If you're in debt because of your business, bankruptcy may allow you to wipe your slate clean.
Written by Attorney Andrea Wimmer.
Updated August 26, 2020
This article is intended for small businesses with a single owner or owners who are a married couple.
A number of factors play a role in determining whether filing a bankruptcy for your business is the right path for you. The first step is to discover the type of business you have. If you are a sole proprietor, no separate business entity exists, and your personal bankruptcy will deal with all of your debts, even those you incurred strictly for business purposes.
If your business is a separate legal entity, such as an LLC or a corporation, a separate filing for your business is possible, though very often unnecessary. You are most likely personally liable for most, if not all, of your business debts. That means if your business defaults or even files for bankruptcy protection, you remain responsible for its debts. Additionally, businesses themselves cannot receive a discharge. In other words, a business bankruptcy rarely (if ever) allows the business owner to avoid a personal bankruptcy. Businesses themselves cannot receive a discharge.
What is your goal?
Since protecting your own credit is not a goal you can typically accomplish by filing bankruptcy for your business, it is important to identify your goal(s) and future plans for your business. Do you want to…
(1) Get a fresh start but continue operating the same type of business? (2) Close up shop and pursue a different career path?
Which goal you choose is first and foremost a personal decision you should make in consultation with your family and folks you trust that know you and your business. An important question that you should ask yourself is how you ended up where you are now. If your business was successful in the sense that it allowed you to make a living and just hit a snag somewhere along the way, it makes sense to use the tools available to you to recalibrate and do what needs to be done to get back on track. If your business, for whatever reason, never got past the stage of being an expensive hobby that did not generate enough income for you to live on, it may be time to move on. It doesn't make sense to work yourself into the ground and struggle day to day when your skills and talents could be better used elsewhere. Ultimately – you are in the driver seat in making this decision!
What business is your business in?
Generally speaking, your business is either a service-based business or a product-based business. In a service-based business, you are the biggest asset your business has (because you are the plumber, carpenter, realtor, etc.) that the business is built around. Without your expertise and work, the business has no real revenue stream.
A product-based business, on the other hand, is more of a brick and mortar operation with a lot of proverbial "stuff" (such as inventory, real property, equipment, or machinery). While you are the heart and soul of your business, you could hire and train anyone to handle some of the main revenue generating tasks.
With that in mind, let's turn back to your goals….
I want to keep my service-based business going!
There are several options available to keep you and/or your business going. Since you are the main asset your business has, often times your best bet will be to close up shop (see below for more on that) and continue on as a sole proprietor. You can wind down your business entity pursuant to your state's laws, purchase any tools of the trade, consumer lists or similar items from the business, and use these tools moving forward. This is both a fairly straight-forward way to go and a tricky path to navigate as it is important to do it "right .”
Most states include protections (i.e. exemptions) for tools of the trade, so timing also plays an important role here. In an ideal world, you buy the tools from the business, wind the business down, then file your personal bankruptcy, exempting whatever tools of the trade you own. This will allow you to keep your business going without having to go through an expensive business reorganization in the bankruptcy court.
I want to keep my product-based business going!
If your business has a lot of assets and you find yourself in a tough spot with creditors, Chapter 11 bankruptcy could be the way to go. Unlike a Chapter 7 bankruptcy, which will necessarily result in the liquidation and shutting down of your business, a Chapter 11 bankruptcy may be used to reorganize your business and its debts. In other words, you are given the opportunity to propose a plan on how to get everything back on track while under the protection of the bankruptcy court.
Closing up shop…
While it may seem as though filing a Chapter 7 for your business is the right thing to do if you've had enough of running your own business and are ready to shut it down, that is not always the case. In fact, often times a Chapter 7 bankruptcy filing for a business turns the relatively simple winding down of your business into a really expensive endeavor with no added benefit. Your state's laws already provide a road map as to what needs to be done to wind down and dissolve your business without the need and expense of bankruptcy protection.
Are you the biggest asset your business has?
If you are in a service-based business and you are your business’ greatest asset, simply closing the business entity according to state law is typically enough to absolve you of being personally liable for your business debts, although there is a slight possibility that your creditors may come after you if you create a new business entity in the future. There is no added benefit to filing a Chapter 7 for your business in addition to filing your personal Chapter 7 bankruptcy to absolve you from your liability on the business debts because (a) there are minimal assets the liquidate, and – more importantly – (b) because a Chapter 7 bankruptcy does not grant a discharge to your business.
What if I have a product-based business, and my business has a lot of inventory, machinery, or other tangible or intangible assets?
In a product-based business, a Chapter 7 bankruptcy may make sense for you even without the benefit of a discharge at the end. When a bankruptcy is filed, a Chapter 7 Trustee is appointed and it will be his/her job to do all of the leg work in winding down your business. This takes the liquidation of the business assets out of your hands and allows you to focus on your future, rather than going through the painful process of selling what you have worked so hard to build.
Do I need a lawyer?
The goal of winding down a business either pursuant to state law or as part of a Chapter 7 liquidation is to get everything wrapped up, with all of your I's dotted and T's crossed. Therefore, if your business has significant assets it needs to deal with in winding down, you should have counsel assist you in the process - regardless of how you go about it. While you may not absolutely need an attorney to assist with winding down the business entity outside of bankruptcy court, you will need an attorney to assist you if your business wants to file for bankruptcy relief. Having an attorney is required as business entities cannot represent themselves in federal court (including bankruptcy court, with some very limited exceptions) in either a Chapter 7 or a Chapter 11 bankruptcy.