Frequently Asked Business Bankruptcy Questions

When many people consider filing for bankruptcy, they think of personal or consumer bankruptcy. However, business or non-consumer bankruptcy is available for individuals and businesses seeking help with business debt.

Business debt differs from consumer debt because it’s incurred from profit-seeking business endeavors instead of consumer purchases for things such as food, clothing, and shelter. A business bankruptcy tends to be more complicated than one filed by an individual consumer—partly because of the significant differences between the two types.

Here are a few things to know before moving forward on your company’s behalf:

• a business doesn’t have to meet income qualifications
• individuals with primarily business debt don't need to pass the Chapter 7 means test
• business debt is rarely wiped out (discharged) in a Chapter 7 bankruptcy, and
• the business owners' personal assets can be at risk (but it depends on the business entity type).

Failing to understand these nuances could easily result in an unexpected—and costly—outcome. If you’re contemplating moving forward with a business bankruptcy, it’s prudent to consult with an attorney. In fact, in some cases, hiring an attorney is a requirement.

You probably already know the type of bankruptcy you should file because, in most cases, it’s relatively straightforward—individuals seeking bankruptcy usually file personal or “consumer” bankruptcy, and businesses file a “non-consumer” or business bankruptcy.

But then again, it isn’t always that clear.

For instance, if you’re a self-employed party planner with a large credit card balance that you incurred after buying school clothes, streamers, and paper cups, you might not know which you’ll qualify to file. The same might be true for a work-at-home travel blogger who racked up debt after vacationing in a new destination.

• So how are you to know? Ultimately, your particular debt will determine the filing type. Here’s the rule: If your debts are “primarily consumer debts,” you’ll file a personal If you have more business debt than consumer debt, you’ll file a business bankruptcy.
• What is a consumer debt? It’s debt incurred when purchasing items you use for personal, family, or household purposes. Such items will include things you need to live, like groceries, clothing, and rent, as well as things you buy for pleasure, such as a gym membership or a trip to Jamaica.
• What does “primarily” consumer debt mean? The answer depends on where you live. Some courts allow you to add up your consumer debt. If the consumer debt amount exceeds that of your business debt, you’ll file a consumer bankruptcy—and vice versa. Other courts ask that you add up the number of debts you have instead of the total dollar value of each type. You’ll have to use the standard used by your local court.

Filing for bankruptcy can have lasting (and costly) consequences. If you’re unsure which type suits you best, speak with an attorney. A local bankruptcy lawyer will review all aspects of your financial situation and provide valuable insight into how the courts handle cases in your area.

If the business will eventually close, it will likely file a liquidation bankruptcy. By contrast, if a business can continue operating after restructuring its debt payment, it would probably benefit from a reorganization bankruptcy.

• Business liquidation. It’s important to transparently unwind a failing business with no hope of recovery. Why? Because it reduces the chance that a creditor will accuse the owner of pillaging company assets before shutting it down—allegations that can translate into costly litigation. In a Chapter 7 bankruptcy, the bankruptcy trustee—the court-appointed official overseeing the case—sells the company’s assets and distributes the sales proceeds to the creditors in an orderly manner. Another valuable benefit? Filing for Chapter 7 bankruptcy assumes much of the burden of closing the owner's business.
• Business reorganization. Many business owners hope filing for bankruptcy will help the company remain open and in time, thrive. A Chapter 11 bankruptcy can help an existing business do that very thing (and in some cases, an individual who owns a business as a sole proprietor can file for Chapter 13 bankruptcy). Also known as “reorganization,” this bankruptcy type allows a company to renegotiate its debt contracts with creditors and come up with a manageable repayment

A struggling business might benefit from one of four types of bankruptcy, depending on its entity type and goal. Businesses closing or have already closed will likely file for Chapter 7 bankruptcy. A business that wants to remain open can file for Chapter 11 bankruptcy.

