You've probably seen or read news stories regarding large corporations filing for Chapter 11 bankruptcy. You also may have wondered how some of these companies re-emerge from bankruptcy some years later and eventually return to profitability. If so, you're not alone. Personal bankruptcy and business bankruptcy are two separate animals, each with its own rules and regulations according to federal and state laws.
Believe it or not it's actually easier for companies to file for, and emerge from, bankruptcy than it is for individual citizen. We'll get into that in just a little bit, but for now it's enough to say that how you file will depend heavily on the way your business is set up and what your current financial situation is. Just like in the case of the individual, business bankruptcy laws are designed to help give the owners of failing businesses a way out - as a last resort.
Sole Proprietorships
In making the generalized statement that it's easier for businesses to file bankruptcy than individuals, the one exception to that rule is the sole proprietorship. With the sole proprietorship, an individual is self-employed with no more than a few employees. Quite often the owners of sole proprietorships work alone because their business is not large enough to have employees. While this method of doing business is easier to set up and manage from an accounting standpoint, the one drawback comes by way of business bankruptcy laws.
As a sole proprietor, the business owner is not a separate entity from his business. In other words, all the assets of the business are his personal property and, from the courts point of view, vice versa. When a sole proprietorship files for bankruptcy not only will business assets be at risk, but so will the personal assets of the business owner. In fact, if a sole proprietorship needs to go into bankruptcy it will always be filed as a personal bankruptcy rather than a business one.
Corporations, LLC's, and Partnerships
If a business is not a sole proprietorship it is most likely either a corporation, limited liability corporation LLC, or a partnership. In all three of these cases the business is its own "person" in a legal sense. That means the personal assets of any owners, board members, or partners are not considered part of the company in any way. If one of these companies were to file for Chapter 7 bankruptcy, none of the personal assets of company officers or owners could be seized to pay the debt.
The downside in this is the fact that business owners and officers are not protected against civil lawsuits. That means a company could go bankrupt, and all the assets seized to pay bills, yet without the court touching the personal assets of owners or officers. But an unsatisfied creditor could then turn around and sue individual parties in civil court. In fact, this is one of the more popular ways for creditors to secure the balance of the money owed them if the bankruptcy proceeding does not work in their favor.
Chapter 7 and Chapter 11 Bankruptcies
The six main categories of bankruptcies are applicable both to businesses and individuals. However, the two most common forms among businesses are Chapter 7 and Chapter 11. According to business bankruptcy laws, these two chapters offer the easiest and most thorough way out of a poor financial situation.
Beginning with Chapter 7, it is identical to personal bankruptcy filed under the same chapter. The business surrenders all of its non-exempt assets which are then sold to pay off creditors. The big difference between Chapter 7 for business and for an individual is the fact that the business has substantially fewer assets that are exempt. Chapter 7 is the most common method among sole proprietorships and small partnerships.
Under Chapter 11 bankruptcy protection, a business is allowed to remain in operation under a court-approved reorganization and repayment plan. The court that approves the Chapter 11 does not get involved in the day-to-day operations of the business. Nonetheless, business transactions which meet courts definition of being "major" must be approved by the court. A Chapter 11 business bankruptcy is similar to a Chapter 13 for an individual in that bankruptcy court will establish a repayment plan which the company must strictly hold to in order to avoid default.
Before business owners decide their only way out is a bankruptcy proceeding, they need to take the time to research all of the options available to them. Personal bankruptcy laws are set up to make things as uncomfortable as possible, in order to dissuade business owners from utilizing the tool unless it's absolutely necessary.