1. Money
You can opt-out at any time. Please refer to our privacy policy for contact information.

What is Business Bankruptcy?

Definition and Types of Small Business Bankruptcy

By

Small business bankruptcy happens. Sometimes small business firms don't make it. They fail financially for various reasons and find themselves faced with deciding if bankruptcy is necessary. Bankruptcy is a process you go through in federal court that is designed to help your business eliminate or repay its debt under the protection of the bankruptcy court. Business bankruptcies are usually described as either liquidations or reorganizations depending on the type of bankruptcy you take.

There are three types of bankruptcy that your business may file for depending on its business form. Sole proprietorships are legal extensions of the owner. The owner is responsible for all assets and liabilities of the firm. A sole proprietorship can take bankruptcy by filing for Chapter 7, Chapter 11, or Chapter 13. Corporations and partnerships are legal entities separate from their owners. As such, they can file for bankruptcy protection under Chapter 7 or Chapter 11.

Business Bankruptcy - Chapter 7

Chapter 7 bankruptcy may be the best choice when the business has no future. It is usually referred to as liquidation. It is usually used when the debts of the business are so overwhelming that restructuring them is not feasible. Chapter 7 is also appropriate when the business does not have any substantial assets. If a business is really just an extension of a particular owner's skills, it usually does not pay to reorganize it and Chapter 7 is appropriate. Chapter 7 bankruptcy usually means that the business is over.

In Chapter 7 bankruptcy, a trustee is appointed by the bankruptcy court to take possession of the assets of the business and distribute them among the creditors. After the assets are distributed and the trustee is paid, a sole proprietor receives a "discharge" at the end of the case. A discharge means that the owner of the business is released from any obligation for the debts. Partnerships and corporations do not receive a discharge.

Business Reorganization - Chapter 11

Chapter 11 is a better choice for businesses that may have a future. Chapter 11 is a plan where a company reorganizes and continues in business. It is reorganized under a court-appointed trustee. The owner of the company may actually be the trustee. The company files a plan of reorganization outlining how it will deal with its creditors. Creditors vote on the plan. If the court finds the plan is fair and equitable, they will approve the plan. Reorganization plans provide for payments to creditors over some period of time which may exceed twenty years. Chapter 11 bankruptcies are exceedingly complex and not all succeed. It usually takes over a year to confirm a plan.

Personal Bankruptcy - Chapter 13

Chapter 13 bankruptcy is a reorganization bankruptcy typically reserved for consumers, though it can be used for sole proprietorships. You file a repayment plan with the bankruptcy court detailing how you are going to repay your debts. The amount you will have to repay depends on how much you earn, how much you owe, and how much property you own. If your personal assets are involved with your business assets, as they are if you own a sole proprietorship, you can avoid calamities such as losing your house if you file Chapter 13 versus Chapter 7.

Consult with a good business bankruptcy attorney before deciding on which type of bankruptcy you will file or whether you will file bankruptcy at all. There may be other options you should explore first.

©2014 About.com. All rights reserved.