Although the business itself can’t file for Chapter 13, the individual business owner might be able to do so—and it might lower monthly debt obligations enough to get the company back on track. Here are brief descriptions of each chapter and the business entities that can utilize that type.

• Chapter 7 bankruptcy. In this frequently filed chapter, the bankruptcy trustee—the court-appointed official tasked with administering the case—liquidates (sells) assets and distributes the proceeds to creditors. Any business can file for Chapter 7 bankruptcy, but only a sole proprietor can have qualifying debt wiped out (discharged). Also, it’s important to note that if the business is a sole proprietorship or a partnership, the sole proprietor's or partners' personal assets can be used to pay off business debt.
• Chapter 13 bankruptcy. In the right circumstances, a qualified business can lower its monthly debt obligation and remain operational after an individual owner files for Chapter 13 bankruptcy (the business itself can't file unless the owner is a sole proprietorship). Also, debt limits exist. If the total debt exceeds the amount allowed, the business (and owner) must file for Chapter 11 bankruptcy instead.
• Chapter 11 bankruptcy. Many companies that want to remain open opt for Chapter 11 bankruptcy. Once filed, the company will disclose its income, assets, and debt and draft a reorganization plan that preserves critical business assets while reducing or eliminating certain debt to pay creditors out of the monthly profit. All business entities can file for Chapter 11 bankruptcy, and there are no debt limits. Even so, larger, established companies use this chapter most effectively. It’s often too costly for a small business with a limited income stream to gain the necessary approval from creditors and the court.
• Chapter 11, Subchapter V. This bankruptcy type is relatively new. It's a cross between Chapters 13 and 11, which allows smaller businesses to keep businesses over using a more economical bankruptcy procedure. Over the past four years, it has been widely accepted and proven effective.
• Chapter 12 bankruptcy. This type is similar to Chapter 13 bankruptcy, but it’s only available to family farmers and fishermen. It allows a small farming or fishing enterprise to stay in business while affording relief through debt restructuring.

Because bankruptcy affects different types of businesses in very different ways, a bankruptcy attorney will likely ask you whether your business is a sole proprietorship, partnership, limited liability company, or corporation.

Next, you’ll be asked whether you’d prefer to wind down the company or keep it going through a restructured payment plan. Only after obtaining this information will the attorney be able to outline your options so that you can decide the best course of action.

Sole proprietors and Chapter 7 bankruptcy. Because a sole proprietor is personally responsible for all business debt, the individual and business are essentially the same regarding bankruptcy. As a result, the entire financial situation of both will be included in the case. Interestingly enough, this structure affords a sole proprietor more solutions than any other type of organization. A Chapter 7 case will wipe out the individual’s responsibility to pay qualifying business debt (as opposed to the business debt itself), as well as personal debt (including personal guarantees—more below). The downside is that the assets of both the individual and the business get included in the bankruptcy estate, too. However, the filer won’t lose everything. The filer can protect a certain amount of property with a bankruptcy exemption. The remaining nonexempt property will be sold for the benefit of the creditors.

Whether or not the company stays open after the bankruptcy largely depends on the type of business. For instance, a dog walking company would likely remain viable because of its service-oriented nature. By contrast, a business that relies heavily on equipment or products, such as a food truck catering service, would probably end up defunct after the bankruptcy. It would be highly likely that the bankruptcy trustee—the individual responsible for overseeing the case—would have the right to sell the truck and food preparation equipment and distribute the sales proceeds to the creditors. With necessary equipment gone, the business would most likely cease to exist.

An additional benefit of filing as a sole proprietor is that if the majority of bills are business debts, the filer won’t have to take the Chapter 7 means test—the financial test determining whether an individual qualifies for a Chapter 7 discharge. Therefore, having a significant income won’t preclude many sole proprietors from receiving a discharge.

