It’s a simple fact of entrepreneurship: Small businesses fail all the time and for many different reasons, some of which are outside of the owner’s control. If you’re falling deeper and deeper into debt by keeping your company open, sometimes the best business decision you can make is to shut down the business and cut your losses.
When it comes to closing a debt-laden business, bankruptcy is one option that can allow you to stop bleeding money and get a fresh start. However, filing for certain types of bankruptcy may not be available for your business entity or the best way to go for your personal situation.
There are multiple types of bankruptcy filings, each with their own benefits and drawbacks. Here we’ll look at what’s involved in a Chapter 7 bankruptcy, discuss its pros and cons, and find out how it affects different types of business entities.
Who can file Chapter 7 bankruptcy?
Both individuals and protected business entities—partnerships, limited liability companies (LLCs), and corporations—can file for Chapter 7 bankruptcy. Business owners can file Chapter 7 for themselves or their business, but since a sole proprietor is personally liable for business debts, the entire financial situation of both will be included when they file for a personal Chapter 7.
Chapter 7 is is a liquidation bankruptcy, which means all of your non-exempt assets will be sold off by a court-appointed trustee to repay your creditors.
Advantages of Chapter 7 bankruptcy
As a sole proprietor, Chapter 7 lets you wipe out both personal and business debt in a single filing. And even though your personal assets will be included in the bankruptcy estate, you can use exemptions to protect some—and maybe even all—of your property.
Indeed, if you don’t have a high income or significant assets, you might be able to use exemptions to protect all of your money and property through what’s known as a “no-assets case.” This is designed to ensure that small business owners have enough assets to sustain themselves while they start over again.
That said, the amount of property you can protect in Chapter 7 bankruptcy varies greatly from state to state and also depends on the value of your assets. Given this, you should consult with us as your Family Business Lawyer to review your state’s exemptions laws.
If your business is a partnership, corporation, or LLC, Chapter 7 is an easy and transparent way to close your business and liquidate its assets, as the trustee becomes responsible for selling off assets and paying your creditors. This provides you with a convenient way to wash your hands of the failing business and start with a clean slate.
Disadvantages of a Chapter 7 bankruptcy
Only sole proprietors receive a discharge of business debts by filing Chapter 7. Also, business entities are unable to use exemptions to protect assets in Chapter 7, which means the trustee will sell off all of your business assets to pay creditors, and your business will be closed for good.
What’s more, even if you own a protected business entity, if you’re personally liable for any of your business obligations (i.e. you personally guaranteed a business loan), you’re still on the hook for that debt unless you file for personal Chapter 7 bankruptcy. This is why many business owners file for Chapter 7 on behalf of both their business and personal liabilities.
The bottom line
Due to the final nature of Chapter 7, it’s not for everyone. It’s best to file a Chapter 7 if you’re looking to shut down your business for good, the business doesn’t have significant assets, and you’re not personally liable for business debt.
It’s not a good option for high income filers or those with lots of property, as depending on your income level, you may not even qualify for Chapter 7. Moreover, some debts are not dischargeable, including student loans, child support and alimony, along with certain income taxes, so in these cases, Chapter 7 would do no good.