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Your Friendly Guide To A Small Business Bankruptcy

Small Business Bankruptcy

Google, Meta, and X(Twitter) do not make up the US economy wholly. A major chunk of all businesses in the United States are small businesses (think 99.9%). Yes, you read that right. 

The sphere of business is not just made up of glamour, capital, and millionaires. The humble group of small businesses are the backbone of the US economy. 

These small businesses are also responsible for providing employment to 47.3% of the Nation’s population. Very small businesses having less than 100 employees make up a whopping 98.2% of all U.S. businesses.  

Small businesses are powerful and play an influential role in the American economy. However, during the 2019 COVID pandemic, these small businesses suffered the most due to the economic recession. 34% of all small businesses in the United States closed down. 

The city of San Francisco saw 48% of small businesses hit closure.

Bankruptcy has been known to provide relief to small businesses who are finding it difficult to stay afloat.

Small business bankruptcy will help a business of limited means get economic relief in difficult times.

In this article, we will talk about small business bankruptcy. We will extensively cover the following:

  • Types of small business bankruptcy,
  • How to file for small business bankruptcy
  • Chapter 7 and chapter 13 of the US bankruptcy code
  • And answer all your doubts on the subject.

Do You Fall Under The Category Of A Small Business?

To better understand the concept of small business bankruptcy, we will have to know what a small business means. The definition under United States business law can differ.

However, the Small Business Administration of the United States is a federal agency that does indeed define what a small business can entail. 

A small business is one that has a limited number of employees and annual revenue. The annual revenue of the business should also be less than $7.5 million.

  • This is what the US Department of State says about a small business.
  • The purpose behind the organization of the business should be profit.
  • This company should own a place of business in the territory of the United States.
  • This business should have less than 500 employees.
  • The business should operate primarily in the United States territory.
  • Significant contributions should come to the economy of the nation from this business.
  • Contribution to the United States economy can come from either of these: buying American products, purchasing American materials, and hiring American labor.
  • The company owner works independently and is not a dominant entity in the US market.
  • These standards come directly from the small business administration of the US. 
  • According to their official website, a small business can be a sole proprietorship, partnership, corporation, or other legal business entity.

If any business meets these standards, it is a small business.

What Is Small Business Bankruptcy?

Reports from the Harvard Economic Tracker show that almost a third of the total number of small businesses (think: 32.5 million) are still struggling in the United States.  

  • While many of the small businesses and start-ups are struggling as a result of financial stress from the pandemic, the path remains murky. 
  • More small businesses are fading into burdens of debt and slowly becoming legally non-compliant.
  • When facing financial turmoil, some small businesses, even if not newcomers, will fade away. They will choose to close up and never reopen. However, a select few will try to work through the limited options available to them. They could opt for small business bankruptcy.

COVID Aftermath

Small business bankruptcy is a type of bankruptcy that has been especially common ever since the pandemic. It is a process under the bankruptcy law of the United States. 

  • One can take refuge under the provision of small business bankruptcy to seek relief from dents and arising liabilities.
  • Bankruptcy has always been a relief to companies who are feeling overwhelmed by financial obligations. Small business bankruptcy allows businesses of limited size and assets to cope with debt. 
  • Through the multiple provisions under US bankruptcy law, they can negotiate with creditors. 
  • The end result can be the liquidation of their assets or a plan to repay their debts gradually over time.

Now that we have gone through the details of small business bankruptcy let us look into the details of how to file for it under different provisions.

Which Type Of Bankruptcy Is The Best Choice For Your Business?

There are multiple provisions of bankruptcy filing under the US bankruptcy code. The problems you are facing might not be the ones others are. 

  • Therefore, one solution will not fit all problems.
  • Lawmakers and regulators of the United States provide you with multiple choices from which you can pick the one that best hits you. 
  • We will now provide the necessary information on using Chapter 7, Chapter 13, and Chapter 11 bankruptcy for the purpose of small business bankruptcy. 

Small Business Reorganisation Act, 2020

The Small Business Restructuring Act might also help you to get your business back on track.