Sole proprietors and Chapter 13 or 11 bankruptcy. A sole proprietor is the only business entity that can take advantage of Chapter 13 protection. (That isn’t to say that an individual who owns a business can’t file a Chapter 13 case—the debtor can file an individual case, but the business and its debts won’t be included in the bankruptcy.) Assuming that the total debt doesn’t exceed the chapter limits and that the company has sufficient income to support a plan, the filer might be able to keep the business open while making payments to creditors over three to five years.

This chapter has the added benefit of allowing the filer to simultaneously catch up on personal bills. For instance, if the owner kept the business afloat by using funds usually allocated for a mortgage payment, this chapter would stop the impending foreclosure and allow the filer to catch up on past-due payments. If the total debt amount is too high (debt limits exist in Chapter 13 bankruptcy), the filer can pursue a Chapter 11 or Chapter 11, Subchapter V case.

Partnerships and bankruptcy. Most partnerships have two options—a Chapter 7 or Chapter 11 bankruptcy. Because a Chapter 7 bankruptcy doesn’t discharge the business debt, in this scenario, it’s only useful if the owners want to wind down a closing or closed business transparently.

In that case, the trustee would be responsible for selling the business assets and distributing the funds according to bankruptcy priority law. This approach gives creditors greater confidence in the debt payment process. In other words, they’ll be more likely to believe they’re getting the amount they’re entitled to receive.

However, this chapter comes with a significant problem for individual partners, and because of it, partnerships rarely file for Chapter 7 bankruptcy. Here’s the problem: Because partners are responsible for the business debt, filing puts the partner's personal assets at risk. Specifically, the trustee could—and very well probably would—take each partner’s individual property, sell it, and use the proceeds to pay down the company debt. And, to add insult to injury, the bankruptcy wouldn’t wipe out any of the individual’s personal debts, either.

On the other hand, if a partnership wants to keep the business open, filing for Chapter 11 bankruptcy might be a good option. The company would develop a plan to repay its debts—quite possibly at a discount.

Corporate structures and bankruptcy. The same basic rules for partnerships will also apply to a limited liability company or a corporation. There’s one exception, however. Because of the shield this type of business structure provides to members and shareholders, the owners' personal assets usually aren’t at risk.

There’s a caveat, however. If a principal improperly handled business assets—for instance, by using them for personal purposes—someone who believes that they’ve been harmed (the “plaintiff”) might choose to bring an alter ego action to “pierce the corporate veil.” If the plaintiff wins, the principal’s personal assets might be at risk in bankruptcy.

Once the matter is in bankruptcy, it is relatively easy to bring an alter ego action. Therefore, if this type of litigation is possible—even if it is unwarranted—the corporate officers should think twice before putting the business in bankruptcy and providing a convenient forum for an alter ego lawsuit. All lawsuits are expensive, no matter what the outcome might be.

Your debt matters when deciding which type of bankruptcy to file. If your debt is "primarily” consumer debt, you’ll choose a personal or individual (consumer) bankruptcy. However, if you have more business debt, you’ll file a business (non-consumer) bankruptcy.

You’ll categorize your debt by looking at its purpose. Specifically, business debt results from a desire to derive a profit. You take out business debt to help you make money in a business venture, not for personal, family, or household purposes. Debt incurred for personal purposes is “consumer” debt.

Here are examples of business debt:

• a business loan
• the cost of leasing office space
• personal and business taxes, and
• the balance owed on a delivery van used in a cookie business.

Figuring out your particular debt type can get tricky. For instance, if you take out a home equity loan and use the funds to open a 24-hour diner, the purpose of the debt would be to make a profit operating a restaurant. In that case, the debt would be a business debt even though you secured the loan with your residence.

Similarly, suppose you raise hamsters and sell them to a local pet store for profit. To track your expenses, you use a credit card to pay for the supplies. But you also use the same credit card to purchase your morning coffee. As a result, you’ll have consumer and business debt on the same account.

Remember that addressing all types of business debt is beyond the scope of this article, and identifying one from the other isn’t always obvious. For instance, in some cases, student loans and income tax debt count as business debt (courts handle this differently). Before filing for bankruptcy, it’s best to meet with a knowledgeable bankruptcy attorney, especially since the initial consultation is often free.

