When Should My Business File for Bankruptcy?

Weighing when to seek bankruptcy protection

By Canaan Suitt, J.D. | Last updated on January 10, 2023

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Bankruptcy law “provides people and companies with a fresh start,” says California bankruptcy attorney Richard H. Golubow

The U.S. Constitution empowers Congress to set up “uniform Laws on the subject of Bankruptcies throughout the United States.” In 1978, Congress enacted the federal Bankruptcy Code, which has undergone several updates, including in 2020. 

Bankruptcy is primarily a matter of federal law, although state laws are also at play in determining exemptions (the property you can keep in bankruptcy).  

The U.S. Bankruptcy Code has several sections called chapters that provide different types of bankruptcy for individuals and businesses. 

If you’re a business owner confronting financial difficulties, the prospect of bankruptcy can be genuinely scary. When should you file for bankruptcy? Are there other alternatives to pursue first? 

There may be good alternatives to filing bankruptcy, depending on your situation. The key advice is to seek legal help sooner rather than later if you suspect financial problems on the horizon. 

Types of Bankruptcy for Businesses 

Bankruptcy is available for individuals and businesses that are experiencing financial difficulty.  

There are different types of business entities, including: 

Depending on the kind of business you own, the amount of debt you have, and the revenue you bring in, different types of bankruptcy are available as options: 

  • Chapter 7 bankruptcy. Chapter 7 is called “liquidation bankruptcy” because it involves selling off assets and using the proceeds to repay creditors. Chapter 7 is often used by individuals to deal with personal debts (such as loans, mortgages, or credit card debt). However, companies may also use it to deal with business debts by selling off assets. In fact, it’s the most common type of bankruptcy. To qualify for chapter 7, individuals and businesses must pass the means test. This test ensures the debtor doesn’t have the financial means to repay debts under a debt reorganization plan. 
  • Chapter 11 bankruptcy. Chapter 11 is a type of reorganization bankruptcy. Through the court-administered bankruptcy process, the debtor business works with its creditors to create a repayment plan in specified installments over the course of several years. Chapter 11 allows businesses to remain operational while paying off debts. Note that Chapter 11 provides a simplified and less expensive bankruptcy process in Subchapter V. Under current law, businesses with outstanding debts under a $7.5 million debt limit can qualify for the simplified process of Subchapter V. The debt limit was raised from $2.5 million in 2020 during the Covid-19 pandemic and may change in the future. 
  • Chapter 13 bankruptcy. Chapter 13 is another type of reorganization bankruptcy often used in personal bankruptcy but is also available for sole proprietors. It involves restructuring debt so the debtor can repay creditors over a few years (generally 3-5). Creditors must agree to the proposed payment plan. 

While chapter 7 liquidation is most common, when it comes to reorganizing a business in bankruptcy, “chapter 11 is what is utilized,” says Golubow.  

Should My Business File for Bankruptcy? 

“We try to keep clients as far away from bankruptcy as possible, but if there’s a need to file, then we’re ready to go,” says  Golubow about working with clients. 

“We understand what bankruptcy can provide, but we also understand that bankruptcy can be expensive and time-consuming.” 

In addition to expense and time, Golubow gives other reasons why clients are often hesitant to pursue bankruptcy.  

“With many parties involved in a bankruptcy, [their financial affairs become] a matter of public record, and it can be very unsettling for clients to file bankruptcy because they realize that they’re a completely open book,” he says. 

“In addition to that, they’re working overtime because they’re trying to run a business, but at the same time, they have to deal with all the requirements imposed upon them when they are a debtor in a bankruptcy case,” says Golubow. 

Because of these drawbacks, an experienced bankruptcy attorney will help you consider other alternatives and use bankruptcy as a last resort.  

Since every business and financial situation is different, it’s essential to speak with a lawyer as soon as possible if you’re worried about financial problems. Waiting to get help can result in the problems getting worse. Acting quickly can potentially eliminate the problems. 

What Happens When I Meet with a Bankruptcy Lawyer? 

Before filing for bankruptcy, an in-depth analysis of your financial situation is necessary. 

“We need to understand why it is that [a business] is suffering financial distress,” says Golubow.  

Once that happens, “based on their specific facts and circumstances and needs, we craft one or more proposed solutions to resolve their financial difficulties, and we try to do so without filing bankruptcy and without any formal court intervention,” he says.  

“So generally, we have a very extensive due diligence checklist that includes questions about the business.”  

The checklist includes the business’s “existing state and historical operations.” In addition, “we ask for documentation so that we can have a better understanding of how the business operates, including its contractual relations with other key parties to their business.”  

Ultimately, “we utilize our knowledge of the Bankruptcy Code as a backdrop, so we understand exactly what we can do if there was a need to file a bankruptcy,” says Golubow. “Then we look to develop out-of-court resolutions with the client and critical constituents.” 

What Is the Bankruptcy Process? 

Specialized federal courts called bankruptcy courts handle bankruptcy.  

To start the bankruptcy process, a business files a bankruptcy petition along with filing fees.  

The petition includes forms detailing the business’s finances and eligibility for bankruptcy. Essentially, the petition presents to the court the sort of analysis Golubow conducts with clients to evaluate their business situation, including the business’s debts, finances, obligations, and history. 

Filing for bankruptcy creates an automatic stay, which prevents creditors from taking legal action from that point forward.  

Additionally, in chapter 7, chapter 13, and some types of chapter 11 cases (notably Subchapter V), a bankruptcy trustee is appointed. This is an individual who will oversee the bankruptcy case. 

You will then have a mandatory meeting of the creditors. While creditors often don’t make an appearance at this meeting, it’s still important since the debtor must appear and testify under oath about their financial situation.

What Are the Benefits of Filing for Bankruptcy? 

Bankruptcy has several potential advantages. For example, bankruptcy: 

  • Allows a business to regain profitability 
  • Allows small business owners to start over 
  • Allows small businesses to pay off debts while remaining in business 

However, you may be able to achieve these outcomes without going through the formal bankruptcy process. It’s best to speak with a bankruptcy attorney about your situation to figure out the best course of action. 

Questions for a Bankruptcy Attorney 

Fortunately, many attorneys provide free consultations, allowing the attorney to hear the facts of your case and for you to determine if the attorney meets your needs. 

To see whether an attorney or law firm is a good fit, ask informed questions such as: 

  • What are your attorneys’ fees and billing options? 
  • Do I have alternatives to filing bankruptcy?  
  • What are my bankruptcy options? 
  • What are the eligibility requirements for the different types of bankruptcy? 
  • How long will bankruptcy take? 
  • Will I have personal liability if I file for bankruptcy? 
  • Will my personal assets be at risk in business bankruptcy? 

You can visit the Super Lawyers directory and use the search box to find a lawyer based on your legal issue or location.  

Look for a bankruptcy lawyer in the Super Lawyers directory.

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