Business owners who file a personal Chapter 7 bankruptcy risk a temporary closure or losing the company entirely, both of which are bad outcomes. But, your business might not be closed at all. The two factors that will play a large part are:
- whether the company has liability insurance, and
- the trustee's ability to sell some business property or the business itself.
Once you understand businesses in bankruptcy, you'll want to learn the other things you should know about a bankruptcy filing. Or take our quick ten-question bankruptcy quiz. It can help you spot potential bankruptcy issues fast.
The Bankruptcy Trustee Will Close a Business Without Liability Insurance
Did you realize that the bankruptcy trustee holds your property in trust during bankruptcy, including your business? It's true, and a business-related lawsuit is the last thing a Chapter 7 trustee wants to handle, so expect the trustee to ask for proof of liability insurance. It's an easy way to minimize liability issues associated with a business remaining open in bankruptcy.
But that's only one factor the trustee will consider. The next is just as crucial and a bit more complicated.
The Bankruptcy Trustee Will Close a Business to Preserve and Sell Property
A trustee concerned about valuable property growing legs and walking off will shutter the company and conduct an asset inventory. But if your business doesn't have anything the trustee can sell, it's unlikely the trustee will pay much attention to it—and the trustee will be less inclined to close it.
So how will you know whether the trustee can sell off part or even all of your business? You'll apply the Chapter 7 property rules to all of your assets, regardless of whether you use something for personal or business purposes. Here are the Chapter 7 basics:
- You'll keep property protected by a bankruptcy exemption.
- Specific business exemptions are rare. Check for wildcard exemptions and tools of the trade exemptions. Your state decides whether you can choose between state and federal exemptions. Evaluate carefully—the federal exemptions are often higher.
- You'll lose property you can't protect with an exemption. The trustee will sell it for creditors. You'll find your state's property exemptions here (scroll to the middle of the article).
- If you'd lose your business or important property in Chapter 7, consider Chapter 13—the trustee doesn't sell property in Chapter 13. Although a company can't file for Chapter 13, you can personally.
In this context—that is, when assessing your business—pay attention to what you actually own. For instance, a sole proprietor owns all business property. But if the company is an LLC or corporation, you won't own any business property—you'll own shares or an interest in the company. That's what you'll exempt.
Businesses the Bankruptcy Trustee Might Not Close
- You're a sole proprietor of a service-oriented business. Service-oriented businesses—such as a small law office, an accounting firm, or a freelance writing business—don't depend on products, so it's less likely that the trustee will close the company for an inventory (and the trustee can't sell your efforts). However, you'll still need to exempt tools, equipment, furnishings, accounts receivables, and other outstanding income sources.
- You own 100% interest in an unsellable LLC or corporation. You don't own business products, equipment, or accounts receivables—the company does. You'll exempt the value of your shares or ownership interest in the company, not particular business assets. The problem? You won't find a specific exemption to cover this. But it won't matter if the business isn't worth much or isn't one a buyer would want—for instance, it's reliant on your labor (you aren't part of the deal). The trustee will likely abandon it. It will be yours to keep.
- You own a portion of the interest or shares in an unsellable LLC or corporation. The scenario is the same as above; however, selling partial ownership can be even more difficult, especially if the other interest holders are family members. Many investors stay away from these companies.
Businesses the Bankruptcy Trustee Will Likely Close
- You're a sole proprietor of a product-oriented business. You need products to conduct business and own the business property personally. If you can't exempt everything—or even if you can—count on the trustee closing the company for an inventory of products, equipment, furniture, and the company books, especially if selling the property will close the business permanently.
- You own 100% of interest or shares in an LLC or corporation the trustee can sell to a buyer. This scenario is especially problematic. You'll need to exempt your shares or ownership interest in the company. However, specific exemption laws don't exist. You could use a wildcard because it will let you protect any asset you choose. But even then, the trustee could sell the company and return the exemption amount to you. For instance, suppose you use a wildcard exemption to protect $5,000 in stock, but the trustee sells the company for $50,000. The trustee will return your $5,000 and net $45,000 for creditors (minus sales costs and the trustee's commission).
- You own a portion of the interest or shares in a sellable LLC or corporation. The scenario is the same as above.
- You're a partner in a partnership. Use caution before filing for bankruptcy and make sure you understand the liability implications for other partners. Many states have laws protecting partnerships in bankruptcy, but they vary wildly, and most partnership agreements contain a clause that dissolves the company if a bankruptcy filing occurs. Speak with a business bankruptcy attorney—the area is too complicated to address in a brief online article.
Be aware that we use simplified scenarios for illustrative purposes, and your case will be more complex. The best way to avoid unnecessary loss is by consulting with a local business bankruptcy attorney about your particular case.
Navigating Your Bankruptcy Case
Bankruptcy is an unusual area of law because it's essentially a qualification process. The laws provide instructions for completing a 50- to 60-page bankruptcy petition, and because all rules apply in every case, you can't skip a step.
One way to keep track of your research is to use the bankruptcy forms as an outline. You'll find links to related bankruptcy forms and other exemption resources in the chart below. You can also look at the list of Chapter 7 and 13 bankruptcy forms to see where this topic fits in the bankruptcy scheme. And this handy bankruptcy document checklist will help you gather the things you'll need to complete the petition.
Need More Info?
We want to help you find the answers you need. Go to TheBankruptcySite for more easy-to-understand bankruptcy articles, or consider buying a self-help book like The New Bankruptcy by Attorney Cara O'Neill.
We wholeheartedly encourage research and learning, but online articles can't address all bankruptcy issues or the facts of your case. The best way to protect your assets in bankruptcy is by consulting with a local bankruptcy lawyer.