When Should A Small Business File For Bankruptcy?
There are many factors to consider when deciding whether or not to file for bankruptcy as a small business. Some common reasons why businesses seek to file bankruptcy include:
- To discharge debt that the business is unable to pay
- To reorganize the business and its finances
- To sell off assets to raise money to pay creditors
If your small business is struggling to make ends meet, it may be time to consider filing for bankruptcy. Bankruptcy can be a difficult decision, but it may be the best option for your business.
What happens to a small business filing for alternative bankruptcy?
Bankruptcy is a legal procedure undertaken by businesses with significant financial problems who cannot fulfill their immediate financial obligations.
When it comes to the bankruptcy code, the objective is usually to restructure debt so that a company may recover from its situation or sell off assets and pay back debts. However, not every scenario is the same, and the prospect of creditors, stockholders, and bondholders regaining their money are determined by a variety of circumstances.
What is a small business debtor?
A “small business debtor” is a person who is engaged in commercial or business activities and has aggregate noncontingent liquidated secured and unsecured debts of less than $2,000,000 as of the filing date for the petition or the order for relief. However, this debt limit may be increased in the near future by the U.S. Congress.
It may include any affiliate or joint debtor of such person who is also a debtor under this title, and a person whose primary business is the ownership of single asset real estate.
What happens when a small business goes to bankruptcy court?
A small business going to bankruptcy court means that the company is in danger of not being able to pay its creditors. In this case, the distressed company may ask the court to either discharge (wipe out) some of its debts or reorganize its debt so it can pay them back over time.
In most situations, a Chapter 7 business bankruptcy filing will terminate the company because no method exists to protect property belonging to a separate legal entity like a limited liability company (LLC). The trustee sells the firm’s assets, pays its creditors, and shuts it down.
On the other hand, sole proprietor small business owners can only file for Chapter 13 bankruptcy protection. As a result, if your firm is a partnership, corporation, or LLC, you will not be able to proceed with its Chapter 13 case.
Sole proprietors and business bankruptcy
You can include personal and business debt in your Chapter 13 bankruptcy if you are a sole proprietor business owner, just like in a Chapter 7 bankruptcy.
If you are a sole proprietor small business owner who has money, a Chapter 13 bankruptcy might be your best alternative. You might be able to keep the company operating while paying less on nonpriority unsecured personal and business obligations such as credit card bills, utility payments, and personal loans.
The small business reorganization act
The following are some of the features of small company bankruptcy:
- shorter deadlines
- a lot of flexibility to negotiate with other creditors
- a private trustee to facilitate the bankruptcy process
The bankruptcy case is facilitated because the debtor must file a reorganization plan for the distressed business with the court’s approval within 90 days of the filing date, and in this way, the trustee may help.
Even if the disgruntled creditors do not accept the plan, the court may still approve it under bankruptcy law.
The restructuring plan must ensure that all expected disposable income for three to five years is used to pay creditors and protect the creditors’ rights. It must be just and equitable to repay creditors equally.
The small business debtors must also submit a disclosure statement to the court that includes information on the scheme for the distressed company’s creditors to consider.
A liquidation analysis that estimates proceeds and cash flow that may be gained if the firm were liquidated must be included in the disclosure statement.
The struggling businesses must also submit some projections about their ability to make payments for the benefit of creditors as indicated in the small businesses’ reorganization plan.
Additionally, once the debtor’s scheme is confirmed, any debts that existed before the confirmation date are removed.
Which business bankruptcy is better: Chapter 7 or Chapter 11?
For a small business debtor, there are several possibilities for business bankruptcy. The business may be reorganized under Chapter 11 Subchapter V (5), or it may be liquidated under Chapter 7.
Chapter 11 bankruptcy is a business reorganization plan, often used by large businesses to help them stay active while repaying every creditor separately with a repayment plan. However, the U.S. Congress recently enacted the Chapter 11 Subchapter V (5) bankruptcy specifically for protection and access to bankruptcy for a small businesses.
Chapter 7 bankruptcy does not need a repayment strategy, but it does require you to sell or liquidate non-exempt assets to satisfy small businesses’ obligations for the benefit of creditors.
Non-bankruptcy alternatives for distressed small businesses
The Coronavirus Aid, Relief, and Economic Security Act (2020) allowed for direct help to American small businesses.
From March 27, 2021, the CARES act raised the debt limit from $2,725,625 to $7,500,000 for Subchapter V cases under the CARES Act. This only applies to qualifying and electing Subchapter V small businesses.
If you are a small business debtor who wants to benefit from this bankruptcy protection, it may be complicated to determine your eligibility. You should seek the counsel of a bankruptcy lawyer to see if you can file for bankruptcy protection.
Bankruptcy might not be your only option as a small business owner in financial distress. You may also consider:
- Obtaining additional financing
- Selling your business
- Closing your business
- Negotiated creditor workouts
- Dissolution or winding down of the business
Working with a law firm as a more efficient alternative
Suppose you are planning on taking advantage of the small business reorganization act and you want to dodge the worst-case scenario. In that case, it is advisable to work with a law firm that understands small business bankruptcy business reorganizations.
Privileges of the bankruptcy attorney-client relationship
A bankruptcy attorney understands perfectly well a bankruptcy process and the bankruptcy code. For them, showing up at the bankruptcy court under financial distress is every day.
If you are still having doubts, you must remember the attorney-client relationship is confidential, which means that the lawyer cannot be forced to testify against you in court.
The attorney can also help you choose the right type of bankruptcy for your business and give you an objective opinion about your case based on your historical financials.
Your lawyer will also be able to help you develop a reorganization plan and negotiate with your creditors. You can organize with them a workout plan to get more cash, how to get new capital, how to continue operating with a debtor, and how to benefit from any automatic stay.
Additionally, if you have any questions about the bankruptcy process for business owners, your lawyer will be able to answer them.