that your business cannot pay or cannot pay in full, rather than immediately filing a bankruptcy petition you might consider negotiating with that creditor or with those creditors.

Frequently the threat of bankruptcy will bring business creditors to the negotiation table in the hope that they will receive a better deal in a private setting than they would in bankruptcy. There are many options a business debtor and a creditor might explore, such as:

  • Extending the secured or unsecured loan term to reduce monthly payments
  • Renegotiating the interest rate on any loan or debt, to reduce the monthly payment
  • Reducing the balance of a secured loan based upon the current market value of the collateral
  • Offering an ownership stake in the business in exchange for debt forgiveness

Any small business owner with debt trouble should contact an experienced business bankruptcy attorney to discuss all available options, including both bankruptcy and bankruptcy alternatives.

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Andrew DePietro contributed to the reporting for this article. 

Photo credit: designer491/Shutterstock.com

 

5 thoughts on “Filing for Business Bankruptcy: Pros and Cons of Chapter 7, 11 and 13

  1. It is interesting that your business can continue operations if you file for chapter 11 bankruptcy. My wife and I noticed there are a couple of businesses in our area that has gone out of business and we’ve wondered if it was due to bankruptcy. If we ran a business, we’d consider hiring a professional to help us know what chapter to file for.

    1. Hi Jane,
      Typically, the shareholders don’t have to file for bankruptcy. Instead, with Chapter 7 bankruptcy, all the company’s assets are liquidated to pay off debt first, with equity shareholders second in line for receiving money from liquidation behind debt holders, aka investors who hold corporate bonds. Check out this page: https://www.investopedia.com/articles/01/120501.asp

  2. Hi James,
    When it comes to thinking about and deciding to pursue bankruptcy, it is very advisable that you have a professional help you file for it. They’ll know the advantages, drawbacks and limitations for each chapter of bankruptcy. So your thoughts on running a business are spot on: Getting professional help for bankruptcy matters can make a huge difference in what happens to your company.

  3. Thank you for telling me that filing for Chapter 7 is advisable for small businesses that do not see any future progress in their field. It might be the right choice for my friend who found himself in a financial bind he can’t escape from after filing for a lot of loans for the past years. It might also be better for him if he were to work with a law firm that can assist him properly with the initial steps he has to take with regard to bankruptcy.

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