Is Bankruptcy Right for your Small Business?
When thinking about bankruptcy for your small or closely held business, your first consideration should be the type of business entity you own: a corporation, a partnership, or a proprietorship?
Corporations, limited liability companies, and partnerships are their own legal entities, separate from their shareholders or partners. This simply means that they alone can file for protection under Chapter 7 or Chapter 11 of the bankruptcy code.
Difficulties with Proprietorship
Sole proprietors are different than other types of companies or business formations in that the proprietor must file for bankruptcy. A proprietorship cannot file for bankruptcy on its own; it must be the owner who files for bankruptcy. This is because a proprietorship is seen as just an extension of the proprietor. The owner then has the option to file for protection under Chapter 7, Chapter 11, or Chapter 13 of the federal bankruptcy code (though Chapter 13 has different eligibility standards, depending on if debt limits are met).
Next Step: Reorganization or Liquidation?
In deciding whether to reorganize your company or simply liquidate it, you should keep in mind those factors that have caused you to decide to file for bankruptcy. Some of the factors to consider are:
- Reorganizing your business will not create new customers, increase gross sales, or make up for the lack of available employees with the skill set your business needs for success.
- Reorganization could give your business a new cash structure that allows it to continue operating, take on new projects, remove imprudent expenses, and avoid the loss of vital assets or cash to creditor collection activities.
- In between Chapter 7 liquidation and reorganization, owners have some room to sell the business or its assets in something other than a fire sale. This can be done through Chapter 11 or 13 bankruptcy.
Perils for Management
Bankruptcy is a huge drain on the resources and time of everyone involved. One of the drains is financial – bankruptcy and reorganization are extremely expensive. Does your management team have the resources and motivation to engage in this difficult reorganization process? Chapter 11 bankruptcy reorganization requires a lot of time for the owners and managers of the business. They must comply with all the requirements of the federal bankruptcy system, meet with bankruptcy attorneys, and negotiate with creditors.
The “bankruptcy bargain” is a term you might hear, where the debtor provides an full disclosure of its economic condition to creditors and the court in exchange for certain bankruptcy protections, such as protection from an automatic freeze. However, with this, the debtor must provide monthly updates on their economic condition and they must operate as a fiduciary for its creditors during the course of the bankruptcy.
You should also keep in mind that most business reorganizations fail. You must be honest with yourself and consider whether or not your business would actually survive a reorganization. Typically, businesses that are based almost entirely on the owner’s skills and personality will not last through a reorganization.
The best solution here is normally to liquidate the business – whether or not this means bankruptcy – and start with a fresh entity. These are strategic decisions that should be made by an entire team. The teams consists of (minimally) the accountant for the business, the business owner(s) and an experienced business bankruptcy attorney.
The Kronzek Firm attorneys are available 24/7 all year long. If you are in need of immediate legal assistance, call 1-517-886-1000. Our lawyers have handled bankruptcy cases for decades in Mid Michigan.