A Guide to Business Bankruptcy

Consumer bankruptcy involves Chapter 7 and Chapter 13 of the bankruptcy code, and typically a business bankruptcy will involve Chapter 7 or Chapter 11 of the bankruptcy code. However, many small businesses and sole proprietorships may have Chapter 13 bankruptcy available to them. Depending on how you have your business set up and how you conduct your business transactions, you may be able to discharge your business debt in a consumer bankruptcy.

If you are a small business owner, you may want to factor in your business plans when deciding what type of bankruptcy to file. For example, a Chapter 7 bankruptcy may be a viable option for you if you want to discharge your debt without a repayment plan and gain a fresh start. However, if you plan on continuing your business, you may want to elect a Chapter 13 bankruptcy in order to maintain a relationship with your vendors and suppliers.

Also, depending on your situation and your business entity, you will need to determine whether you need a consumer bankruptcy, a business bankruptcy or both.

The decisions regarding the type of bankruptcy you elect to file will depend on your situation and goals. An experienced bankruptcy lawyer can help you understand the benefits and limitations of your bankruptcy options so you can make an informed decision about how to proceed.

With more than 15 years of experience, the Texas bankruptcy attorneys at Leinart Law Firm, with offices in Fort Worth and Dallas, can help you understand your bankruptcy options, as well as advise you and guide you through the bankruptcy process. We can answer your questions and provide you with accurate information and advice based on experience so you can make informed decisions.

We also put together this guide so that you can have idea of your options first:

Avoid the Means Test in a Business Bankruptcy

Most people seriously considering bankruptcy qualify for Chapter 7 straight bankruptcy by passing the means test without any trouble. However, for some people, especially those who formerly operated a business and now have higher than average income, this test can be difficult to pass. For these people, being able to avoid the means test can be very helpful, potentially saving tens of thousands of dollars.

The means test is designed to require those who have the “means” to do so to pay back a meaningful amount of their debts. Those people are not allowed to file a Chapter 7 case, but must instead go through a three-to-five-year Chapter 13 case. The means test is based first on your income, and then if that’s not low enough, also on your expenses, using a very complicated set of rules. Being able to avoid all this and be permitted to file a Chapter 7 case regardless of your income and expenses can be a huge advantage.

Have More Non-Consumer than Consumer Debts

You CAN completely avoid the means test if your debts are not “primarily consumer debts.” Therefore, you could be eligible to file Chapter 7 regardless of the amount of your income. This law reflects the rationale that if your debts are largely from a failed business, you should be allowed to file a Chapter 7 case and get a “fresh start” regardless of the amount of your present income and expenses.

What Does “Primarily Consumer Debts” Really Mean?

The Bankruptcy Code defines a “consumer debt” at Section 101(8) of the Bankruptcy Code as one “incurred by an individual primarily for a personal, family, or household purpose.”

For each one of your debts, ask whether that debt was created for these listed purposes or instead mostly or completely for business purposes. Tally the amount of debt that you have for the two different types of debt — consumer and non-consumer. If the total amount of consumer debt is less than the total amount of non-consumer debt, your debts are NOT “primarily consumer debts.” If that’s true for you, you can avoid the means test.

Notice That Some “Consumer” Debts are Really Not

If you financed the startup and ongoing operation of your business with what are otherwise sources of consumer credit — credit cards or home equity lines of credit, for example — they may still qualify as non-consumer debt. Talk with your attorney about how this would be interpreted in your situation.

Your Business Debts Can Be Higher Than You Think

Certain kinds of business debts can skyrocket beyond what they appear to be, and you may even have some business debts that you did not know about. Both of these can pump up the non-consumer side of your debts so that you don’t have “primarily consumer debts” and can avoid the means test. One example of a much-higher-than-expected business debt could be from a commercial lease that you abandoned, because the unpaid lease payments projected out over the intended term of the broken lease and other contractual obligations could add tremendously to your balance owed. Examples of unexpected debts could be claims raised by partners, employees, vendors or others allegedly harmed by the business closure. Or your business records may not be well organized, so that you have older debts that you have forgotten about or are not sure of the current balances.

If you have more or larger than expected business debts, they may allow you to skip the means test and discharge all your debts through a Chapter 7 case when you could not have otherwise.

