Bankruptcy Basics for Businesses

From sole proprietors to large corporations, businesses sometimes encounter situations in which their debts and expenditures exceed their income. When that happens, bankruptcy may be one method for a debtor to obtain a “fresh start” and relief from dischargeable debts – and businesses may be able to continue operating, under certain conditions.

Types of Bankruptcy

United States Bankruptcy Code contains several chapters that describe rules for each type of bankruptcy. The three chapters most common for small businesses are Chapters 7, 11, and 13. Following is an overview of how those chapters differ.

Chapter 7 (“Liquidation”)

An individual consumer or any type of business may file for Chapter 7 bankruptcy. Individuals must pass a “means test,” which the court uses to determine financial eligibility for this bankruptcy chapter. A debtor who has too many assets or exceeds a certain ratio of income to debt may not be eligible for Chapter 7 bankruptcy. Businesses do not need to pass a means test. Generally, businesses applying for Chapter 7 have few assets and debts that are significantly greater than income.

Once bankruptcy paperwork is filed, creditors are forbidden from pursuing debt collection activities unless a creditor receives court relief from the automatic stay. This type of bankruptcy virtually eliminates debts, but there are some debts that cannot be erased in bankruptcy: student loans, tax obligations, child support or spousal support, and secured debts (such as mortgages or car loans).

The court may choose to sell your assets to repay your creditors. If you want to keep certain assets, such as a car, you can agree to legally reaffirm that debt, which means you agree to make timely car payments, and your lender agrees to not repossess your vehicle.

Married couples may file bankruptcy jointly or individually. Even if filing as an individual, you would need to provide paperwork regarding your spouse’s income and assets, as well as a list of all income, assets, expenditures, debts, and tax returns.

Chapter 13 (“Rehabilitation”)

Individual debtors and businesses that are sole proprietors may file this type of bankruptcy. Other business structures are ineligible for Chapter 13.

As of April 2016, filers could not have more than $394,725 in unsecured debts or more than $1,184,200 in secured debts (which is any debt based on collateral, such as a mortgage or a vehicle loan). Those debt limits may change each year.

The benefit of Chapter 13 is that it allows debtors to catch up on payments for secured loans. So people who are facing foreclosure may file for Chapter 13 to stop the foreclosure sale. During their bankruptcy plan of three to five years, they make payments to a trustee, who pays the mortgage lender. The trustee may distribute funds to other creditors, too.

Chapter 11 (“Reorganization”)

This is the only bankruptcy option for partnerships, limited liability companies, or corporations that want to continue doing business during and after bankruptcy. Chapter 11 may be the best option for landlords who own a single rental property with less than four units that provides the majority of their income.

Creditors face many challenges in a bankruptcy proceeding to protecting their interests including navigating around the protective stay, proof of claims, priority of claims, dischargeability of debt, and the treatment of creditors in the reorganization plan. Usually, the bankruptcy trustee appoints a committee to represent creditors, and that committee may hire attorneys and charge the debtor for attorney fees. But when cases are classified as a “small business case,” the trustee may decide not to appoint a committee. Small business filers without committee oversight must make regular filings with the bankruptcy court regarding financial outlooks.

Lusk Law, LLC, specializes in assisting small businesses, helping to avoid litigation when possible, and we’re ready to actively represent our clients in court when necessary. Our experienced attorneys provide legal counsel and representation to entrepreneurs in Frederick County, Howard County, Baltimore County, Baltimore City, Carroll County, Washington County, and Anne Arundel County, and other jurisdictions in Maryland, District of Columbia, Pennsylvania, and Virginia. Please call us at 443-535-9715 or fill out our contact form if you have any questions about this topic.

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