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Should I File Bankruptcy?

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Is Filing for Bankruptcy a Good Idea?

If you operate your own business, you know the struggles of trying to maintain cashflow, pay your bills and find new opportunities. Sometimes this struggle becomes overwhelming and you may find that your company is in serious debt. When this happens, it's important to examine your financial situation objectively and carefully so you can decide what to do next.

Why Consider Bankruptcy?

Creditors are business people themselves and can be surprisingly understanding if your business is experiencing cash flow problems. Typically, the key is communication: Contact your creditors directly and explain your circumstances. At the very least, they may realize that you are trying to do the right thing and may be less aggressive in taking collection action. Of course, the best case scenario is that your creditors may be willing to work with you by extending or modifying payment agreements.

However, there are some cases in which bankruptcy may be in your best interest:

  • Creditors won't work with you: In most cases, creditors would prefer to work with you on getting your debt repaid. But if you can't negotiate reasonable terms with your creditors, bankruptcy may be the one thing that protects you from a lawsuit.
  • The debts are overwhelming: If your business is failing and its debts are significant, filing for bankruptcy may prevent your going deeper into debt.
  • You're personally responsible for business debt: If you are operating a sole proprietorship, or you used personal assets to guarantee some of your business debts, bankruptcy may be the best option to help you avoid personal financial disaster.
  • It's time to close the business: If you are burnt-out, dealing with a family crisis that is making running a business impossible, or have realized that your business isn't going to recover, bankruptcy can provide financial closure. 

Bankruptcy for Businesses

Chapter 7: Sometimes known as a "fresh start" bankruptcy, Chapter 7 is available to both businesses and individuals. However, its benefits differ for each. In a Chapter 7 bankruptcy, assets belonging to an individual or business are liquidated. The proceeds are then distributed to creditors.

After the liquidation and distribution of assets, the court discharges eligible debts owed by individuals and businesses organized as sole proprietorships. If your business was organized as another type of legal entity— for instance, a limited liability company, partnership or corporation—any debt remaining after liquidation will still remain. Because the business is defunct, however, it would be difficult, if not impossible, for a creditor to collect on this debt.

Managing this remaining debt can be a problem, however, if you personally guaranteed or signed for it. For example, if you put company expenses on a personal credit card or used your home as collateral, creditors can still try to collect these debts from you, which could result in severe financial losses. In such cases, your attorney may recommend filing for both personal and business Chapter 7 bankruptcy at the same time.

If you aren't sure if you have personal responsibility for debts owed by your LLC, partnership or corporation, talk to your bankruptcy attorney and accountant. You may need to research your records to determine whether your personal finances are vulnerable to creditors.

Warning

If your LLC or corporation files for a Chapter 7 bankruptcy and there is remaining debt that you did not personally guarantee, you are usually not responsible for paying it back. However, a creditor's lawyer may attempt to "pierce the corporate veil" by attempting to prove that the business was operating fraudulently or as a "sham" LLC.

For example, if your business didn't have regular directors' meetings and didn't comply with state regulations on how corporations should operate, a creditor's lawyer could argue that it doesn't deserve LLC or corporate protection. If the judge agrees, your assets, as well as those of your partners or fellow directors, may be vulnerable.

Chapter 11: If you would like to keep your business operating but need some breathing room to reorganize and renegotiate with your creditors, Chapter 11 may be an option. However, Chapter 11 does not discharge your debts, but rather just allows you to restructure and negotiate debt modification agreements so that you can meet your obligations.

Chapter 13: This type of bankruptcy allows individuals to enter into a long-term debt repayment plan while keeping their assets. At the end of the payment plan, which can take three or five years, the court discharges the balance of the remaining debt. Chapter 13 is only an option for businesses organized as a sole proprietorship, and there is a limit to the amount of debt you can owe to qualify for the Chapter 13 process. Like Chapter 11, this type of bankruptcy may be suitable if you are hoping to keep your business operating.

