Small Business Bankruptcy

While much of the way forward remains murky, many small businesses were casualties of the 2020 coronavirus pandemic and more may fade away as the pandemic rolls into its third year.

The Harvard Economic Tracker said that more than one third of the 32.5 million small businesses in the United States closed – either temporarily or permanently – despite Washington spreading hundreds of billions in (strings-attached) forgivable loans.

Because truly small businesses — those with fewer than 100 employees — account for 98.2% of all U.S. businesses (Small Business Administration), it’s easy, and chilling, to see what a negative impact that has on the U.S. economy.

Some small businesses — not just newcomers, either — simply will fade away, closing their doors, never to reopen. Others, caught wrong-footed when their states shut down, will choose bankruptcy.

Which type of bankruptcy depends on the answers to these questions:

• What is your business’ structure?
• Who is liable for the debt?
• Do you want to stay in business?
• Do you have a viable plan for staying in business?

Like most problems in business and finance, one solution does not fit all. Luckily — using the term advisedly — lawmakers and regulators have created sufficient variety of choices that you should find a suitable fit right off the bankruptcy code rack.

Better still — scrambling for silver linings here — there’s hope in a bankruptcy law that took effect in February. The Small Business Restructuring Act may be just the lifeline some need to survive.

Filing Bankruptcy as a Sole Proprietorship

Lacking a formal legal structure (incorporation or LLC) in place, bankruptcy law regards a sole proprietorship and its owner (or owners, in the case of married couples running the business) as one and the same. Creditors owed business debts can sue sole proprietors personally, putting their possessions at risk.

Choosing the right bankruptcy path is critical.

Chapter 7 Bankruptcy for a Sole Proprietorship

Chapter 7 bankruptcy — known also as “liquidation” or “straight” bankruptcy — means the end of the business. The process involves surrendering nonexempt property to be sold by the trustee assigned to your case, with the proceeds being distributed among creditors.

Exemptions, varying by state, are designed to let you to hang onto fundamental necessities to help with your fresh, post-bankruptcy start. Among these are some home equity, vehicles, furniture, clothing, and tools of the trade.

Generally, however, exemptions for business assets are not large. If you choose Chapter 7, you’ll most likely lose it. That’s the ugly part.

Here are the upsides to Chapter 7:

• If most of your debt comes from your business, you are eligible to file Chapter 7 without having to pass a bankruptcy means test.
• You are not directly on the hook for any debts. Typical business debts — what you owe suppliers, landlords, vendors, and credit card companies — will be wiped clean.
• The time from filing to discharge is fairly brief, from four to six months.

Chapter 13 Bankruptcy for a Sole Proprietorship

Chapter 13 works for sole proprietorships essentially the same way it does for individuals: Businesses that have a steady, reliable income can ask the court to approve a repayment plan (paid to a trustee who pays creditors) lasting between three and five years.

At the end of the agreed-upon plan period, if you are current with your debts, the balance will be discharged — erased — and you may continue operating without oversight from the court.

A key consideration for any sole proprietor considering Chapter 13: You retains your assets, both personal and business-related.

Small business owners must qualify, however. They cannot have more than $419,275 in unsecured debt, and $1,257,850 in secured debts (that is, loans backed by assets).

Filing Bankruptcy as a Partnership

Partnerships are formal arrangements between two or more parties for the management and operation of a business. But technically, a partnership does not exist as a separate legal entity; it simply describes the association of the partners.

In good times, partners share in the profits. In bankruptcy, they may well share in the obligation to satisfy debts. It all hinges on the structure of the partnership.

The partnership that files for Chapter 7 bankruptcy, whatever the setup, is in for a rough ride, resulting in the loss of investments, lawsuits outside bankruptcy court, and the likely collapse of the partnership itself.

Thinking of trying the Chapter 13 reorganization path? Good luck with getting creditors to accept a long, drawn-out partial repayment plan if some combination of the partners has sufficient personal assets to pay off all the partnership’s debts. An alert creditor may attempt to move the case into Chapter 7 to recover all it’s owed, rather than some reduced portion.

That’s the reason most partnership agreements contain a poison pill clause: The moment one partner files for bankruptcy, the business dies, preventing trustees or creditors from suing other partners to recover debts.

Let’s assume a particular partnership lacked an instantaneous-dissolution provision. Sorting whether there are sufficient assets in the partnership to meet the outstanding debt, or if there will be a deficiency, can consume a lot of time. Meanwhile, the court may restrict the general partners’ ability to transfer personal assets, or require them to post a bond or make some other assurance they are good for the deficiency.

General Partnership (GP)

General partnerships are partnerships in their simplest form. When a GP files for Chapter 7 — liquidation — bankruptcy, the partners are personally on the hook for all the partnership’s debts.

Limited Partnerships (LP)

A limited partnership has both general partners and limited partners. Again, general partners are personally responsible to creditors. Limited partners are liable only for the debt, if any, they personally guaranteed.

Limited Liability Partnerships (LLP)

If you’re part of a limited liability partnership — not all states provide for them in their statutes — your liability for the partnership debt may be limited, as the name suggests. Here, too, limited liability partners remain liable for any debts personally guaranteed.

Filing Bankruptcy as a Limited Liability Company (LLC)

Operating as a limited liability company creates separation between the business entity and those involved in its operations. An LLC that files for Chapter 7 bankruptcy will result in the business’ assets being liquidated to resolve its debts.

Generally, the LLC’s owners are not personally responsible for business debts — unless, as with limited partners, the owners have personally guaranteed any of those debts. In that event, the owners may have to file personal bankruptcy to avoid their liability.

LLCs that simply have hit a rough patch and foresee a viable way forward also have the option of filing for reorganization under Chapter 11 bankruptcy. Once affordable only for large corporations, the Small Business Reorganization Act, which became effective in February, simplifies and streamlines Chapter 11 for small businesses. Check with an attorney for details.

Already, however, Congress’ response to COVID-19 has altered some SBRA’s provisions. Among other important changes, the March 27  CARES Act raised the ceiling for new cases filed between March 28, 2020 and March 27, 2021, to $7,500,000 from $2,725,625.