As with personal bankruptcy, a business bankruptcy is matter of federal law. The federal Bankruptcy Code has a number of chapters under which a business can file for bankruptcy. The appropriate chapter depends on the specific business, the organizational structure of the business, the specific situation, and the post-bankruptcy goals of the business.
In most cases, a business will file for bankruptcy under Chapter 7, which is a liquidation, or Chapter 11, which is a reorganization. If the business is a family farm or a fishing enterprise, it might be possible to file under Chapter 12, which is specific to those types of family businesses. However, Chapter 12 is rare. Virtually all business bankruptcy cases will fall under Chapter 7 or Chapter 11.
Creditors can force a business into involuntary bankruptcy. The chapter options for involuntary bankruptcy are the same as if the business had filed on its own.
Differences between Chapter 7 and Chapter 11 Bankruptcy
The main difference between these two types of bankruptcy is the final outcome. Under a Chapter 7 bankruptcy, the court oversees the sale of all the business assets to pay off creditors, which generally results in the close of the business.
Under a Chapter 11 bankruptcy, the court-appointed trustee oversees a reorganization of the business with the goal of leaving bankruptcy as a stronger, more financially-viable enterprise. During the reorganization, the business will generally restructure its debt into a payment plan that the business can handle with its future earnings.
Business Bankruptcy of a Sole Proprietorship
If a single person entirely owns the business, then the business cannot file for a Chapter 7 liquidation. The individual can file for Chapter 7 bankruptcy, however, and those proceedings may cover the business debts.
A sole proprietorship can file for Chapter 11 reorganization. However, some bankruptcy attorneys are starting to file for sole proprietorship reorganization under Chapter 13, the bankruptcy reorganization chapter that applies to individuals. The purpose under either reorganization chapter is to consolidate the business debts and keep the business going.
Advantages of Filing for Bankruptcy
A bankruptcy filing offers three advantages to businesses: the automatic stay, the centralization of all creditor claims, and the discharging of debt.
Discharging of Debt
Filing for bankruptcy doesn’t mean that creditors must forgive the business’s debts. Under all chapters, the business must generally still pay its debts. However, bankruptcy often does mean that the business may be able to pay less than the amount originally owed to a credit.
When a bankruptcy court approves the discharge of a debt, the court means that the the amount paid has fully satisfied the creditor’s claim with the approval of the bankruptcy court. After discharge of a debt, the creditor generally no longer has any claims against the business as related to that debt.
Automatic Stay and Centralizing Creditor Claims
If a business can’t pay its bills, creditors start calling and they may even start filing lawsuits. Once a business files for bankruptcy, creditors can no longer pursue repayment on their own. Creditors must operate through the bankruptcy court. A bankruptcy filing leads to stays in any other lawsuits filed against the business are stayed. A stay means a temporary stop in outside lawsuits so that the bankruptcy court can first address all matters related to the bankruptcy filing.