By John G. Merna, Esq.
How to use business bankruptcy laws to navigate setbacks.
The pandemic has effected many businesses from the small sole-proprietor business owner up to the largest corporations. Many are filing business bankruptcy to get shelter from their creditors. Whether it is the economic evolutionary shift from brick and mortar operations to internet-based stores or the demographic shift in consumer spending, many business were effected by the pandemic. Simply speaking, the pandemic accelerated the growing increase in internet use for business and as a tool used within a business. In normal times, it may have taken 10 years to see the changes we have seen in less than two towards remote work, internet reliance, and increased internet commerce.
During the last two years many business owners faced the uncertainty of how long the social lockdown, reduction in business in their specialty, or shifting demographics or demand have asked themselves “Can my business survive?” Some won’t. This blog is to help you better understand how to analyze what bankruptcy law may do for you.
Owner’s Personal Liability From Their Business
Many naive entrepreneurs enter the world of business with the false illusion that a making their business a corporation, limited liability company (LLC), or partnership can protect them personally in the event the business fails.
What most don’t know when they start a business is almost all business debt such as leases, business credit cards, suppliers, have to be personally guaranteed. It is not until a business gains a certain size and value that mainstream lenders can be convinced not to request the security of a personal guarantee from a co-signer.
So what does that mean? It means that when a business fails or starts having trouble the creditor can come after the business owner regardless if the business is a corporation, LLC, or partnership because of the personal guarantee.
For instance, almost all credit cards, and landlords for that matter, required a guarantor even on a business card application or a new commercial lease. This is truer the newer the business because of the greater risk of failure.
Another way to state this problem, the only protection a corporate entity provides a new business owner is against possible liability to the public they are providing service or products too. Even this protection is limited.
But this blog is regarding business owners’ liability for the debt of the business and how a business bankruptcy or a personal bankruptcy may resolve that liability.
So your business is struggle. I will assume that if you are able to keep the business open your would not be in need of this information.
In the Event of Business Closure
Example 1: Let’s say you the business owner has decided to close the business that is an LLC and wants to eliminate the debt. The question that comes up is do I need to file a business bankruptcy?
The answer is only if the business has substantial asset. If there is no value in the form of equipment, accounts receivables, or other assets, then there is no reason for the business to file a bankruptcy. A liquidation or elimination of debt is accomplished with a Chapter 7 bankruptcy.
Fundamentals of a Chapter 7 Business Liquidation for a Closed Business
1) A business does not receive a discharge of debt in a Chapter 7 bankruptcy. It is not necessary because the business is defunct, kaput, dead. Like the saying goes “You can’t squeeze water from a rock.” So a business doesn’t need a discharge of debt.
2) Absent any value or assets in the business there is no reason to file a bankruptcy.
3) Regardless of a business Chapter 7, the co-signer or guarantor of any business debt is not protected by a business Chapter 7 bankruptcy.
So what is the purpose of a business liquidation Chapter 7? The purpose is merely to dismantle the business in an orderly manner liquidating the assets to pay the creditors fairly.
Therefore, if a business does not have substantial assets there is often little reason to file a business Chapter 7.
So what happens to the debt? With all the personal guarantees the creditors go after the business owners and co-signers that guaranteed the debt. Ultimately, most business owners of a failing business are faced with a “personal” bankruptcy whether it is a Chapter 7 liquidation or a Chapter 13 reorganization.
What if you want to try and keep a small business open.
Example 2: Let’s say your business is floundering due to the pandemic shutdown. You have cash reserves for a few weeks or months. However, as is true for all, the longer the shutdown or reduced business the greater the damage. The question for many business owners is do they have the resource to pull out of the dive and hang in long enough to rebuild?
If they don’t have the resources to pull out of the slump without help, a bankruptcy reorganization may be useful. The question then becomes what Chapter of reorganization? This depends on the size of the business.
Types of Bankruptcy Reorganization
There are several different Chapters of bankruptcy reorganization. Chapter 13 bankruptcy is a consumer or individual reorganization often called the “wager earners plan”. Chapter 11 is a large debt holders or business reorganization. Chapter 12 is farm reorganizations. Subchapter 5 was added to Chapter 11 of the U.S. Bankruptcy Code in 2019 to make reorganization bankruptcies more accessible to small businesses.
Businesses that file under Subchapter 5 can force creditors to accept court-approved repayment plans of three to five years. In essence, the new Subchapter 5 has reduced the cost and procedurally heavy process small business debtors were faced with in Chapter 11.
Small Business Bankruptcy Options
A person with a sole proprietorship would only be eligible for a personal Chapter 13 reorganization. Unlike llc’s, corporations, and partnerships, which are recognized as separate entities, a sole proprietorship has no formal independent status. In other words, a sole proprietorship is just a fictitious name for yourself. You are just telling the public, “I, John Doe, am “doing business as” (DBA) Acme Widgets.”
It is possible that a business owner with a small corporation or LLC could uses want to use a Chapter 13 to solve their personal and business cash flow issues. However, if their assets and the amount of the debt are too high it is more likely a Chapter 11.
Often the simplest question to ask yourself before deciding about bankruptcy reorganization is “Would it be better to let the business fail and start over again or fight to reorganize?” The answer is usually found in whether the company has any intrinsic value in terms of assets or contracts. Personal services companies can often just shut down, rebranded, and start over anew without debt instead of struggling with years of accumulated debt. Often the lessons of the first few years of business, or more correctly the mistakes you learn from, can help the second attempt be more successful.
This blog covers just a few of the considerations a struggling business is faced with when considering bankruptcy. Any business owner facing financial hardship should consult an attorney when considering bankruptcy.
Merna Law offers free telephone consultations to business owners considering business bankruptcy. Over the years our attorneys have guided many business to successfully reorganize or eliminate their business debt and get a fresh start.
If you have a question about how a bankruptcy can help you and your business give us a call today at 800-662-8813.
Keywords: business bankruptcy, business reorganization, Chapter 11 Bankruptcy, Subchapter 5 bankruptcy.
Locations: Richmond, Virginia Beach, Newport News