Filing for business bankruptcy means someone else steps in to liquidate your business’s assets and settle its debts (in this case, the bankruptcy trustee).
A corporation or an LLC files a Chapter 7 business bankruptcy, a different animal than a Chapter 7 personal bankruptcy. Filing a business bankruptcy lets the owners turn their business over to the trustee for an orderly liquidation. The business stops operating, and the court liquidates its assets and pays what it can to business creditors. Exemptions don’t apply in a business bankruptcy, so the trustee can take anything the business owns: The entire company is liquidated.
When the liquidation is complete and the proceeds have been paid out to creditors, the business won’t owe any remaining debts. Lease obligations, contracts, utility bills, credit cards, loans, overdue accounts, and all other business debts will have been paid to the extent possible by the bankruptcy trustee. If creditors aren’t fully paid, that’s their tough luck. The business owners are off the hook unless they are personally liable for the debts.
In theory, the business owners receive anything left over after the creditors are paid. Typically, however, a business that files for Chapter 7 business bankruptcy has liabilities that exceed its assets, and there is nothing left for the owners.
Business Bankruptcy Doesn't Erase Personal Liability
If you are personally liable for corporate or LLC debts, you’ll still be on the hook even after your business’s liability is discharged in business bankruptcy. You will need to discharge your personal liability for the debts by filing for Chapter 7 personal bankruptcy or by negotiating a settlement with the creditor(s). Otherwise, the creditor(s) can still come after you for full repayment of the debt, even after the business is closed and its liability for the debts is discharged in business bankruptcy.
Extra Costs for Business Bankruptcies
The court fees in a Chapter 7 business bankruptcy are the same as for Chapter 7 personal bankruptcy. The trustee is likely to get a bigger fee, because the trustee is paid on commission: The more of your business property and assets the trustee can liquidate and distribute to your creditors, the more the trustee is paid. This money comes out of what the creditors would otherwise get, however; you don’t have to pay it directly.
The real added expense in a business bankruptcy is attorney fees. You must hire a lawyer to file for business bankruptcy; you can’t do it yourself.
In a business bankruptcy, the trustee will undoubtedly sell your assets for less than you (or an ABC firm) could get for them, and the process won’t be private. In contrast, if you sell your business’s assets and settle the business’s debts yourself (or with the help of a lawyer or ABC firm), there may be little reason to file for business bankruptcy. As long as you aren’t personally liable for any remaining debts—or you file a personal Chapter 7 bankruptcy to wipe out that liability—you are off the legal hook, your business is closed, and the debts can’t be collected.
Business Bankruptcy Won't Work for Partnerships
Partnerships rarely file for Chapter 7 business bankruptcy because it doesn’t rid the partners of their personal liability for the business’s debts. In fact, it actually makes it easier for creditors to reach the partners’ personal assets, because the trustee in a Chapter 7 bankruptcy case may sue the partners personally to recover some cash to pay the partnership’s debts. Speak to a business lawyer if you’re interested in filing a business bankruptcy for your partnership.
One-Owner LLCs or Corporations May Not Need Business Bankruptcy
If you are the sole owner of a corporation or LLC, filing for Chapter 7 personal bankruptcy may be the solution to both your and your business’s debt problems. In this case, the bankruptcy trustee might decide to take over your corporation or LLC and liquidate and dissolve the business for you. Your Chapter 7 personal bankruptcy would free you of any personal liability for the business’s debts.
Excerpted from Bankruptcy for Small Business Owners: How to File for Chapter 7, by Attorney Stephen Elias and Bethany K. Laurence, J.D.