Everything a Small Business Owner Needs to Know About Filing for Chapter 7 Bankruptcy

There comes a time for some small business owners when the bills are just overwhelming and there is no relief in sight. Whether an owner wants to save their business or liquidate it, there is a way out. It’s called bankruptcy, specifically Chapter 7 of the bankruptcy code.

In a Chapter 7 bankruptcy, a small business owner can decide to save their business or liquidate it, mainly depending on whether it is a corporation or a sole proprietorship. An incorporated business is a distinct legal entity apart from the owner, as opposed to a sole proprietorship, which is the same as the owner. This article will provide a short explanation of the Chapter 7 provisions.

Chapter 7 and the Sole Proprietor

As a sole proprietor, the owner is responsible for all the debts of the business. In Chapter 7, a sole proprietorship also files for personal bankruptcy to eliminate all business and personal obligations.

In Chapter 7 for a sole proprietorship, both the owner’s personal and business debts are wiped out. This is because the business and the owner are considered the same in a sole proprietorship, making business debts a personal obligation. If the owner of a sole proprietorship reneges on a promise to pay business debts, creditors can recover debts from both the business and the owner’s assets.

Chapter 7, Partnerships, and the Corporation

A business that was formed as a partnership, limited liability company (LLC), or corporation is a separate legal entity from its owners, and the responsibility for debts will depend on many circumstances. In a partnership, a general partner is liable for all business debts. By contrast, limited partners are not personally liable for business debts in a partnership.

With a corporation or an LLC, owners or stockholders are not personally liable for debts if they have not personally guaranteed or consigned any obligations. They are only liable to the extent of their investment.

A partnership is formed when two or more individuals agree to own and operate a business. A Chapter 7 bankruptcy shuts down and liquidates that business. The way a partnership is dissolved, and claims paid, depends on whether the partnership is a general partnership or a limited liability partnership. A general partner is personally responsible for business debts, while in limited partnerships, multiple partners are not liable for business debts.

Filing a Chapter 7

After Chapter 7 is filed, an automatic stay is imposed, preventing almost all recovery efforts from creditors. The court will appoint a trustee who will sell the debtor’s nonexempt real property to pay off the creditors in order of their priority. There are no exemptions in these cases, and a trustee will liquidate the business assets to pay proceeds to creditors.

A Chapter 7 bankruptcy impacts different business structures in different ways. A business’s legal structure is a critical factor when facing a bankruptcy. If a business’s claims are not paid, the business is dissolved and creditors paid from the proceeds of the sale.

LLCs and corporations are distinct legal entities, and businesses that are registered in these forms are responsible for their own debts. Owners of corporations and LLCs are usually not held personally responsible for business debts. In these cases, a Chapter 7 bankruptcy liquidates a corporation and LLC’s assets to settle creditor claims.

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