It depends. If you, as an individual, have already filed personal bankruptcy and received a discharge for business debt (at least some of your obligations were wiped out), you might have to allow a certain period to elapse before you’ll be entitled to another discharge. How much time must pass (if any) will depend on the bankruptcy chapter you filed before, as well as the chapter you intend to file again.

A business (other than a sole proprietor) cannot receive a discharge in Chapter 7 and cannot file a Chapter 13 case. However, it can receive a debt discharge in Chapter 11.

When Seeking a Chapter 7 or 13 Discharge

Only an individual or sole proprietor is entitled to a discharge in Chapter 7 or Chapter 13 bankruptcy. If you’ve received a discharge in one of these capacities and you’d like to receive another, here’s how long you’ll have to wait:

• Chapter 7 bankruptcy after a Chapter 7 or 11 discharge. The filer must wait eight years.
• Chapter 7 bankruptcy after a Chapter 12 or 13 discharge. The filer must wait six years (unless the filer paid 100% of unsecured claims or 70% of unsecured claims in a good faith plan).
• Chapter 13 bankruptcy after a Chapter 7, 11, or 12 discharge. The filer must wait four years.
• Chapter 13 bankruptcy after a Chapter 13 discharge. The filer must wait two years.

When Seeking a Chapter 11 or 12 Discharge

The rules for filing and receiving a discharge under Chapter 11 or 12 are much easier to meet. First, an individual, sole proprietor, partnership, limited liability company, or corporation can receive a discharge in Chapter 11 or 12 bankruptcy, regardless of any previous discharge. In other words, there’s no waiting time between discharges.

Exceptions exist, however. Specifically, you’ll want to be sure to tell your attorney if you (or the business entity) violated a court order or had another case dismissed during the 180 days before your bankruptcy filing. In that case, you might not qualify for another discharge.

No. The rule is as follows: An individual or a sole proprietor filing a business (or non-consumer) bankruptcy can get qualifying debts wiped out (discharged) in a Chapter 7 bankruptcy once every eight years.

If the individual or sole proprietor wants to file a Chapter 7 bankruptcy more than once within the eight-year period, it can do so. But debts won’t be wiped out. It’s the discharge that’s limited—the ability to get debts wiped out—not the filing itself.

Here’s how it works.

If a second Chapter 7 bankruptcy gets filed before eight years, the bankruptcy trustee—the individual tasked with administering the case—will sell any nonexempt property (property the filer isn’t entitled to keep) and distribute the funds to creditors. The filer won’t receive another discharge, however. Because the desire to obtain a discharge prompts most Chapter 7 filings, filing more than once within an eight-year period is rare, although it can happen.

It’s important to understand that partnerships, limited liability companies, and corporations aren’t entitled to a discharge under Chapter 7 bankruptcy. These entity types use this chapter to liquidate (sell) and disperse assets to creditors transparently.

Successive Chapter 7 filings aren’t usually an issue for these entities because the initial Chapter 7 bankruptcy filing effectively dismantles the business. A defunct company doesn’t need additional bankruptcy relief.

A sole proprietor can always file for bankruptcy on behalf of the business. However, partnerships and corporations work a bit differently. A corporate resolution allowing for the bankruptcy filing must be included in a corporate bankruptcy. All general partners must agree to file for bankruptcy to be considered voluntary. You'll find more information in 341 Meeting of Creditors for Businesses.

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Yes. If the business has valuable assets—such as cash, investments, equipment, or real estate—and a creditor is concerned about getting paid, it can file for bankruptcy under Chapter 7 or Chapter 11 (involuntary relief isn’t available under Chapter 12 or Chapter 13 bankruptcy).

Forcing a business into an involuntary bankruptcy can benefit a creditor in several ways. It causes the automatic stay—the order that stops collection activities—to go into effect. The stay evens the playing field because one creditor cannot gobble up all of the business assets to the detriment of the others.

