Small Business Bankruptcy

How to File for Bankruptcy

As an entrepreneur, you probably view bankruptcy as a worst-case scenario. The reality is that bankruptcy is a better scenario than going to debtor's prison! Of course, filing for bankruptcy isn't something to strive for, but every entrepreneur should understand how the bankruptcy process works -- just in case things don't go as planned.

As a goal-oriented small business owner, bankruptcy is something you hope you never have to think about. But, if the unthinkable happens in your business, a basic knowledge about how bankruptcy works might just be a godsend.

Small Business Bankruptcy

Bankruptcy laws are designed to protect you - the debtor - as well as your lenders. It wasn't long ago that people who couldn't pay their debts were locked away in prisons and forced to survive on a diet of bread and water until they could pay up. If your business fails nowadays you might not be able to afford much more than bread and water, but you can be assured that you won't be sent to jail and that your lenders will be reimbursed in the most fair and equitable manner possible.

Federal law generally allows for two different kinds of business bankruptcy: Chapter 7 and Chapter 11.

Chapter 7 Bankruptcy
Chapter 7 bankruptcy is the most common form of bankruptcy. It involves the total liquidation of the company's assets in order to repay debts owed to qualified lenders. An appointed trustee collects all of the assets that have been designated as non-exempt by the court, sells them, and distributes the proceeds to the creditors.

Chapter 11 Bankruptcy
While Chapter 7 bankruptcy can be described as a liquidation, Chapter 11 bankruptcy can best be described as a reorganization or rehabilitation of the business. The goal of Chapter 11 bankruptcy is to restructure the business and debt payments in such a way as to allow the business to meet its obligations from future earnings. As in the case of Chapter 7 bankruptcy, Chapter 11 reorganizations are also supervised by a court-appointed trustee.

Bankruptcy proceedings can be initiated either by the small business owner or by creditors. Once they have begun, however, both sides are subject to limitations. Business owners are restricted from selling or transferring assets and creditors are restricted from contacting the business owner for the purpose of collecting the debts.

In the event of a bankruptcy, secured creditors (creditors who have collateral for their loans) are paid before unsecured creditors. Typically, the secured creditor will be given the item(s) they have secured as collateral. If this does not fully repay the amount owed to them, the remaining debt will be transferred into the same category as the business' other unsecured debts such as credit cards, utility bills, etc.

Resist the temptation to buy into a scheme that promises to save money by helping you do your own bankruptcy. The stakes are too high and bankruptcy law is too complicated to take yourself on as a client.

Instead, look for a reputable bankruptcy attorney who has a proven track record of success with small businesses. A good attorney may not make it possible for you to avoid bankruptcy, but he might help you get through it with your checkbook - and your dignity - intact.

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We greatly appreciate any advice you can provide on this topic. Please contribute your insights on this topic so others can benefit.

  • A4 Auction posted on 3/16/2009
    A4 Auction
    Auctions are a great way to liquidate companies as they can be done in far less time than most liquidators.
  • Almost Out of Business posted on 3/18/2011
    Almost Out of Business
    My business factors its invoices through a factoring company. The customer that signed the invoices and agreed to pay the factoring company the past due invoices has gone out of business in bankruptcy. Now the factoring company is asking me to pay the money. And my company is really on the edge of folding. How do i get out of this debt? Am I personally responsible because I was the CEO?
  • Ken Gaebler posted on 3/18/2011
    Ken Gaebler
    You should talk to a small business lawyer and see what they say. My guess is that it really depends on things like what entity type you are, the factoring company contract you signed, etc.

    Unless you agreed to be personally liable for the debt to the factoring company, odds are that filing bankruptcy will get you out of the debt. However, there are a lot of nuances to bankruptcy law. The trustee can even unwind recent payments you made and recover that money in order to pay other creditors.

    In addition, filing bankruptcy is usually equivalent to closing your business forever. Yes, you can file Chapter 11 and try to reorganize but most small businesses that file for bankruptcy are filing Chapter 7, a liquidation bankruptcy. So, are you ready for that? If not, you probably need to negotiate with the factoring company -- get them to lower the amount they will accept and offer a payment schedule to make good on the debt over time.

    Good luck. People talk about the domino effect of business bankruptcies and it sounds like you're living a case study of it. Be sure to talk to business advisors and to a lawyer before you make any big decisions.

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