Bankruptcy Questions and Laws

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Permalink Reply by Team Sta.rtUp.biz on June 20, 2008 at 6:43pm

Ironically, it costs money to go bankrupt. For a lot of small business looking to wrap up their businesses, it doesn’t make economic sense to go through a formal bankruptcy proceeding. Lawyers, accountants, trustees, and the courts all come with costs. And after these bills are paid, the creditors of the business will stand in line (according to their statutory ranking in the bankruptcy code) to divvy up the remaining assets. For larger businesses, bankruptcy may make sense, depending on the particular facts of the situation.

There are three bankruptcy statutes: Chapter 7, Chapter 11, and Chapter 13. Chapter 7 is a liquidation and is generally the simplest. Chapter 11 is not technically a liquidation, but rather a “reorganization”. Chapter 11’s are usually used by large companies looking to continue their corporate existence, and can be quite expensive depending on how contentious the creditors and trustee are and a host of other factors. Chapter 13 is basically a debt management/reduction plan and should be considered when debts that are not dischargeable under a Chapter 7 bankruptcy are at issue (i.e., taxes). However, Chapter 13 is not available to companies, not even sole proprietorships (only individuals).

As a practical matter, small businesses that are operating as sole proprietorships and aren’t doing well generally simply close their doors and do their best to settle with their outstanding creditors amicably. Creditors who aren’t fully paid may attempt to force the business into involuntary bankruptcy, but typically don’t if insufficient assets remain and the probability of a sensible recovery is minimal.

Businesses that have organized themselves as LLCs, corporations or partnerships don’t have the option of simply closing up shop, but rather need to dissolve or wind up the formal entity according to their operating agreement, bylaws, or partnership agreement, respectively.

Even if you are operating as a sole proprietor (and I hope you’re not, from a liability standpoint), it is smarter to formally end the business instead of taking what would seem to be the “easy” way out by shutting your doors. In this process, you will communicate with your state tax assessing entity, your financial institutions, and all your creditors to officially end the life of the entity and settle all outstanding issues. You should make sure to have documentation of any settlements and account closures.

And one more word of advice: a creditor who feels slighted could attempt to “pierce your corporate veil” and show that your business was not formally separate from you as an individual. The creditor might attempt to show that the company was simply your "alter ego." If the creditor is successful in proving that to the court, the creditor could access your personal assets. So, in a nutshell, do your best to be fair and honest with all parties in the process.

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