Declaring bankruptcy for a business is never an easy decision. When faced with insurmountable debt over a long period of time, however, business bankruptcy can be the best option.
What Happens When a Business Files for Bankruptcy
When you file for bankruptcy, an injunction called an automatic stay goes into effect immediately. Collection agencies and creditors will be prohibited from trying to collect debt from you. In most cases, they will no longer be able to call, send letters, file lawsuits, garnish wages, or seize any assets. In cases of a ‘successful’ bankruptcy, the court will discharge certain debts that you will no longer be held accountable for.
The fate of the business depends on the type of business bankruptcy filed.
Types of Business Bankruptcy
Chapter 7 Bankruptcy
Under chapter 7, the company goes out of business and a bankruptcy trustee liquidates the business’s assets to repay creditors. This may be a good option for companies with little to no income and a lot of outstanding unsecured debt. A business cannot stay operational after filing under chapter 7. Debtors who qualify for chapter 7 bankruptcy may be individuals, partnerships, corporations, or other business entities.
Chapter 11 Bankruptcy
Chapter 11 bankruptcy gives companies a chance to reorganize their business, stay in control of assets, and negotiate a payment plan with creditors for less than the original debt owed. All parties must agree upon the repayment plan. This may be the best option for a business that wishes to continue operating.
The business continues to manage day-to-day operations, but major business decisions must be approved by the bankruptcy court. Chapter 11 bankruptcy is frequently used by corporations, sole proprietors, or partnerships.
Chapter 12 Bankruptcy
Chapter 12 is a relatively new bankruptcy law and is designed for family farmers or fishermen who have a consistent annual income. It allows them a chance to repay all or part of their debts over time. Chapter 12 was created due to the economic realities faced by many family farmers/fishermen. It is less complicated and less expensive than Chapter 11.
Impact of Business Bankruptcy
Declaring bankruptcy can have serious consequences for a business. If you are considering business bankruptcy, you will want to be aware of how it will affect your business moving forward. Here are just a few things to keep in mind:
- Bankruptcies are listed on public record and can stay on business credit reports for up to 25 years.
- Due to the unregulated nature of business credit, a bankruptcy will impact all three business credit profiles in a variety of ways.
- A bankruptcy will negatively affect your business credit profiles by raising your risk potential of ceasing operations without paying back creditors.
Benefits of Business Bankruptcy
While no one wants their business to go into bankruptcy, there can be positive effects if done correctly. Compelling reasons to file for business bankruptcy include:
- Filing can give owners a chance to come up from under the weight of their debt, set up a payment plan with creditors, and renegotiate debt or contracts.
- Filing for bankruptcy can save a business from closing permanently, which would be the best reason to go to bankruptcy.
- Some businesses end up getting some of their debts dismissed or drastically reduced.
- Limit personal liability. If a business is going to close, doing so without declaring bankruptcy could leave the owner liable for debts. closing a business with Chapter 7 will stop bills from building up.
What to Do If Considering Business Bankruptcy
If you are thinking about declaring bankruptcy for your business, make sure you understand the options and weigh the impacts. Often, it is best to speak to an expert to ensure you have explored every option available. If you plan to continue operations, rebuilding and monitoring your business credit should be a top priority. At North Shore Advisory, we have the experience to help you make an informed decision, understand the consequences, and prepare for the road ahead. Contact us today to get started.
Frequently Asked Questions
When should a business consider bankruptcy?
A business should consider bankruptcy when it has high debt and can see that it will soon be in a position where it will not be able to function and pay for all expenses to operate. Many businesses did this during Covid since they were not able to bring in sales and income. Common scenarios:
- If a business has one very large account that brings in most of their sales and they lose the account.
- If an industry changes dramatically and there is no longer a need for a business’s service. For example, the printing business became quite obsolete after the internet became the new way to advertise.
Does business bankruptcy affect personal credit?
Business bankruptcy can affect your personal credit if you have signed personally for any business credit that has been extended. Depending on the amount of the debt owed personally, you may need to file for personal bankruptcy as well. This should be discussed with a business and personal bankruptcy attorney and your CPA.
What types of bankruptcy can a company file for?
Companies can file for either chapter 7 or chapter 11 bankruptcy. In some cases, family farming or fishing businesses can file for chapter 12 bankruptcy.