Small Business Owners: Chapter 13 vs. Chapter 7 Bankruptcy

Learn about your options for business bankruptcy under both Chapter 7 and Chapter 13.

For most small business owners, Chapter 7 bankruptcy is a better option. But in some situations, Chapter 13 bankruptcy is the way to go.

When Chapter 7 Bankruptcy Is Better than Chapter 13

Here are some reasons why Chapter 13 is not ideal for most small business owners.

It’s Difficult to Run a Business While in Bankruptcy

All of your personal and business property is under the bankruptcy court’s control. You must get court permission to borrow money or to buy or sell business assets (other than typical, day-to-day operating decisions). You can’t use credit cards, and you have to submit monthly reports to the bankruptcy trustee. If business picks up or you take on a side job, the extra money will have to go toward your debts.

You Must Keep Up With Plan Payments

It might be even harder for a business owner to keep up with plan payments for three to five years. You need to make every plan payment on time, even if your income is seasonal or fluctuates with the economy. If you can’t keep up with your payments, the bankruptcy judge can modify the plan to some extent. However, if it appears that you won’t be able to make at least the payments required by the bankruptcy code, the judge will likely convert your case to a Chapter 7 bankruptcy or dismiss it. If your case is dismissed, you’ll owe your creditors the balance of your debts: what you owed at the start of your bankruptcy case, plus the interest that stopped accruing while you were in bankruptcy, less whatever you paid through your repayment plan.

It Costs More and Takes Longer

Although the filing fees are comparable (currently, $310 for Chapter 13 versus $335 for Chapter 7), you will almost certainly need a lawyer to file for Chapter 13, which can cost thousands of dollars. In addition, you’ll usually be required to repay at least some of your unsecured debt (although some courts approve what are known as 0% plans, in which unsecured creditors receive nothing), something you wouldn’t have to do in Chapter 7. What’s more, a Chapter 7 bankruptcy case is over in a matter of months, compared to the three to five years you’ll spend in Chapter 13.

For all of these reasons, Chapter 7 personal bankruptcy is almost always the better choice for business owners. Rather than trying to continue your debt-ridden existing business under the close supervision of the bankruptcy court, it usually makes more sense to close down, file a Chapter 7 personal bankruptcy to deal with your debts, and then start a new—but similar—business free of debt.

When Chapter 13 Is Better than Chapter 7

For some business owners, Chapter 13 might make more sense than Chapter 7:

You Can’t Pass the Means Test

Those who can’t pass the means test or are otherwise ineligible to use Chapter 7 will have to use Chapter 13 to get bankruptcy relief. For more on the means test, see The Means Test and Other Eligibility Issues.

You Want to Keep Your Asset-Rich Business Open

Those who want to keep an asset-rich business open during bankruptcy shouldn’t use Chapter 7, because the trustee will likely shut the business down and sell its assets. (However, these business owners might be best served by avoiding bankruptcy altogether and trying to settle their debts, as discussed below.)

You Don’t Want to Lose Certain Assets

Debtors might choose Chapter 13 if they don’t want to lose particular, perhaps unique, nonexempt assets that they would lose in a Chapter 7 bankruptcy. (This is a tricky area and you should probably go over the details with a lawyer).

A Significant Portion of Your Debt Won’t Be Discharged in Chapter 7

Debtors might want to use Chapter 13 if they have significant debts that wouldn’t be discharged in Chapter 7, but would be discharged in Chapter 13.

You Want to Get Current on Your Mortgage or Car Loan

Those who will need the long-term protection of the bankruptcy court while they get current on their personal mortgage or car payments might choose Chapter 13 rather than Chapter 7.

You Would Benefit From a Cramdown

Those who would benefit from a cramdown might choose Chapter 13 over Chapter 7. One additional advantage of a Chapter 13 over a Chapter 7 bankruptcy is that it lets you reduce what you owe if you are significantly upside down on certain secured debts—that is, you owe more than the collateral for the debt is worth. You can reduce what you owe on a secured debt down to the value of the collateral in what’s called a “cramdown.” Once you cram down your debt to the value of the property securing it, you usually get to keep the collateral. For more on how cramdowns work, see How a Cramdown Works in a Chapter 13 Bankruptcy Case.

Excerpted from Bankruptcy for Small Business Owners: How to File for Chapter 7, by Attorney Stephen Elias and Bethany K. Laurence, J.D.

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