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FAQ: Business Organizations and Transactions

How do small businesses file for bankruptcy?

While every business owner wants their business to be a success, many businesses fail each year. While some simply go out of business and close up shop, others are forced into bankruptcy because of mounting debt. The options for bankruptcy available to these businesses will vary depending on the type of entity selected and the debts amassed.

Bankruptcies available to all types of debtors

Chapter 7 bankruptcies are available to all types of debtors including corporations, partnerships and sole proprietors. When a debtor files a Chapter 7 bankruptcy petition, a trustee is appointed to manage the bankruptcy process. The debtor will list all the assets and debts he or she holds on the bankruptcy petition for the trustee to review.

The trustee will sell any of the debtor's property that is not exempt from the bankruptcy process to satisfy the debts owed to creditors. A debtor will then receive a discharge in bankruptcy — the discharge means that the debtor is no longer personally responsible for the debts that appeared on the bankruptcy petition. But not every person who files for Chapter 7 bankruptcy will receive a discharge. Furthermore, certain debts may not be listed as part of a bankruptcy petition.

Chapter 11 bankruptcies are also available to all types of debtors including sole proprietors, partnerships and corporations. Individuals not eligible for Chapter 7 bankruptcy may file for Chapter 11. In a Chapter 11 bankruptcy, rather than a sale of assets by the trustee, debtors will come up a repayment plan for their debts. The repayment plan will be based on the debtor's earnings. Any repayment plan must be approved by the bankruptcy court judge.

Bankruptcies only available to individuals with lower amounts of secured debt

Chapter 13 bankruptcies, like Chapter 11 bankruptcies, are filed to obtain repayment plans based on the debtor's future income. But Chapter 13 bankruptcy is only available to individuals (including individuals operating unincorporated businesses) with secured debts not more than about $1 million and unsecured debts of not more than about $350,000. A party filing for Chapter 13 bankruptcy will only obtain a discharge of debts listed if the debts are repaid according to the repayment plan, although a hardship discharge may be available in some cases.

What type of bankruptcy do businesses usually choose?

In a Chapter 7 bankruptcy, the individual or business that files for bankruptcy will lose the assets that make up the business. Thus, the assets sold in Chapter 7 bankruptcy will probably be greatly reduced in value.

But for businesses filing for Chapter 13 or Chapter 11, no assets are sold. The business will continue to operate, hopefully successfully, and repay the debts owed to creditors. Although the creditors may not receive all that they are owed in a Chapter 13 or Chapter 11 bankruptcy, they will likely receive more than if the business had filed a Chapter 7 bankruptcy and liquidated its assets.

Therefore, most creditors and business owners will agree that a Chapter 11 or Chapter 13 bankruptcy will be a better option to maintain the business and repay creditors.

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DISCLAIMER: This site and any information contained herein are intended for informational purposes only and should not be construed as legal advice. Seek competent counsel for advice on any legal matter.

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