Types of Small Business Bankruptcy

There are three main types of bankruptcies small businesses must consider. 

Depending on your company’s organizational structure, monthly earnings, and bankruptcy attorney, the type of bankruptcy that’s best for you differs. 

Let’s look at how Chapter 7, 11, and 13 bankruptcy filings differ and who they’re best suited for!

Chapter 7

Chapter 7 is the most common type of bankruptcy. 

Another name for Chapter 7 is liquidation bankruptcy. 

Typically, Chapter 7 filings take between four and six months. 

Unlike other forms of bankruptcy, federal bankruptcy laws demand business owners still pay the following types of debt: 

• Alimony 
• Child support 
• Select taxes 
• Student debt (in most cases) 
• Liens on property 

There are advantages and disadvantages of Chapter 7 bankruptcy (which I’ll cover later). 

What is It?

As previously mentioned, Chapter 7 bankruptcy is often called ‘liquidation bankruptcy.’

If you declare bankruptcy under Chapter 7, this option typically results in your business closing during or after the process. 

Therefore, businesses that cannot create a repayment plan for their debts or have no assets left to sell will declare this type of bankruptcy. 

In these cases, bankruptcy laws require a trustee to sell or liquidate the company’s remaining assets in order to repay secured and unsecured debt. 

Once the trustee sells everything, they distribute the money among creditors. 

If there is still debt remaining, the debts are discharged, meaning the debtor is no longer legally required to pay them. 

It’s important to note that although Chapter 7 can wipe out your debt, it does not erase the credit history of the bankruptcy itself, which can remain on your credit report for up to ten years.

Pros and Cons of Chapter 7 Bankruptcy

There are certain advantages and disadvantages to Chapter 7 bankruptcy. 

For example, some of the pros associated with this type of bankruptcy case include: 

• It relieves business owners from debt collectors 
• Most Chapter 7 filers have success in getting their debts discharged 
• You get to keep your property 

Still, there are a few cons to know about with Chapter 7 filings, which include: 

• You can’t file for Chapter 7 if your income is over a certain threshold 
• The owners’ credit will take a hit 
• You can lose certain types of property and nonexempt assets 

Chapter 11

Chapter 11 bankruptcy is a type of reorganization bankruptcy. 

Typically, large corporations and LLCs (or any business legal structure that operates separately from its owners) utilize Chapter 11. 

Most small businesses don’t opt for Chapter 11 bankruptcy because it is: 

• Complex 
• Time-consuming 
• Expensive 

When a company has too much debt but still has disposable income and wants to stay in business, Chapter 11 is an excellent option. 

What is It?

Chapter 11 bankruptcy allows the debtor to propose a plan of reorganization to keep its business alive and pay creditors over time. 

The process begins with filing a petition in bankruptcy court, which should include the following things:  

• Detailed financial information about the company’s assets
• A description of the company’s liabilities
• Business Affairs

If the court approves the bankruptcy plan, the business can decrease its debts by repaying some obligations and discharging others. 

Also, the debtor can terminate burdensome contracts and leases, recover assets, and rescale operations to become profitable again. 

However, during this process, the debtor remains in control of its business operations as a debtor in possession, but it is subject to the oversight and jurisdiction of the court.

Pros and Cons of Chapter 11 Bankruptcy

Like other forms of bankruptcy, Chapter 11 has its pros and cons. 

For instance, some of the advantages include:

• Room for Recovery: Chapter 11 bankruptcy allows businesses to restructure their debts and continue operating, which can be a company lifesaver.
• Control of Assets: Debtors retain control of their business operations despite legal proceedings. 

On the flip side, the disadvantages may include:

• Complex and Expensive: The filing process for Chapter 11 bankruptcy is notoriously difficult and costly. Legal and administrative fees can pile up, which some small businesses cannot afford.
• Public Scrutiny: During the process, the business’s financial information becomes a public record, impacting the company’s reputation and relationships with clients and suppliers.

Chapter 13

Chapter 13 is for companies with reliable disposable income who wish to keep their business but must repay their loans. 

Per the bankruptcy code, businesses must follow a repayment plan that lasts between three to five years.

If the business completes the repayment plan successfully, the following types of unsecured debt are discharged: 

• Personal loans 
• Medical bills 
• Credit card payments 

This type of bankruptcy is only available for small businesses that operate under sole proprietorships. 

What is It?

Chapter 13 bankruptcy, also known as a wage earner’s plan, allows individuals and businesses with regular income to develop a plan to repay all or part of their debts. 

Under this bankruptcy petition, debtors propose a repayment plan to pay creditors over three to five years.

If the debtor’s current monthly income is less than the applicable state median, the plan will be for three years unless the court approves a more extended period. 

Further, if the debtor’s current monthly income exceeds the applicable state median, the plan generally must be for five years. 

The law forbids creditors from starting or continuing collection efforts during this period.

Pros and Cons of Chapter 13 Bankruptcy

Of course, there are advantages and disadvantages to filing for Chapter 13 bankruptcy. 

For instance, some of the pros associated with this type of bankruptcy include the following: 

• Control Over Assets: Chapter 13 bankruptcy allows business owners to retain control over their assets while paying their debts.
• Flexible Repayment Plan: The repayment plans are based on the debtor’s income, allowing owners to repay their debts in manageable installments.
• Potential Discharge of Remaining Debts: Some unsecured debts may be discharged after completing repayments.

Regarding the disadvantages associated with this type of bankruptcy, one must consider the following things: 

• Long Commitment: The repayment plans under Chapter 13 can last up to five years, requiring a long-term financial commitment.
• Impact on Credit: Filing for Chapter 13 bankruptcy will remain on the debtor’s credit report for seven years.
• Limitations on Secured Debts: There are limits on the amounts of secured and unsecured debt a debtor can have. 

Consider these pros and cons carefully before proceeding with Chapter 13 bankruptcy!