Small Business Bankruptcy Chapter 7 in California When To File
One of the most frequent inquiries I get are from my Los Angeles Area small business owners wanting to file bankruptcy “on” their businesses.
“I need to file bankruptcy because my business is failing”, they tell me.
However, it is rarely necessary to file bankruptcy for a business that is not trying to stay in business, if that business is held by a separate entity such as a corporation, LLC, or LLP**.
When To File Bankruptcy For Your Corporation LLC LLP
Is your small business owned under a corporation, or LLC, or LLP, or is it simply a sole proprietorship of yours (e.g. John Doe dba Doe’s Garage)?
If the business is not a separate legal entity, such as a corporation, LLC, LLP, etc., then you must examine the personal/individual bankruptcy options of the business owner(s) because there is no separate business entity.
Who Owes The Debts On Your Business?
Let’s say you’ve tried everything and you have decided to close the doors of your small business (assuming your business location has doors). You have stopped or will stop operations and want to walk away.
If your business is a separate legal entity, such as a corporation, LLC, or LLP, then its creditors have recourse against the assets of the business.
And, if you signed a personal guarantee on any of the business debts, then they also have recourse against you (the owner) individually.
Moreover, some debts may also become your personal responsibility even in the absence of a personal guarantee. This includes things like the trust fund portion of unpaid payroll taxes and sales tax obligations.
Even if a corporation did get a discharge of debts in bankruptcy, that would not affect the personal liability on any personal guarantees or other of the above-mentioned obligations.
That is why in most of these cases, it is a personal bankruptcy case that is needed; not a corporate “business bankruptcy”.
When To File Chapter 7 For Corporations**
Corporations do not receive a discharge of debts in Chapter 7.
For some reason, this concept is very difficult for many to understand.
One reason that no discharge is entered for corporations in Chapter 7 is that it would be completely unnecessary.
If a corporation is no longer operating and going out of business, what benefit would there be to discharging its debts?
If no more business is to be conducted, servicing existing debts is a non-issue.
However, there are times when a Chapter 7 can be beneficial in these cases, when the small business has a lot of assets.
This occurs where a new entity has been formed to run essentially the same business, and the new owners need some assets from the “old” corporation to run the new one (for example, machinery, or software, the brand name, or whatever).
In that case, a Chapter 7 filing helps shield the owners from liability as the Chapter 7 Trustee can sell the assets to the new business (after a normal bidding process). Then the owners of the new business cannot be accused getting the assets for less than fair market value and it helps remove any successor liability issues.
When To File Chapter 11 For Corporations in Los Angeles
Chapter 11 is filed when the small business corporation wants to stay in business and reorganize.
It can also be used to liquidate assets and control the sale more than would be possible in a Chapter 7.
Chapter 11 to stay in business requires proposing some kind of repayment plan.
Many rules must be followed to get a Plan approved, including obtaining a certain number of votes from creditors, which can be difficult.
The new SubChapter V Chapter 11 enables a payment plan based on projected disposable income, typically over a 5 year period, and can be accomplished even without creditors being able to vote.
To see more on the Chapter 11 options, visit my Los Angeles Chapter 11 bankruptcy page.
When To File Bankruptcy if Your Business is a Sole Proprietorship / DBA
If your small business is NOT a corporation** then there is no separateness between your business and yourself individually. You are one and the same.
So, in this case, filing a bankruptcy “on your business” means filing a personal bankruptcy case.
Filing a personal bankruptcy might be necessary if you have personal guarantees or other liability on debts from a corporation** which you are unable to pay.
Personal bankruptcy can be filed under Chapter 7, 11, or 13, depending on the facts and circumstances of your case (amount and type of debt, value of assets, income and expenses, etc.).
A consultation with a qualified and experienced bankruptcy attorney is necessary to determine whether you need to file a bankruptcy and, if so, which Chapter would be best.
**When I refer to corporations I am including, for the sake of this article, any non-individual entities such as LLCs, LLPs, S-Corps, and C-Corps.