  • This act is an extension of the bankruptcy code. The government brought about the act in full force on the 19th of February 2020. It created a 5th sub-chapter under Chapter 11 of the Code.
  • The purpose is to provide a cost-effective option for reorganization to small businesses. 
  • It is basically a streamlined option available to businesses filing for bankruptcy under Chapter 11.
  • The act sets a secured debt limit of $2725625 and a secured debt limit of $7500000 for 1 year. It operates under the CARES Act.

Who Qualifies Under This Law?

A small business debtor will qualify under this act if:

  • they are engaged in business activity with a non-liquidated secured debt and unsecured debt under the limits.

The act requires that 50% of the pre-petition debts come from commercial activity. 

How Do You File For Small Business Bankruptcy Under This Act?

Any small business debtor will have to file first-day motions under Chapter 11 of the bankruptcy code. This process is lengthy and takes time and money.

  • The debtor will have to submit a copy of their business balance sheet.
  • They will have to file a statement of their operations.
  • The government will also need a statement of their cash flow and Federal income tax returns.

The court will appoint a trustee. This person will help in the mediation and reorganization of the debtor’s assets. 

  • In case all parties do not agree to the plan, an intermediary will act as a mediator for agreement.
  • The Trustee can look into the financial condition of the debtor.
  • Within 60 days of filing the petition, the bankruptcy court will take action.
  • The bankruptcy court will even try to expedite the process to provide immediate economic resolution. 

Small Business Bankruptcy Filing As A Sole Proprietorship

When there is a lack of a formal legal structure, US bankruptcy laws need proof of a sole proprietorship. 

  • One would also need to prove that they are the sole owner of a business. Ownership is a concern when a married couple or group of friends is running the same business. 
  • Ownership and proprietorship under the bankruptcy laws of the USA are one and the same. 
  • When sole proprietors owe the creditor debts, the credited can see the proprietor or the owner personally. 
  • This is why bankruptcy can be a risk for sole proprietors. 

Problems While Bankruptcy

Let us look into some problems that small businesses with sole proprietors can face while filing for bankruptcy. 

  • There is a lack of distinction between business property and personal property. This can give rise to personal liability for business debts. 
  • Let us assume that in a later stage of the bankruptcy proceedings, the court orders a liquidation of assets. 
  • Now, these businesses could end up losing all their personal assets, as well. This could include their homes, personal savings, emergency funds, etc.
  • Not many bankruptcy options are available to sole proprietorships. Lawmakers could argue that provisions are enough. 
  • However, only Chapter 13 and Chapter 7 of the United States bankruptcy code are the go-to for sole proprietorships. 
  • This means that they can either liquidate their assets to pay off their debts or come up with a repayment plan. 
  • If the proprietorship is choosing Chapter 7 of the Bankruptcy Code, they run a risk of losing personal property. 
  • A closer of business, a loss of livelihood, and a loss of personal assets all together don’t look so good. 
  • A big business can choose to go through the bankruptcy process in a much easier manner. However, small business bankruptcy proceedings are much more complicated. 
  • A sole proprietor has to provide a detailed explanation of their income and expenses during the proceedings. If they make even a little mistake and give accurate financial records, it could disrupt the procedure.

Bearing these things in mind, it is important to file for the right kind of bankruptcy as a sole proprietorship.

Bankruptcy Under Chapter 7

Chapter 7 deals with bankruptcy through liquidation. It is also known as straight bankruptcy. 

  • It usually signifies the end of a business. Through this process, you surrender your non-exempt property for liquidation. 
  • Liquidation of assets means that the government makes arrangements to sell your property and gather money to repay your debts. Liquidation orders usually come directly from the court. 
  • However, when going through Chapter 7 bankruptcy, there are certain exemptions. 
  • State governments and courts of varied jurisdictions impose various limits on bankruptcy. The exemptions are not huge but only fundamental in nature. 

However, these exemptions allow you to keep certain fundamental necessities with you. 

What Is The Process For Filing Bankruptcy?

First, you will have to consult an attorney who specializes in Chapter 7 bankruptcy. 

Then, your bankruptcy attorney will help you understand if you qualify for filing bankruptcy under this chapter. 

