Chapter 7 Bankruptcy Can . . . Help You Walk Away from Your Business

Law Office of Robert L. Firth July 18, 2016

Closing down a failing business can be much easier and safer with the benefits of a Chapter 7 “straight bankruptcy” case.

Closing down a failing business can be a very challenging and stressful task. Most likely you have a bunch of creditors beating at your door to get paid. It’s exhausting dealing with the juggling act of trying to decide who to pay out of the very little you have available. How do you weigh your legal and personal obligations to all of them? And once you decide you’re going to close the business, how do you know when’s the best time to do it? What can or should you do with whatever business assets you have left?

A Chapter 7 bankruptcy filing can cut through these dilemmas. It allows you to legally pass the buck about a lot of this to the Chapter 7 trustee, with the help of your bankruptcy lawyer.

A Chapter 7 can help close down your business by:

  • immediately protecting your personal assets

  • giving the bankruptcy trustee the tough and risky work of distributing the last business assets

  • getting rid of all or most of your debts so that you can move on in your financial life

  • arranging to pay a special creditor or two

Let’s look at each of these briefly.

Protection of Your Personal Assets

Whether your business is set up as a sole proprietorship or corporation, or any other kind of business entity, creditors will be trying to reach into your personal assets and income to get paid. A bankruptcy filing will immediately impose the “automatic stay” to protect you and your assets from lawsuits, garnishment, foreclosures, repossessions and such.

Also, in bankruptcy often all your personal assets would be permanently protected through state or federal “exemptions.” These are laws which allow you to keep your possessions away from your creditors. Exemptions also protect your assets from the bankruptcy trustee who acts on behalf of the creditors. These exemptions often cover all of your assets. These include tangible ones like your vehicle and furniture, and intangible ones like retirement accounts.

If your business is a corporation, be aware that the “automatic stay” of your personal bankruptcy case does not prevent collection action taken directly against the corporation and its assets. Also, your personal exemptions usually do not protect assets legally belonging to the corporation. The corporation may need to file its own bankruptcy to protect itself. However, this is often not a practical concern because by the time you would be filing a personal bankruptcy the corporation would likely no longer have any meaningful assets.

Distribution of Your Business Assets without Personal Risk

Assume that the business is not in the form of a corporation but is rather a sole proprietorship. Then any assets that it does have would come under the jurisdiction of the bankruptcy court once you file your Chapter 7 case. That’s because everything you own, including your business, belongs to your bankruptcy “estate.” Often those assets are legally protected so that you can keep some or all of them. They would not go to your bankruptcy trustee, and then to your creditors. This would be done through the personal “exemptions” mentioned above.

What happens to the business’ assets that do not fit within your asset exemptions? The Chapter 7 trustee would have the right to take possession of them, sell them, and use the proceeds to pay your creditors. The creditors are paid according to an elaborate priority system. It’s not unusual for this priority system to first pay debts which you want to be paid. Those can be debts that are not discharged and you would need to pay them anyway after your bankruptcy. These could include employee wages, income and other taxes, child and spousal support arrearage, among others. Giving the trustee the job of liquidating some or all of the business assets and paying creditors according to the law takes this major headache away from you.

“Discharge” (Permanently Write Off) All or Most of Your Debts

Simply put, a Chapter 7 bankruptcy discharge would clean your financial slate of a many of your debts. Sometimes all of your debts. Then you can put the business experience behind you. You can move forward without being burdened at every turn.

Arrange for Orderly Payment of Any Remaining Debts

After the closing of a business often there are some debts that are not discharged. But the financial streamlining that Chapter 7 provides can put you in the best possible position to take care of those debts that remain.

Also you may choose to remain obligated on certain secured debts so that you can keep your home and vehicle, for example. You may not be able to discharge other debts—certain taxes, in particular.

Whether Chapter 7 is the right choice will often turn on how much such debt would remain. Could you realistically pay it off in a reasonable time without unreasonable pressure from the taxing authorities or other creditors? Or would you need the ongoing protection of the bankruptcy court and the other benefits that a Chapter 13 “adjustment of debts” would provide.

In the next few blog posts we will discuss this issue. After closing down a business and filing bankruptcy, when would Chapter 7 be adequate? When would the extra power of Chapter 13 be preferred? We’ll look at particular debt and asset issues, starting with the next blog post on taxes.