Especially now, as the pandemic causes more and more businesses to struggle financially, small business bankruptcy is becoming a likely path for many owners.

Contrary to popular belief, bankruptcy doesn’t necessarily mean your business must close. In fact, certain types of bankruptcy can actually help your business stay open.

This page will answer your questions about the process and effects of small business bankruptcy.
Table of Contents

Personal liability

As the owner of a small business, you likely understand the need to keep business and personal expenses separate. But do creditors think the same thing about debts?

This depends on the structure of your business. Corporations, limited liability companies (LLCs), sole proprietorships, and other combinations of business structures all treat debt differently.

For example, corporations and LLCs are specifically designed to limit the financial liabilities of the business owners.

Additionally, if you sign a Personal Guarantee, you may be personally liable to repay your business debt.

Is my spouse liable for my business debt?

Though you likely want your spouse to be protected from your business debts, this isn’t always the case. If you run a sole proprietorship or you’re a partner in a partnership, your spouse could be held responsible for the debt just as they would if it were personal debt.

Your spouse could also be in trouble if they were a cosigner or they guaranteed your business debt. This applies whether or not you or your partner agreed on limited liability. If they signed on it, they owe it.

This is only true in common law states. If you live in a community property state, it’s a different story.

In community property states, even if a spouse has not signed on a debt, everything is owned equally by both people in a marriage.

Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin are all community property states. In Alaska, a married couple can choose whether or not to adhere to community property rules.

Types of small business bankruptcy

There are three main types of bankruptcy that can help businesses: Chapter 7, Chapter 11, and Chapter 13. Each one accomplishes different things according to the types of debt you have and your business goals.

Chapter 7

Chapter 7 bankruptcy can be filed by both individuals and businesses. It’s a good fit for sole proprietorships and can help LLCs and corporations liquidate and close down in an organized manner.

With this type of filing, you can take care of both business and personal debts. Chapter 7 is also the fastest way to get out of debt. In a mere 3 to 4 months, your qualifying debts will be discharged.

Because this is known as “liquidation bankruptcy,” this is not for business owners who want to continue operations. Chapter 7 will help you close down. You will likely liquidate many of your business’ assets. If you want to keep your business open, explore other types of bankruptcy.

Chapter 13

Chapter 13 bankruptcy can help a business reorganize its debts and stay open. However, it can only be filed by an individual.

While its main purpose is to help an individual reorganize their personal debt, if that individual runs a sole proprietorship, they can include their business debts in the filing.

Once you file and everything is approved, you begin a three- or five-year repayment plan. The plan requires monthly payments to your creditors to pay off a portion of what you owe.

If you own a corporation or an LLC, your business debts cannot be included in a Chapter 13 filing. But this doesn’t mean it can’t help you. Sometimes, reorganizing your personal debts can help you get your business back on its feet as well.

Chapter 11

Chapter 11, like Chapter 13, is a type of reorganization bankruptcy. It’s mostly for businesses; individuals can only file if they have exceptionally large amounts of personal debt.

The following business types can file for Chapter 11 bankruptcy:

  • Corporations
  • Small businesses, defined as “any person or entity engaged in business or commercial activities with less than $2,490.925 in creditor claims.” This can include limited liability companies (LLCs).
  • Partnerships
  • Sole proprietorships

Learn more about how different types of business file for Chapter 11 bankruptcy here.

Note on Chapter 12

Chapter 12 bankruptcy is relatively uncommon compared to Chapters 7, 11, and 13. This is because it’s specifically designed for small farming and fishing operations. If this describes your business, you can read more about filing for Chapter 12 bankruptcy here.

Deciding what type of business bankruptcy to file

Speaking with a bankruptcy attorney is the best way to determine which type of bankruptcy to file. Although you can file “pro se” (on your own), it’s risky to attempt.

If done incorrectly, filing by yourself could land you with even more debt. Bankruptcy expert and contributor Steve Rhode wrote about choosing the right bankruptcy attorney for your situation. We recommend using his advice to find a good match.

Your credit after a business bankruptcy

Your credit will only be affected by business bankruptcy if you were personally liable for the debt. For example, if you run a sole proprietorship and you filed for Chapter 7 bankruptcy to deal with both business and personal debts, this will show up on your credit report.

On the other hand, if you run a corporation with limited liability and the business files bankruptcy, this will not show up on your credit report. You were never personally on the hook for the debt.

Both Chapter 11 (if you file as an individual) and Chapter 7 bankruptcy will stay on your credit for 10 years from the date of filing. A Chapter 13 bankruptcy filing will stay on your credit report for 7 years from the date of filing.

This sounds like a long time, but the negative effects on your credit lessen with every year that passes. Take steps to repair your credit as soon as you can and you will eventually improve your financial standing.

Starting a new business after bankruptcy

Want to start a unique, new business? You may need initial funding to get your new venture started. You likely won’t have many problems with a business plan that’s different from your former venture.

However, if you try to start a business similar to the one that bankrupted you, that may be an issue.  If your new business plan is similar to your former business, it may be harder to get a loan. Lenders want to feel confident that your new plan will be more financially successful, and you won’t have to file for bankruptcy again.

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Article last modified on December 30, 2022. Published by, LLC