Lasting Effects of Business Bankruptcy

By Cara O'Neill, Attorney
A Chapter 7 business bankruptcy liquidates the assets of a struggling company while a Chapter 11 or 12 can help an income-generating company stay in business by reorganizing debt.

Bankruptcy offers struggling businesses one of three types of relief. It can help:

  • a sole proprietor eliminate business debt
  • a company close in a transparent manner, or
  • an income-generating business stay afloat through a debt repayment plan.

The options available will depend on the business organization and whether the business files a Chapter 7, 11, or 12 bankruptcy.

You can find out more by reading Small Business Bankruptcy Relief.

Chapter 7: Business Dissolution (and Rarely, Debt Elimination)

It’s unusual for a business to close by filing for Chapter 7 bankruptcy (with the exception of a company owned by a sole proprietor). It doesn’t usually provide many benefits since Chapter 7 won’t discharge the company debt (again, except in the case of a sole proprietor).

Additionally, the risks of exposing the personal assets of those holding ownership interests tend to outweigh the convenience of having the bankruptcy trustee assigned to the matter take the laboring oar of selling off company assets.

Here’s how it works.

  • Sole proprietor. If you own a business as a sole proprietor, you’re in a unique position. Chapter 7 bankruptcy will cancel both qualifying personal and business debt, including leases, court judgments, and medical bills. However, both personal and business assets will be available for liquidation on behalf of creditors, too. Some sole proprietors, especially those in service-oriented businesses that don't rely on much product or equipment, can remain in business.
  • Partnerships. When a partnership files this chapter, if the partnership property isn’t sufficient to repay the business debt, the trustee can pursue the personal assets of the partners to repay business debt.
  • Corporations and LLCs. These businesses don’t often use bankruptcy for a company wind down either. First, these businesses aren’t entitled to a debt discharge, and second, bankruptcy provides a convenient forum for filing an alter ego suit—another tool that creditors can use to reach the personal assets of shareholders to repay business debt.

Filing for Chapter 7 isn’t without value, however. It works well when it’s important to close the company transparently to avoid the appearance of mishandling assets. The trustee takes on the responsibility of selling the company’s assets and distributing the proceeds to creditors. But again, the benefits rarely outweigh risks to the stakeholders.

(If you’d like more information, check out Frequently Asked Business Bankruptcy Questions.)

Chapter 11 and 12: Reorganization and Repayment

If your company is still making money, you might be able to keep your business running. Under Chapter 11 (or, in some cases, Chapter 12), you can reorganize the business and repay the debt (or a portion of it) over time.

Chapter 13 also allows debt reorganization, but only individuals can file this chapter. It can be beneficial for an individual operating as a sole proprietor because both the individual and business debt get included in the reorganization plan.

Who Can Authorize a Business Bankruptcy Filing?

Before you meet with a bankruptcy lawyer, it’s important to know who has the authority to file a case—and you can expect the lawyer to check that it’s you before speaking with you. If an unauthorized person initiates the bankruptcy, the court can dismiss the petition.

  • Sole proprietor. A sole proprietor owns the business in its entirety and is responsible for paying the company debt. As the owner, a sole proprietor can initiate a business bankruptcy; however, the owner cannot file bankruptcy in the name of the business alone. The owner’s personal finances will be included in the bankruptcy.
  • Partnership. A partnership is similar to a sole proprietorship; however, more than one owner—or partner—exists. Like a sole proprietorship, general partners are personally liable for company debt, and a bankruptcy filing places the personal assets of the partners at risk. If the partnership appoints a managing partner, that partner can initiate a bankruptcy. If not, all general partners must sign the bankruptcy petition; otherwise, the filing will be an involuntary petition. (For more information, read Can a Creditor Force a Business Into Bankruptcy?)
  • Limited liability company. An individual cannot own a limited liability company. Instead, a person—called a “member”—can hold an ownership percentage or unit of the LLC. The articles of organization list the ownership interests and name the managing members (the people who have authority to make decisions on behalf of the LLC). The articles must give the individual initiating the LLC’s bankruptcy the power to do so.
  • Corporation. As with an LLC, a corporation is a separate entity and can’t be owned by an individual. Instead, ownership interest is obtained by purchasing shares of stock. The board of directors elects corporate officers to take certain actions on the corporation’s behalf. You’ll find the authority to file a corporate bankruptcy in the organizational documents. A shareholder cannot initiate a corporate bankruptcy, which can be problematic if the business is failing and an authorized officer can’t be found.

(Find out what to expect at the 341 meeting of creditors for businesses.)

Filing Individual Bankruptcy for Business Debt: Personal Guarantees and Credit Scores

Even if your business files for bankruptcy, you’ll remain obligated to pay for any debt for which you agreed to assume responsibility personally—and that might not be the outcome you’d like. For instance, if you signed a business credit card agreement or took out a business loan in your name, or you signed a personal guarantee, you’ll remain responsible for that debt. Similarly, filing for bankruptcy will only affect your personal credit report if you took out credit in your name or you are a sole proprietor.

Because most agreements to pay company debt with personal funds can be wiped out in bankruptcy, many business people leave the business out of bankruptcy and file an individual Chapter 7, instead.

  • You might not need to take the means test. Usually, an individual who files for personal bankruptcy must meet income qualifications and pass the Chapter 7 means test. If, however, your business debt exceeds your personal debt, you don’t have to meet this requirement, which can be beneficial if you’re receiving a significant income.
  • Your credit will be affected. Keep in mind that filing for bankruptcy comes at a cost. A business bankruptcy might not appear on your credit report. A personal bankruptcy filed in your name will show up on your credit report for up to ten years.

You can find out more by reading answers to frequently asked questions about personal bankruptcy.

A Business Bankruptcy Lawyer Can Help

The law surrounding business bankruptcy is complicated. Plus, the facts of each case are unique. This article provides a brief, general introduction to the topic. For more detailed, specific information, contact a bankruptcy lawyer.

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