Also, a bankruptcy trustee—the court-appointed individual that oversees the case, including the 341 meeting of creditors—can step in and manage the business and unwind transfers of money or assets that the company might have made in an attempt to avoid paying creditors (fraudulent or preferential transfers).

However, involuntary bankruptcies rarely get filed because creditors must meet certain criteria—and it isn’t easy to do so. For instance, if the business has less than 12 creditors, a single creditor can file the petition as long as that creditor’s claim meets the current claim amount requirements. The debt must be undisputed (the business acknowledges that it owes it) and unsecured (not guaranteed by property called “collateral,” such as a commercial building or a company vehicle).

Although this test might sound simple to satisfy, it isn’t, and here’s why: If the business has more than 12 claims (bills), three creditors must join in and sign the involuntary petition—and all debts, no matter how small, must get counted. Most creditors don’t want to work together because once in bankruptcy, the creditor must share the assets with others and will likely receive a portion of the amount owed. It can be more lucrative to work towards collecting a debt in full without competition from other creditors.

An involuntary case can be expensive, too. If the business contests the case (disagrees with the creditors’ right to file it), the case will move into litigation and proceed to trial—and litigation is expensive. Before filing, a creditor would assess the likelihood of coming out ahead after paying for attorneys, experts, and other costs of suit.

Other risks exist, too. For instance, if the court finds that the creditors shouldn’t have filed the matter (improperly filed the case in bad faith), the creditors would be required to pay the business’s attorneys' fees.

It depends. As an individual, you cannot own the corporation itself because it exists as a separate legal entity. Instead, you hold your ownership interest in the form of shares, a property type.

When you file for personal bankruptcy, you must disclose all your property—including your corporate stock. Additionally, you’ll tell the court how much the stock is currently worth by assigning each share a value.

What will happen next will depend on the following:

• the type of bankruptcy you file
• the value of your shares, and
• whether your state’s exemption laws will allow you to exempt (keep) them.

Specifically, each state allows its residents to keep a certain amount of property. If the property isn’t needed to maintain a household and employment, it’s unlikely that your state will have a specific exemption that covers it—and corporate shares aren’t assets that most states believe are necessary for everyday life.

However, you might have a wildcard exemption allowing you to keep a certain amount of any property you choose. In that case, you can use your wildcard exemption to protect your interest in the company (although typically, wildcard exemptions aren’t for large dollar amounts).

If you can exempt the shares, then the answer to this question is simple—nothing happens to your corporation. Your ownership interest and corporate participation will not change.

If you can’t exempt the shares, the analysis becomes more complicated.

Filing for Chapter 7 bankruptcy. The bankruptcy trustee can sell nonexempt shares and distribute the proceeds to the corporate creditors. If that happens, the corporation will likely continue to exist. However, you’d lose all ownership interest in the company.

Remember that just because the trustee has the right to sell your shares, that doesn’t mean someone will want to buy them. The outcome depends primarily on how necessary you are to the company's profitability.

For instance, the shares will likely sell if the company remains operational (and profitable) without you. The situation will be entirely different if you own all or a majority of the shares, and it isn’t practical for someone else to manage the business in your absence.

Let’s say you’re the only plumber in a plumbing enterprise and aren’t willing to stay on as an employee. It would be unlikely that the trustee could find a buyer because the corporation would be worthless without you. The trustee would likely abandon the property (the shares), and you’d retain your ownership interest.

Filing for Chapter 13 bankruptcy. You can hold on to the shares even if they’re nonexempt. But there’s a catch. You must pay your creditors the value of the nonexempt stock through your three- to five-year repayment plan.

Filing for Chapter 11 bankruptcy. Sometimes a filer's debts exceed the amount allowed by Chapter 13. In that case, you can reorganize your debt by filing an individual Chapter 11 bankruptcy.