No business owner likes to talk about it, but the fact is that many small business will face bankruptcy at some point in their lifecycle. This is a short guide to understanding business bankruptcy.

Bankruptcy itself is not bad. In fact bankruptcy is a mechanism to protect the debtor, creditors and the general public. Your business’s suffering financials are what inevitably lead to bankruptcy. In the end, bankruptcy is about precisely navigating legal courts. As such, you should find a bankruptcy attorney to assist you.

1. What is Bankruptcy?

The ability to file bankruptcy is created by the federal laws of the U.S. They are intended to protect individuals, businesses, and their creditors. Bankruptcy laws for businesses facilitate and enable reorganization of debt by the business, or the orderly liquidation of assets to pay off creditors without destroying the business. By choosing to go through bankruptcy you are electing to let a federal bankruptcy courts help solve your business’s financial situation.

There are 3 primary advantages to filing for bankruptcy: 1) the discharge of most debts, 2) the protection of intellectual or proprietary property held by the company, and 3) the automatic stall of ALL creditors attempts to collect on their debts. Bankruptcy, however, does not create a completely clean slate. There is often a dramatic effect on one’s credit and reputation after filing bankruptcy that can make future business deals more difficult.

2. What types of Bankruptcy are available to a business?

Chapter 7 – Allows for the liquidation of assets to pay off secured debt. In return, most of the business’s unsecured debts will be erased. The business can keep any property considered “exempt” under the federal bankruptcy laws. Chapter 7 takes 3 – 6 months.

Chapter 11 – Allows for the reorganization of the business’s assets. Under this option, the court oversees a flexible process by which the debtor business and its creditors work out payment arrangements to their mutual benefit. The business’s owners maintain control of the business and remain in possession of its assets.

3. When does bankruptcy make sense for my business?

Business will continue – Where there is no hope for the corporation to continue, simply closing the doors, liquidating the assets (if any), and terminating the corporate existence should be sufficient. In the case of personally guaranteed loans, however, the business owner may benefit from filing bankruptcy individually as this will eliminate his obligation to pay the debts of the corporation out of his own pocket

You have important assets to protect – Where there are important assets to protect, like a patent, filing for bankruptcy may make sense. There is no guarantee, however, that filing bankruptcy can protect such property. This is up to the parties to negotiate and for the court to ultimately decide.

You have tried to negotiate – Bankruptcy in some way forces your creditors to sit down at the table with you to work out repayment of debts. Bankruptcy, however, like many legal avenues, incurs legal and court costs. By negotiating with your creditors, you may avoid even having to get as far as bankruptcy.

4. What mistakes should I avoid if bankruptcy is inevitable?

Do not hide your assets – Federal bankruptcy courts are intended to help the debtor. Do not try to hide assets from them. Even if those assets are considered “exempt” under federal law, attempting to hide these are grounds for fraud.

Fully disclose your financial situation – Like above, disclosure is key when going through bankruptcy proceedings. Having a good lawyer is important when making the correct disclosures. Do not try to fudge the numbers in your favor, otherwise, this could be grounds for fraud.

About Author Matt Faustman


Matt is the co-founder and CEO at UpCounsel. Matt believes in the power of online platforms to change antiquated ways of life and founded UpCounsel to make legal services efficiently accessible. He is responsible for our overall vision and growth of the UpCounsel platform. Before founding UpCounsel, Matt practiced as a startup and business attorney.

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