  • They will come up with an accurate valuation of your properties.
  • If you are eligible under this chapter, you will have to fill out the necessary documents. 
  • Keep income statements, bank statements, loan agreements, tax returns, and other financial documents handy. 
  • Find the petition for bankruptcy with the help of your lawyer. 
  • Within 60 to 90 days of filing, the court will order an automatic stay on the creditor’s activities. 
  • Next, you will have to attend the meeting of creditors called the 341 meeting. 

Once the liquidation process is completed with the help of the court-appointed Trustee, the discharge of your debts takes place.

Bankruptcy Filing Under Chapter 13 For A Sole Proprietorship

Chapter 13 works well for sole proprietorship in the same way it does for individuals. 

  • If you are a small business that has a reliable source of income, you can opt for Chapter 13.
  • It consists of a repayment plan over a span of 3 to 5 years.

How Do You File For Bankruptcy Under Chapter 13?

Before proceeding, you will have to consult with an experienced bankruptcy attorney specializing in Chapter 13 of the bankruptcy code.

  • Provide your financial details, like bank statements in common expenditure proof, to your attorney. 
  • After they are done with the evaluation, ask them if you are eligible under this chapter.
  • See if you are income and unsecured debts meet the threshold specified under the code.
  • Collect all your financial documents that the lawyer asks you to.
  • Complete the process of credit counseling from a government-approved agency. Collect your certificate for credit counseling course completion.
  • Now that the formalities are over, you can discuss with your attorney and come up with a repayment plan that best suits you.
  • Ask your lawyer to file the bankruptcy petition at a court having appropriate jurisdiction.
  • Now, the process will be the same as the process in Chapter 7. The court will pass an automatic stay order if it deems fit. Creditors will stop their debt collection efforts. 

Now, you will meet with the creditors and slowly start the execution of your repayment plans. Once you have repaid all your debts, you are debt-free.

Bankruptcy Filing As A Small Business Partnership

Partnerships are legal formal arrangements between two parties or more regarding the operation of a business. In legal terms, the partnership is not a separate entity. 

  • It describes a collaboration between two legal bodies.
  • Currently, the United States consists of many small businesses that make up partnerships. This is because forming partnerships is a very easy process. 
  • The building parties simply enter into a partnership agreement and operate the business together.

Types And Bankruptcy Obligations

Partnerships can be of various types:

General Partnership

Here, all partners of the business have an equal share in the profits, liabilities, debts, and management of the business.

  • Each partner of a General partnership is personally liable for the debts and legal obligations of the partnership. 
  • To file for a small business bankruptcy, this type of partnership will need to file for bankruptcy on a personal basis.

Limited Partnership

This is a combination of general partnerships and Limited ones. 

  • It has both types of members. 
  • The Limited partners have limited liabilities and responsibilities. 
  • The Limited partners are not responsible for large parts of the debt.
  • Partners of a limited partnership enjoy limited liability. 
  • The more the investment of the partner, the more their liability. 

In case the partnership is facing bankruptcy, only the general partners will be able to file for bankruptcy using their personal assets.

Limited Liability Partnership

All partners in this sort of partnership are not personally liable for the debts or negligence of other partners.

  • In this sort of partnership, the partners enjoy Limited protection. 
  • Their personal assets will not be involved in the case of debt or other legal obligations.
  • When the partnership faces legal challenges like bankruptcy, individual partners will have no responsibility.

Bankruptcy Filing Process For Small Business Partnerships- Chapter 7

A bankruptcy filing process is not that different for the different types of partnerships. First, the small business entity has to hire a bankruptcy attorney. This step is the same for all businesses.

General Partnership Chapter 7 Bankruptcy Filing

The liability of each partner is unlimited.

  • Since all partners are individually liable, there will not be a single joint filing. 
  • The different partners of the general partnership will file for bankruptcy separately.
  • The bankruptcy process will require the partners to submit a detailed assessment of their Assets and liabilities.
  • They will also have to signify to the court what share of the partnership and its debts they hold.

The court will appoint a Trustee to liquidate the nonexempt Assets of the partners.

Limited Partnership Bankruptcy Filing Under Chapter 7

Partners of a limited partnership also cannot file for individual bankruptcy. 

  • However, the nature of their liability is limited even after the bankruptcy.
  • The personal Assets of these partners are protected.
  • They only lose their respective Investments.
  • The general partners of a limited partnership have unlimited personal liability and may lose personal assets.

