The affect a business bankruptcy plays on a business owner is generally determined on how the business was originally structured. When a business is formed there are several different categories it can fall into, including a sole proprietorship, corporation, or a limited liability company. Based on what type of structure a business falls into is what determines how a business bankruptcy will affect the business owner.

Bankruptcy on a Sole Proprietorship

When a business owner starts their own business under a sole proprietorship structure then the owner is personally liable for all business debts that are incurred. Business owners that own this type of company do endure damage to their credit report if they file for bankruptcy. To put it simple, in the eyes of the court the business owner and their personal debt and business debt are one in the same. The best type of bankruptcy to file when an owner files for one on a sole proprietorship company is a Chapter 13; this type allows the business owner to reorganize their business and pay off debts over a certain period of years. If they file a Chapter 7 bankruptcy then their home, automobile and other personal assets can be sold to pay for business debts incurred.

Bankruptcy on a Corporation or Limited Liability Company

When a business owner opens a business under a corporation structure or a limited liability company structure then their personal assets cannot be affected during a business bankruptcy. In the eyes of the court the business owner and their business are not considered one entity. Due to the fact that business owners cannot be held personally liable during a business bankruptcy they often open a business under a limited liability company structure.

Employee Wages During a Bankruptcy

Anytime a business owner files a business bankruptcy they must pay any wages that are owed to business employees; this applies to any type of business structure. If the business owner fails to pay employees their earned wages then the business owner can be held personally liable.

What Happens To A Bankrupt Business?

All businesses have the option to file for bankruptcy if they fall too heavily into debt and this is known as a Chapter 11 bankruptcy. This differs slightly from personal bankruptcy in a few ways. Instead of clearing debt, Chapter 11 simply restructures debt and may bring in outside consultants to change business practices. The debt may lowered, but is rarely completely removed after filing for Chapter 11. Courts can mandate a wide array of rules on the bankrupt company after filing. This can include quarterly updates given to the lenders, downsizing of employees, and the selling of company properties and holdings.

All of these factors depend on the type of debt as well. Certain financial responsibilities will remain no matter the circumstances. An example of this would be an unpaid payroll for employees which must be paid no matter the state of the company or the owner.

When Can Lenders Come After LLC Owners?

The nature of limited liability companies dictates that owners are not responsible for any debt incurred on behalf of the company, but there are a handful of exemptions from this rule. During loan processes, many banks and other firms will require owners to assume partial responsibility or co-sign for the loans. In this case, these debts will transfer over to the owner who may need to file for personal bankruptcy. For companies with this problem, many times the LLC will not only be dissolved, but creditors may go directly after all owners. This could result in the seizing of all personal properties or the garnishing of future wages.

A much rarer example in which the owner would be responsible for their LLC’s debt would be if the court deems them personally responsible for negligence in regard to their businesses debt. While these cases are rare, they can happen due to extreme financial carelessness.

The complicated nature of bankruptcy laws and limited liability companies make it necessary to contact a bankruptcy or business lawyer to discuss all options available as exact laws change from state to state.

What many small business owners fail to understand is that bankruptcy – while ugly and horrifying at first, may actually be a blessing in disguise. If used correctly, then you may actually maneuver yourself into a situation where your small business actually comes out on top and becomes relevant again.

So what are your options when faced with bankruptcy? Well, every small business is different, but there are basically three main options when filing for bankruptcy.

1. Chapter 11: This is the bankruptcy that is used by most businesses during the process. The object of chapter 11 bankruptcy is to reorganize and liquidate. By doing this you can try to restructure the small business debts and try to come out on top. Small business owners who choose chapter 11 have had success, but they also have to prepare themselves for an expensive and very time-consuming process.

2. Chapter 7: This type of bankruptcy initially signals the end to your small business. You are basically saying that you don’t want – or can’t, restructure or liquidate anything. While this is a good way to get you free and clear of small business debt, there is a risk involved, as some personal items may be up for grabs for creditors. Sometimes it may be worth the risk though, because when it’s over you don’t owe anything.

3. Chapter 13: This type of bankruptcy option is not used as often, but it can still be very helpful if used correctly. To file for chapter 13 you have to be an individual that is operating a business that is unincorporated. You also have to have a steady source of income. If you file chapter 13, then you allow the court to set-up a 3-year or 5-year plan that will allow you to pay down as much debt as possible over that time.

Bankruptcy doesn’t have to be the end of the world for you or your small business. As a matter of fact, if used correctly, you may find yourself in a much better position than you were before.

In these difficult economic times, many businesses are filing for bankruptcy in order to consolidate resources and reduce or eliminate debt. Since declaring bankruptcy can be a difficult process, it makes sense to consult a business bankruptcy lawyer that specializes in debtor’s counsel. A bankruptcy lawyer helps the company to determine which type of bankruptcy would be the most useful, determine which debts can be discharged, notify them of how both state and federal bankruptcy laws apply to their situation, and prepare and file the bankruptcy petition on their behalf.

Bankruptcy Types

Business bankruptcy commonly occurs in one of two types: Chapter 7 and Chapter 11. Chapter 7 bankruptcy is the most common form of bankruptcy to be filed, although the filing process and forms involved can be quite complex. Under Chapter 7 bankruptcy, unsecured debts can be discharged, freeing the company of the obligation to pay. Creditors are unable to collect on debts unless expressly permitted by the court, and any assets of the company not specifically exempt are liquidated in order to repay debts. Chapter 11 bankruptcy seeks to restructure debts under a plan that the creditors will approve of, and the business can continue to operate, unlike under Chapter 7, where it is dissolved. The filing process for either type of bankruptcy is quite complex, especially after changes made to federal law in 2005, and depending on a company’s financial situation, one type or the other may be preferable, so it is important that companies consult a bankruptcy attorney to find out which option will yield the most optimal results.

Other Bankruptcy Issues

While state law does not supersede federal law when it comes to bankruptcy, there are cases where state law further clarifies areas of bankruptcy proceedings that federal law does not cover. Of particular importance is which types of debts may or may not be discharged. Certain debts, such as federal taxes, or debts incurred after filing for bankruptcy, can never be discharged, but other types of non-exempt debt vary by state. Assets exempt from liquidation also vary by state. Only by consulting a business bankruptcy attorney can a company determine what they can expect after filing for bankruptcy.

Chapter 13 and Chapter 11 bankruptcy have certain key similarities that can cause confusion for anyone who doesn’t specialize in bankruptcy.

Who Can File for Chapter 11 and Chapter 13 Bankruptcy?

Chapter 11 bankruptcy is available for businesses and individuals with a very large amount of debts and income.  Filings are available for almost all individuals as well as sole proprietorships; however there are debt/income limits for eligibility. These limits change each year.

Chapter 11 Bankruptcy- Creditors Vote

In both Chapter 11 and Chapter 13 bankruptcy, the debtor and the debtor’s lawyer or law firm create a plan to reorganize and consolidate the debt. In Chapter 13 bankruptcy, the creditors accept the plan assuming it meets
certain legal standards. In Chapter 11 Bankruptcy, the creditors vote to determine whether they will pass or reject the plan.

Under Chapter 11, if the creditors turn down the plan, the debtor can come up with a new plan. The judge may force the creditors to accept the debtor’s plan or the negotiations may simply fail. If negotiations fail, the business will either have to file for business Chapter 7 bankruptcy, or, the case may be dismissed.

To learn more about bankruptcy in the Austin, Georgetown, Leander, or Round Rock area, you can schedule an appointment for a free initial consultation with one of the members of our legal team. Just call 512-992-2421 or
contact our offices online.