Paul Horton: When is Bankruptcy an Option for a Small Business?

When a business owner is thinking about bankruptcy, the best next step to take is to talk to a Bankruptcy Lawyer. The next question to ask is whether the business is a corporation, a partnership, or a proprietorship. Corporations, limited liability companies and partnerships are legal entities separate from their shareholders or partners. They can file Chapter 7 or Chapter 11 bankruptcy in their own right. Proprietorships, however, are just an extension of the owner: they can’t file bankruptcy alone. The proprietor must file bankruptcy, since the assets and the liabilities of the business are really just one form of assets of the proprietor. The individual owner may file Chapter 7 bankruptcy, Chapter 11 or Chapter 13 (if the debt limits are met).

Reorganize or liquidate your Business?

The next question is whether the business should be reorganized or liquidated. To answer this question, you have to know what has caused the problems the business now faces and what are the prospects for change. Reorganization can’t create a market; increase gross revenue, or make up for a poor fit between the skills available and the skills required to run the business. On the other hand, reorganization could free up cash from servicing the old debt to permit current operations; permit rejection of leases or contracts that are no longer advantageous (an expensive facility lease or improvident equipment purchase); or prevent the loss of vital assets or cash to creditor collection actions.

In between Chapter 7 liquidation and reorganization, a liquidating Chapter 13 or Chapter 11 could provide a breathing space for the owners to sell the business as a going concern or its assets in something other than a fire sale. The resulting proceeds could pay taxes or unpaid salaries; sale of the business could provide ongoing jobs for the work force under new ownership. The bankruptcy could then be converted to Chapter 7 or dismissed if bankruptcy protection is no longer needed. The court will probably condition dismissal of the case on payment to creditors of the sale proceeds.

One must also ask whether management has the resources and desire to engage in the reorganization process. Bankruptcy reorganization in Chapter 11 requires significant time on the part of the owners and managers to comply with the requirements of the bankruptcy system, interface with counsel, and negotiate with creditors. It is usually expensive as well.

Bankruptcy and Businesses

The ‘bankruptcy bargain’ is that, in exchange for the protection of the automatic stay and other bankruptcy protections, the debtor provides full disclosure of its financial condition to creditors and the court, both at the beginning of the case and on a monthly basis thereafter, and operates as a fiduciary for its creditors while the bankruptcy is ongoing.

A reorganization can drain an already stressed organization of management’s time to participate in bankruptcy proceedings and money since the legal expenses are significant. Most reorganizations fail, usually for lack of a real plan to solve the problems.

One should also consider whether the business is one that could be started up again after a liquidation of the current business. Businesses that require little capital, have few assets, or are really just extensions of the owner’s skills and personality might not be amenable to being reorganized. The owners may be better off liquidating the business, in or out of bankruptcy, and starting over in a fresh entity. This can be a complex issue and requires good professional advice to do correctly.

Chapter 7 may be best, either for the individual or a corporation, when:

If the business has no future, it has no substantial assets or qualities that cannot be reproduced after bankruptcy, or the debts are so overwhelming that restructuring them is not feasible, reorganization won’t help.

Individuals can get a discharge of the dischargeable debts and a chance to start over. However, corporations don’t get discharges, so a corporation won’t get a fresh start in a Chapter 7, the way an individual does. Nonetheless, a Chapter 7 can provide an orderly liquidation under the direction of the trustee and at no expense to the shareholders. Creditors are assured that they will be paid to the extent of the assets available and the priority of their claim. Former management is assured that the assets that are available go (after the expenses of the Chapter 7) to pay taxes for which the individuals may be liable.

Meet With a Bankruptcy Attorney

Like any decision pertaining to bankruptcy, whether or not to seek bankruptcy protection for your small business is an issue which should be discussed thoroughly with a bankruptcy attorney.

Free Consultation with Bankruptcy Lawyer

If you have a bankruptcy question, or need to file a bankruptcy case, call Ascent Law now at (801) 676-5506. Attorneys in our office have filed over a thousand cases. We can help you now. Come in or call in for your free initial consultation.