Filing Of Chapter 7 Bankruptcy For Limited Liability Partnerships

The partners enjoy liability protection against other partner’s actions. 

  • This means the debts of one partner will not lead another partner to go bankrupt.
  • If individual partners are having financial troubles, they will have to file for bankruptcy.

Partnerships Filing For Chapter 13 Bankruptcy

Chapter 13 bankruptcy is also called reorganization bankruptcy. 

  • Filing for Chapter 13 bankruptcy is a different process for each kind of partnership. 
  • Let us look into the details. 
  • Partners of a partnership file for bankruptcy individually.

General Partnership

Here, each partner has unlimited liability for debts and legal liabilities of the partnership. 

  • They all file for personal bankruptcy under the US bankruptcy code.
  • If they meet the individual eligibility criteria, they discuss with their attorneys to come up with a repayment plan.
  • Together, they propose the plans to the bankruptcy court.
  • They pay off their debts gradually according to the plan.

Limited Partnership

Individual partners file for personal bankruptcy.

  • The general partners of the limited partnership have personal liabilities.
  • The partnership also comes up with a repayment plan. They get it approved by the court having jurisdiction.
  • All partners pay off the debt according to their investment in the partnership.

Limited Liability Partnership

In this type of partnership, all the partners enjoy limited liability protection against other partners. They have to carefully discuss their financial situation with the bankruptcy Attorney.

However, if the partnership has gone into bankruptcy due to the negligence of one partner, they alone will be responsible for it.

Bankruptcy Filing As A Small Corporation

A commercial structure that can be classified as a small business under US law is a corporation. 

  • Corporations are legal entities that are distinctly separate from their shareholders. 
  • These shareholders are the owners of the corporation. 
  • If a corporation meets the various standards of a small business under US law, it will be treated as a small business.

Types Of Corporations

Now, let us look at the different types of cooperation present under the United States law.

C Corporation

This is the most common type of Corporation present in the United States. It is a type of Corporation that has a separate identity. 

  • This means that the corporation will have separate liability from its owners. A C 
  • Corporation has a multiple number of shareholders. 
  • Small c corporations have the same workings as small businesses.

S Corporation

These are not a separate legal entity. 

  • The shareholders/owners pay the corporate tax and not the corporation in itself. 
  • All profits and losses of the corporation make it to the shareholder’s personal tax filings. 
  • There are certain criteria that a corporation should meet. For example, there should be no more than 100 shareholders. 
  • Also, there has to be one class of stock.

Non-Profit Corporation

As the name suggests, non-profit corporations are organized for charitable, educational or other religious purposes. 

  • Owing to the nature of their purposes, these corporations enjoy a tax-free status.
  • Small corporations have to go through bankruptcy proceedings under Chapter 11 of the bankruptcy code. 
  • Only individuals and sole proprietors can use Chapter 7 and Chapter 13 to file for bankruptcy.

Small Business Bankruptcy Under Chapter 11 And SBRA

Small corporations that are facing financial difficulties can take refuge under Chapter 11 of the bankruptcy code. 

  • They can restructure their debts and continue operations successfully after it is completed. 
  • Filing for bankruptcy under Chapter 11 can become financially struggling. 
  • However, if they fall under the debt limits of sub-chapter 5, they can take the help of the Small Business Reorganization Act. 
  • However, if the debt limits surpass that of sub-chapter 5, they are in more complex financial trouble than they can handle. 

Let us talk about these options in a bit more detail.

Chapter 11 Of The Bankruptcy Code

Chapter 11 is tailor-made for small businesses to file for bankruptcy. Different types of corporations can reorganize their financial situation through it.

C Corporation And S Corporation

C corporations are independent legal entities. They can file for bankruptcy under Chapter 11 of the code.

S corporations are used for taxation purposes. Their outstanding characteristic is that they have a maximum of 100 shareholders.

An S Corporation can file for bankruptcy under Chapter 11.

The board of directors of the corporation has to pass a resolution. This resolution is to notify the body of the bankruptcy filing.

