Introduction To Bankruptcy Filed by a Business
If your business is in trouble, you may be facing the possibility of having to file for bankruptcy. Business bankruptcy is different from a personal bankruptcy. With a personal bankruptcy, the individual must decide whether to file a Chapter 7 liquidation or Chapter 13 Plan to repay some debt over a five year period. With a business bankruptcy, the owners must decide whether liquidation or reorganization will better serve the needs of the business and its owners. This article seeks to help you define the situation and explore your options.
Corporations, LLCs and Partnerships Can File A Business Bankruptcy
If the business is a corporation, limited liability company or partnership, then the business is a legal entity separate and apart from its shareholders, members, or partners. These three types of entities, as opposed to sole proprietorships, can file either a Chapter 7 or Chapter 11 bankruptcy in their own right. By contrast, sole Proprietorships are just an extension of the owner. As such, the sole proprietorship cannot file bankruptcy on its own; the owner of the sole proprietorship must file a personal bankruptcy (Chapter 7 or Chapter 13) because the assets and the liabilities of the business are really the owners’ personal assets.
What's The Difference Between Reorganization and Liquidation?
Assuming you are not a sole proprietor, the business owners must decide whether the business should be reorganized (Chapter 11) or liquidated (Chapter 7)? To properly answer this question, the business owners must determine what caused the present insolvency problems facing the business and the realistic prospects for change. Reorganization can't create a market; increase gross revenue, or make up for an impossible labor market. If this is what caused the bankruptcy, then a chapter 7 may be appropriate. However, it might temporarily free up cash from servicing the old debt and paying for disadvantageous leases that may have caused the company’s current financial predicament. In a Chapter 11 Reorganization, old debt can be renegotiated and bad leases/contracts can be cancelled.
In between the Chapter 7 liquidation and the Chapter 11 reorganization, is a Chapter 11 liquidation, which may provide the business with sufficient breathing room to sell the business, or its assets, in something other than a “fire sale”. The resulting proceeds could then be used to pay taxes and/or unpaid salaries. The bankruptcy could then be converted to a Chapter 7 or dismissed if bankruptcy protection is no longer needed. The court, however, will probably condition a dismissal on the payment of the sale proceeds, or a portiont thereof, to the creditors.
When considering a business bankruptcy, it is also important to consider management’s position. A Chapter 11 Bankruptcy reorganization will require the owners and managers to devote a significant amount of time and expense. The "bankruptcy bargain" is just that– a bargain. In exchange for the protection of the automatic stay and other bankruptcy protections, the debtor provides full disclosure of its financial condition to its creditors and the court, both at the beginning of the case and on a monthly basis thereafter. In exchange, the business owners must operate as a fiduciary for the benefit of the business creditors while the bankruptcy is ongoing. Unfortunately, this bargain often drains an already stressed organization of management's time and money since the legal expenses are significant. You should also consider the fact that most reorganizations fail, usually for lack of a real plan to solve the problems.