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4 Types of Bankruptcy You Need to Know

Author: Karen Harned Date: July 01, 2014

Do you have Chapter 7 confused with Chapter 11? We’ll set you straight.

Starting a business is an exciting time. But the reality is that not all businesses make it, and a time may come when you need to consider filing for bankruptcy.

If so, the first thing to think about is liability—namely yours. If you are a sole proprietor or a general partner in a partnership, then you are personally liable for business debts. That means creditors can take your personal assets to satisfy debts owed. If your business is a corporation or limited liability company, or if you are a limited partner, then creditors are allowed to go after only your business assets unless you cosigned or personally guaranteed the debt.

Depending on your business structure and liability, there are typically four types of bankruptcy to consider.

Chapter 7

If you do not plan to restart your business and do not have substantial assets, this type of bankruptcy, commonly referred to as liquidation, may be your best choice. Sole proprietorships and small businesses often opt for this type of bankruptcy when their businesses are closely tied to their owners’ particular skills. For sole proprietorships, you will need to file for personal bankruptcy to eliminate debts because your business is not a separate legal entity. Partnerships, corporations and LLCs generally use a Chapter 7 business bankruptcy to shut down and liquidate themselves. But you cannot use a Chapter 7 business bankruptcy to erase personal obligations on business debts, which is why many business owners often file for personal bankruptcy under Chapter 7 as well.

Chapter 11

This is your best option if you plan to continue your business in the future because it allows you to reorganize your debt. But know that the reorganization can be expensive and complicated. It will include a repayment plan that creditors must vote on and that a trustee must oversee. If your business has less than $2,343,300 worth of debt, it can be classified as a “small business debtor,” which can speed up the process. This bankruptcy option is available to sole proprietorships, corporations and partnerships. However, Chapter 13 may be a better option for sole proprietors because it is less complicated.

Chapter 12

Chapter 12 is designed for family farmers or family fishermen with regular annual income. Under Chapter 12, you establish a repayment plan that requires you to make payments in installments to creditors during a three- to five-year period.

Chapter 13

If your business is a separate entity, you cannot file under Chapter 13; it is reserved for sole proprietors or small business owners wishing to discharge personal liability for business debts. Under Chapter 13, you are allowed to keep your property and reorganize your debts by filing a repayment plan with the bankruptcy court.

Remember: Bankruptcy is not always the best option for a struggling business, so consult an attorney to determine if it is right for your business before moving forward.

Visit NFIB's Small Business Legal Center for more advice.

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