  • Their next step is getting in touch with a bankruptcy attorney.
  • With the help of their attorney, they will file the petition in court.
  • Once the court goes through the petition, the automatic stay order will come into effect.
  • When the corporation files for bankruptcy under Chapter 11, they are the debtor in possession.
  • The board of directors will remain in management until the court signs a trustee.
  • Now, the corporation will have to submit details of its assets, liabilities, incomes, expenditures, tax statements, and all financial matters.
  • Now, the corporation will get legal and financial Advisors. They will come up with a plan for reorganization and repayment to the creditors.
  • They will continue business operations and restructuring of debts.
  • If the creditors are willing, they can engage in negotiations with the Corporation. Creditors and debtors can together come up with a reorganization plan.
  • This reorganization plan will ultimately need the court’s approval.
  • The plan will outline how the creditors will emerge and function well after a bankruptcy.

Nonprofit corporations like the profit counter half can file for bankruptcy like a small business under Chapter 11 of the bankruptcy code.

Non-Profit Corporation

Chapter 11 will help the nonprofit Corporation reorganize its debts.

  • For this purpose, first, the nonprofit Corporation has to carefully assess its financial situation. A bankruptcy attorney will play a very important part in this stage.
  • Together with the financial and legal advisors, the corporation will access its debts, assets, and income sources.
  • The aim is to restructure the operation and continue.
  • After the assessment is done, the Attorney will prepare the necessary paperwork. They can also choose to negotiate with creditors before presenting the reorganization plan to the court.
  • The corporation will initiate Chapter 11 proceedings through a petition. The petition will include all sorts of financial disorders and a list of Assets and liabilities.
  • After the court deems fit, an automatic stay order will come into effect.
  • Debt collection activities will stop. The debtor and creditor will hold a meeting to decide the plan of action.
  • The court will hear the creditor’s claim. Through these claims, they can ask for payment from the nonprofit corporation. 
  • If the court deems fit, the creditors can negotiate further plans of repayment from the Corporation. After getting the final confirmation, the repayment plans will take effect.
  • Now, the non-profit corporation has to make regular payments to the creditor. The corporation may also choose to sell some of its assets for this purpose.

After they have paid a reasonable portion of their debts, the corporation can take positive steps towards emerging from bankruptcy.

Small Business Reorganisation Act Of 2019

This act came as a fifth sub-chapter of Chapter 11. It helps small businesses within the debt limits of $2725625. 

  • Since all businesses can file for bankruptcy under Chapter 11, this chapter, specifically small businesses, can get proper help.
  • Now, you need to understand that choosing between Chapter 11 and the reorganization will depend on the needs of your small business.
  • Therefore, this act provides a cost-effective process for small businesses to restructure their debts.
  • First, you will have to check if your business is qualifying under this subchapter. If the economy is going through inflation, the total debt amount will vary.
  • Now, the corporation will have to get a credit counseling certificate. Financial advisors will also help them look at alternatives for bankruptcy.
  • Next comes the petition for bankruptcy. A petition including all financial details should be submitted to the court. 
  • However, this chapter is a little different because the court appoints a trustee. The Trustee will take an active part in coming up with the reorganization plan.
  • Both the creditor and the court have two approves of this plan. Only after the final confirmation will the implementation process begin. 

After the plan is successfully in place, This small business will enjoy a debt-free status

Finally, A Small Talk On Small Business Bankruptcy

If your small business bankruptcy is intimidating, then hear us out. We understand that if you are going through bankruptcy, finances are probably too great right now. However, you should definitely invest in a lawyer with whatever you have left. Debt collection activities can become quite taxing. 

Hiring legal professionals will help you negotiate with your creditors. 

Only a bankruptcy lawyer can go through the details of your financial situation. They can help you choose the best course for the petition. 

Sometimes things may not be as bad as they seem to be.  Only your legal and financial advisors will be able to tell you if your small business is actually headed toward bankruptcy. 

Do a little research on your own and have all financial documents and proof ready. A little preparation before the court appearances will go a long way.

That’s it for our comprehensive guide on small business bankruptcy. We hope our article helps you through this difficult time.

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Debkanya Bhattacharya
Debkanya is a lawyer turned writer. With an experience of 3 years, she is your go-to source for all things law. She has a soft corner for the US and international section. When the weekend arrives, you'll find her reading up on politics, Austen, or travel blogs over a cup of coffee.

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