Small Business Bankruptcy Litigation

If you are closing your business and filing for bankruptcy in part because you are being sued, what happens to the lawsuit against you and the business?

Business Litigation Can Kill Your Business

A business often closes its doors because it is fighting a lawsuit.

The disputes from which these lawsuits arise can take many forms, such as a simple collection action by a supplier on unpaid inventory, a contractual dispute with a major customer about the services or products provided by the business, an enforcement action by a governmental agency for a serious regulatory violation, a battle with a competitor about patent infringement or some other essential intellectual property, or an internal fight involving the other owners or investors in the business.

The business may be teetering on the edge of closing already when a lawsuit against it is filed. Or the business may be pushed into closing in large part because the opposing party wins a major judgment against the business and/or the owner (or the business) runs out of money to pay the costs of litigation.

So what happens to the litigation against you and/or the business once you file for bankruptcy?

(This question assumes that your business is in the form of a sole proprietorship. If it is a corporation, a limited liability corporation, a partnership, or some other form of business entity, there are other complications. If your business is in one of these other forms, please call to set up a consultation with us about your particular situation.)

Bankruptcy Filing Forces an Immediate Breathing Spell

Filing bankruptcy — whether under Chapter 7, 11 or 13 — imposes the “automatic stay,” the provision of the Bankruptcy Code that legally stops creditors from taking any new collection action against you, including filing a lawsuit, or from continuing any action, such as pushing forward with a pending lawsuit. This automatic stay is imposed simultaneously with the filing of your bankruptcy petition, without even the need for a judge to sign an order and without any say by the creditor or opposing party. This stay requires your adversary to at least temporarily stop pursuing you, and this break in the action, for reasons discussed below, often stops the litigation permanently.

Reasons Why Most Litigation Will End upon Your Bankruptcy Filing

The primary reason that bankruptcy stops business litigation is because the debt or claim that your adversary is trying to get you to pay will most likely be discharged — legally written off permanently — in your bankruptcy case.

Your adversary can ask for “relief from the automatic stay” to try to get the bankruptcy judge’s permission to continue the lawsuit or to collect on a judgment. But that likely won’t go anywhere if the claim or debt is of the kind that would be discharged anyway.

Your adversary could also file an “adversary proceeding” in bankruptcy court to object to the discharge of the debt or claim. But these objections present significant legal and practical challenges:

  1. They are difficult for your adversary to prevail in. The legal grounds for objections are relatively narrow. Debts are presumed to be discharged unless those narrow grounds of “nondischargeability” can be proven to be met. This is entirely different and usually much more difficult than just proving that your business owes money or other damages. Beyond establishing the existence of a valid debt or claim, as would be done in a conventional lawsuit, your adversary must also prove that you engaged in certain specific narrow types of bad behavior that make that valid debt or claim not dischargeable in bankruptcy. This usually requires you to have been involved in fraud or material misrepresentation against your adversary when incurring the debt, or to have embezzled, committed larceny, engaged in fraud as a fiduciary, or caused intentional and malicious injury to your adversary or to its property.
  2. Beyond these legal hurdles, when you file for bankruptcy, your adversary gets practical indications that it would be wasting its time and money to keep pursuing you. Your bankruptcy documents, filed under penalty of perjury, provide a detailed set of information about your finances. They usually reveal that you have nothing worth chasing. So even if your adversary believes it has a valid and nondischargeable claim against you, when faced with the reality that all of its effort and expense would not be doing it any practical good, most adversaries will call it quits.

Business Bankruptcy and Personal Bankruptcy, Do You Need to File Both?

The Practical Answer

No. In most situations — at least when your business has closed or is about to — your business will either not be able to or not need to file for bankruptcy separate from your own personal filing.

When Your Business Cannot File a Separate Bankruptcy

Your business will not be able to file a separate bankruptcy if it is not a separate legal entity (corporation, partnership, LLC, etc.). Many small businesses are “sole proprietorships” — the business’s assets and debts are just part of your personal assets and debts. Since there is no separate legal entity, there is nothing or nobody that can file for bankruptcy other than you personally.

In this situation, the business’s assets and debts are really just part of your own personal assets and debts. So your personal bankruptcy covers all of the business’s assets and debts.

