Corporations and LLCs rarely file a business bankruptcy using Chapter 7. Why? Chapter 7 won't help keep the company open. Chapter 11 is the bankruptcy type that helps struggling businesses restructure debt payment obligations to benefit the company and its creditors. It's the chapter used most by LLCs and corporations declaring bankruptcy.
Also, closing an LLC or corporation by filing a Chapter 7 business bankruptcy can be risky, so LLCs and corporations usually wind up outside bankruptcy. In most cases, business owners fare better filing their own Chapter 7, 13, or 11 bankruptcy after a company closure.
If you're shutting down a company and considering a Chapter 7 business bankruptcy, or if the business has already closed, you'll want to understand:
We also explain why winding down a corporation or LLC is more expensive in Chapter 7 bankruptcy, when you'd want to file your own bankruptcy case, and more. Once you've mastered this area, check out our quick ten-question bankruptcy quiz. It can help you spot potential bankruptcy issues fast.
It can be either. Both businesses and individuals file Chapter 7 when they don't earn enough to pay their debts. Whenever a company files for Chapter 7 bankruptcy, classifying the case is simple—it will be a Chapter 7 business bankruptcy.
However, you can't assume that every bankruptcy filed by an individual is a personal bankruptcy because an individual filer's status doesn't determine whether it's a business or personal bankruptcy. You must look at the type of debt involved.
Here's the rule.
If the majority of an individual filer's debts are "business-related"—incurred while pursuing a profit-generating business venture—the case is a business Chapter 7 bankruptcy. If most of the individual filer's debts are "consumer" debts related to running a household, the Chapter 7 case is a personal or "consumer" bankruptcy.
Example. Let's suppose that Jen closed down Cool Jump, LLC, an indoor trampoline business, after rising electricity costs drove her AC bill to an unsustainable level. In this situation, a Chapter 7 case could be a business or consumer bankruptcy, depending on who files and the debt owed.
Why does it matter whether a Chapter 7 case is a personal or business bankruptcy? Unlike consumer filers, business filers don't need to qualify for Chapter 7 bankruptcy by passing the means test, which can be a big deal. Here's how it works.
Suppose you take a high-paying job shortly after closing a business, and your wages are so high that you don't pass the means test. You won't have to take the means test if most of your debts are business-related and will still be able to wipe out all qualifying debt in Chapter 7.
However, there's a caveat. Even though you don't have to meet means test requirements, the bankruptcy court will look at your actual income and expenses. If the difference shows you can afford to pay a reasonable amount to creditors, you won't qualify for Chapter 7 and will have to file for Chapter 13 or 11.
Check your business bankruptcy status with a bankruptcy lawyer. Courts use different standards when determining whether most of a filer's debts are business-related or consumer in nature. Your local bankruptcy attorney can explain the standard and assist with the appropriate calculations.
Not much, other than in most cases, the business closes. When you put an LLC or corporation in Chapter 7, the Chapter 7 trustee appointed by the bankruptcy court will do the following:
It might seem like a good way to go, given that the trustee would be doing most of the work. But the Chapter 7 process can be expensive and risky for LLCs and corporations. We explain more below, along with why you'd likely be more satisfied filing for bankruptcy yourself.
The company won't receive a debt discharge, the order that erases the obligation to repay its debt. This fact surprises most people considering putting a defunct company into Chapter 7. But believing bankruptcy will erase a business's debt and, more importantly, the owner's personal liability to pay the business debt is a common misunderstanding.
Chapter 7 doesn't eliminate the debt liability of an LLC or corporation because a closed company doesn't need a discharge. Creditors can't collect from a company that no longer exists.
This system also allows creditors to collect from people who agreed to be personally liable for the business's debt—a result most business owners aren't happy to learn.
Similarly, a closed business doesn't need property, so the trustee sells all the assets. Unlike in a personal Chapter 7 bankruptcy, LLC members and corporate shareholders can't use bankruptcy exemptions to take business property out of the business's Chapter 7 case and keep the property for themselves.
Instead of putting the corporation or LLC in Chapter 7—which doesn't erase personal liability and often causes more problems—you can fix your personal liability problem in one of two ways:
A business bankruptcy lawyer can assess your situation, develop a strategy, and assist you with whatever level of implementation you need.
Filing for Chapter 7 bankruptcy unwinds LLCs and corporations publicly and transparently, which can be a good approach when creditors are concerned they won't receive their fair share of the company assets.
Allowing the Chapter 7 trustee to inventory and sell the assets and distribute the sales proceeds according to bankruptcy's priority payment rules can help alleviate problems by reducing the chances of asset-related lawsuits.
The biggest downside? A bankruptcy case provides an easy way for creditors who would otherwise get little to nothing to seek payment from stakeholders personally in "pierce the corporate veil" actions.
A creditor who initially wrote off a debt will start thinking about getting paid again after receiving notice of a bankruptcy filing, and many will call a bankruptcy attorney to find out what to do next. Because the case is already in bankruptcy court, filing a bankruptcy lawsuit or "adversary proceeding" would be relatively simple.
Because all lawsuits are costly to defend, even those based on tenuous grounds, most officers avoid the risk by unwinding companies outside of bankruptcy.
Using Chapter 7 to close a company is often more expensive than it would seem. You must hire an attorney to represent the company, so the most apparent expense involves legal fees. The less obvious cost? You'll pay more if you're obligated to pay its business debt.
The trustee will likely sell the company's property for less than the actual value because people buying bankruptcy assets want a deal. But that's not all. Not only will the trustee get less, but you'll also pay the trustee a hefty percentage of the sales proceeds. Here's where you can find out how much you'll pay the trustee in Chapter 7 bankruptcy.
The decreased amount paid toward the business debt will leave you with more to pay toward your business debt liability.
Most business bankruptcy lawyers agree that overall, Chapter 7 bankruptcy isn't optimal for almost all business types, and is a poor choice for partnerships and sole proprietors whose companies rely on expensive tools, products, or real estate.
Partnerships rarely file for Chapter 7 business bankruptcy because, like LLCs and corporations, partnerships aren't entitled to a debt discharge. Also, a Chapter 7 filing can put partners' personal assets at risk.
Because partners are personally liable for partnership debt, the trustee in a Chapter 7 bankruptcy case can sue the partners personally to recover cash to pay the partnership's debts. Learn more about partnerships in Chapter 7 bankruptcy.
When a sole proprietor files for Chapter 7, all debts and assets—business and consumer alike—are included in the bankruptcy because the company and individual are essentially the same. Sole proprietors sometimes benefit from Chapter 7 because they can erase personal and business debt in the same case. They're also the only business entities that can, in some instances, file Chapter 7 and keep a business open.
If you're a sole proprietor wondering whether a Chapter 7 would be a good idea, consider two things:
Here's how these factors will affect a sole proprietor Chapter 7 analysis:
A business bankruptcy lawyer can explain your options and, if Chapter 7 won't be beneficial, help you determine whether Chapter 13 or 11 would be a good option.
Bankruptcy is essentially a qualification process. The laws provide instructions for completing a 50- to 60-page bankruptcy petition, and because the rules apply to every case, you can't skip a step. We want to help.
Below you'll find resources we think you'll enjoy or go to TheBankruptcySite for more easy-to-understand articles.
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