If you're struggling to make ends meet for your business you can dissolve your business under state law or file bankruptcy. The type of bankruptcy you'll file depends largely on the business's structure. You can file personal bankruptcy — Chapter 7 or Chapter 13 —bankruptcy if you're a sole proprietor. If your business is an LLC, corporation, or other legal entity, you may want to file Chapter 11 instead. It's often good to get legal help when filing a business bankruptcy.
Written by Curtis Lee, JD.
Updated June 1, 2022
You’ll want to consider several factors when deciding if filing bankruptcy for your business is the right path. If you own or co-own a small business consider these questions before filing bankruptcy: What legal form does your business take? What are you hoping to achieve by filing bankruptcy?
This list isn’t exhaustive, but it’s a good place to start when deciding whether you should file bankruptcy for your business.
What Type of Business Do You Have?
Businesses come in many forms, but common structures include:
If you have a sole proprietorship, you don’t have a separate business entity for your products or services. So you can file for personal bankruptcy, either Chapter 7 or Chapter 13. A personal bankruptcy will handle all of your debts, even those you incurred strictly for business purposes.
If you have a registered business entity, such as an LLC or a corporation, you may be able to file separately. But filing bankruptcy for these small businesses is often unnecessary because you’re often personally liable for business debts. Plus, businesses can’t receive a discharge. In other words, a business bankruptcy rarely allows the business owner to avoid a personal bankruptcy.
What Is Your Goal by Filing Bankruptcy?
It’s important to identify your goals and future plans for your business before filing. For example, do you want a fresh start but also want to continue operating? Or do you want to close up shop and pursue a different career path? When thinking about the future, keep in mind that filing bankruptcy for your business may affect your credit score.
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Filing Bankruptcy for a Service-Based Business vs. Product-Based Business
Shuttering a service-based business according to state laws and filing personal bankruptcy under Chapter 7 will typically take care of your business debts. But depending on how the bankruptcy process goes, creditors might come after you if you create a new business entity in the future.
Filing Chapter 7 bankruptcy for your business is possible but not ideal if you don’t have a lot of assets that can be liquidated to pay off creditors. Also, depending on your business structure, creditors might try to seize your assets to repay your business’ debts. Even if you’re not at risk of paying back creditors or you have plenty of assets to liquidate, Chapter 7 bankruptcy may not be the best decision. For example, in some states, it’s actually cheaper to dissolve your business rather than file for bankruptcy.
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 you file bankruptcy, the court appoints a trustee to administer your case and sell your assets.
Filing Bankruptcy When You Want to Keep Your Business Going
If you want a financial fresh start but also want to continue operating your business, your options depend primarily on the type of business you have.
If You Have a Service-Based Business
Because you’re the main asset of your business, your best bet may be to close up shop, file personal bankruptcy, and continue as a sole proprietor. Most states include protections called exemptions for tools of the trade. So you may be able to dissolve your business entity under your state's laws, purchase the tools of the trade from the business, and take advantage of this exemption in your personal bankruptcy.
If You Have a Product-Based Business
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. Chapter 7 results in the liquidation of your business, but you can use Chapter 11 bankruptcy to reorganize your business and its debts. In other words, you’re allowed to propose a plan for getting everything back on track while under the protection of the bankruptcy court.
Do You Need a Lawyer?
It depends. Whether you use state law to dissolve your company or a Chapter 7 liquidation, if your business has significant assets, things can get complicated. Either way, you should probably have legal counsel assist you in the process, regardless of how you go about it.
You aren’t legally required to have an attorney assist you outside of bankruptcy court. But you’re legally required to have an attorney if you want to file bankruptcy on behalf of your business. Business entities typically can’t represent themselves in bankruptcy court, so an attorney may be necessary.
When deciding whether to file bankruptcy for your business, consider your goals for filing bankruptcy, the legal form of your business, and whether you have a service- or product-based business. Depending on these factors, a personal bankruptcy like Chapter 7 or 13 may be a good option. But some business owners will want to consider the benefits of filing a Chapter 11 bankruptcy for their business instead. And don’t forget that the best option might be dissolving your business under state law, rather than filing bankruptcy.