When Your Business Does Not Need to File a Separate Bankruptcy

Even if your business is a separate legal entity, then usually by the time you are filing for a personal bankruptcy the corporation/partnership no longer has enough assets to be worth the expense of filing a separate business bankruptcy merely to distribute those remaining assets. As far as the corporation/partnership’s debts, they die with the business. You may well personally be liable for some of those same debts if you co-signed for them, gave a personal guaranty, or by operation of law — for inappropriately mingling corporate and personal assets, or otherwise not maintaining the formalities of the corporation, for example. These personal liabilities would be handled through your personal bankruptcy.

When Your Business May Benefit from Filing a Separate Case

There are two quite limited scenarios in which your business could require its own case separate from your personal bankruptcy case:

  1. If your business is a separate legal entity (corporation, partnership, LLC, etc.) and not merely a sole proprietorship, AND it is currently in operation and you intend to keep it in operation, it may benefit from its own Chapter 11 “business reorganization.”
  2. If your business is a separate legal entity, but is no longer in operation or will soon not be, AND it has meaningful assets that need to be distributed to the creditors, filing a separate Chapter 7 case for it may be worthwhile to avoid dealing with that asset distribution yourself.

Chapter 11 is a relatively expensive and complicated procedure that needs to be very carefully considered before entering into it. Usually it is not worthwhile, unless there are many hundreds of thousands of dollars of business debt, or even a few million dollars.

Similarly, using a Chapter 7 case to distribute the assets of a closed business can be a delicate decision and procedure. Although there are advantages in letting a bankruptcy trustee take care of this chore, you lose a fair amount of control over what happens, so you need to understand the risks. In both these situations, there is likely some urgency. So talk to a business bankruptcy attorney right away if either may apply to you.

Can Filing For Business Bankruptcy Affect My Personal Credit Score?

Keeping a business running in the face of mounting debt can be hard work. In some cases, filing for business bankruptcy can save both you and your company from financial ruin, especially if you are concerned about maintaining a favorable credit score.

The effect of business bankruptcy on your personal credit score largely depends on what kind of company you operate. Sole proprietorships and general partnerships entail personal responsibility for all debts incurred on behalf of a business. Debts incurred by corporations and LLCs, on the other hand, do not typically affect personal credit standing.

If I File Bankruptcy For My Personal Debts, Do I Have To File For My Business Too?

If you file bankruptcy for your personal debts and you run a fairly large company with expensive equipment or many employees, then you may also need to file a business bankruptcy as well. However, if your business is small or you work as a freelancer, you might not need to file for commercial bankruptcy at all. To know whether you need to file bankruptcy for your business along with a personal bankruptcy, consult an experienced attorney.

Consumer and Business Bankruptcy Lawyer

We have extensive experience with consumer bankruptcies for individuals who own small businesses. We can provide meaningful bankruptcy representation to:

  • Sole proprietorships
  • Limited liability companies
  • S corporations
  • C corporations
  • Partnerships

The type of business you own, whether the debt is personal debt or business debt, and other factors will be used to determine whether bankruptcy is right for you and your situation. We can help you understand the law and advise you about the benefits and limitations of your bankruptcy options.

We Provide Compassionate, Courteous Service

When you are going through a difficult legal situation, it is common for personal things to come to the surface. You can rest assured that you will never be judged on any personal matters. We aim to provide information, guidance, and respectful representation as you are going through this legal process. If bankruptcy is the proper legal action you need to take, we can assist you through that process. If it is your best interests to pursue other legal avenues, we are happy to facilitate that as well.

Quick Communication and Customized Legal Strategies

We have an established reputation as caring, passionate, and dedicated attorneys. We know that it can be frustrating when you are looking for answers from your attorney, and you aren’t getting a response within a reasonable time frame. When you choose Leinart Law Firm, you will always get replies in a timely manner. On your first consultation, you will meet with an attorney and talk about your particular financial situation to get a custom legal strategy in the works right away.

Contact a Consumer & Business Bankruptcy Attorney

We offer a complimentary consultation and evaluation at one of our offices in Dallas, Fort Worth or Plano to ensure that bankruptcy is a viable option for your situation and to discuss how the bankruptcy laws can help you and your business get a fresh start. Please schedule your no-obligation, free, confidential consultation and evaluation with an experienced business and consumer bankruptcy lawyer by contacting us toll-free at 800-518-3328.