Warning

Filing for bankruptcy can have long-term repercussions on your personal credit as well as on your current or future businesses. A personal bankruptcy can appear on your credit reports for 10 years. In addition, there are business credit reporting systems that may show your company's bankruptcy. These business credit reports are often pulled by potential creditors or retail partners when evaluating whether to work with your business.

Is Personal Bankruptcy Also Necessary?

One challenge that business owners face when filing for business bankruptcy is determining whether they are personally liable for any of their business's debts. This is often an issue when a company is structured as a sole proprietorship, but even incorporation does not always provide protection against business creditors.

Personal liability comes into play when an owner pays for business expenses on a credit card or uses personal property, such as a home, to secure a business loan. If your private assets were used to secure business capital or you used a non-business credit card to cover expenses, you may also need to file for personal bankruptcy, as well.

Bankruptcy Vs. Debt Settlement

One alternative to filing for bankruptcy is approaching your creditors and settling your debts for less than what you owe. One significant advantage of debt settlement, particularly if you are operating as a sole proprietorship or if your personal assets were used to secure a debt, is that you can avoid having to go to court and having a bankruptcy on your credit reports. You may also feel better about negotiating a settlement with your creditors rather than risking them receiving nothing after your debts are discharged in bankruptcy.

Debt settlement has its own challenges, however. Some creditors won't be interested in settling or may demand more than you can realistically pay. When you enter into a debt settlement agreement, you won't have the kinds of protections offered by bankruptcy, such as the automatic stay against collection attempts, including liens, levies and wage garnishment.

Another thing to consider is that creditors may report your negotiated debts as "settled" to credit bureaus. This can have a negative impact on your credit, so if you are avoiding bankruptcy because of credit concerns, keep in mind that you likely won't emerge from debt settlement with your credit unscathed. Finally, you may be liable for taxes on the forgiven debt amount.

An attorney or accountant may be able to assist you in determining whether settling your debts outside of bankruptcy is a feasible option for you. Be wary of so-called "debt settlement" companies that promise to resolve your debts for pennies on the dollar. These companies often promise a lot but can't deliver, and you may find yourself in a worse financial predicament than before.

Is a Lawyer Necessary?

If you've decided that bankruptcy is the way to go, it can be tempting to try to save money by not using a lawyer. This is often a bad idea, particularly if you are not a lawyer yourself.

Here's why:

  • Bankruptcy cases can be complex, particularly if they involve a business bankruptcy or the combination of a business and personal bankruptcy. Competent legal advice is often essential in getting the outcome you desire.
  • There are different types of bankruptcy, and you and your business may not benefit, or even qualify, for some of them. An experienced attorney knows how to qualify clients for the type of bankruptcy that will do them the most good.
  • Most court systems, with the exception of Small Claims Court, are set up for the use of legal professionals. As a non-lawyer, you'll be at a disadvantage in the system, and court officials, including clerks and judges, are not permitted to offer you legal advice.
  • If your case is dismissed by a judge because you did not file the correct papers or follow the law in your case, you will end up losing any court fees that you have already paid, along with the time you have already spent on your case.
  • You may need legal advice even after your bankruptcy debt has been discharged or during the repayment phase of a Chapter 13 case. Being able to consult with an attorney who is already familiar with your case is good for both your peace of mind and financial recovery.

Tip

If you are considering filing your bankruptcy case without legal representation because of costs, there are options. Some forms of bankruptcy, such as Chapter 13, may allow you to incorporate at least some of your legal bills into your repayment plan. This can help you reduce your immediate, out-of-pocket costs. Depending on your circumstances, you may also be able to connect with a low-cost bankruptcy attorney through your local Legal Aid Society or Bar Association.

Next Steps

If you've decided to investigate bankruptcy, contact a lawyer with experience in bankruptcies for businesses like yours. If you have an attorney for your business or personal legal matters, she may be able to recommend a bankruptcy lawyer. During your consultation, lay out your financial situation and the attorney can present your options.