Can Chapter 7 Bankruptcy Solve Your Business Debt Problems?

Chapter 7 bankruptcy can help you eliminate personal liability for business debts.

If your small business is struggling with debt, filing for Chapter 7 bankruptcy might help. However, Chapter 7 bankruptcy won't help every small business owner.  Find out when it might and might not work for your business, and when other options might make more sense.

Small Business Chapter 7 Bankruptcies Are on the Rise

If you're considering filing for bankruptcy because your small business is drowning in debt, you're not alone. The economic downturn that began in 2008 took many small business owners (not to mention politicians, bankers, and economists) by surprise. For a variety of reasons from reduced consumer spending to cutthroat competition, cutbacks by business customers, and shrinking (or disappearing) lines of credit the number of bankruptcies filed by small business owners has skyrocketed.

As a small business owner, you might be considering bankruptcy because:

• Your business debts have grown so large that you'll never be able to pay them back.
• You want to get out of an expensive commercial lease, sales contract, or vehicle or equipment lease that's preventing you from operating profitably.
• You want creditors and bill collectors to stop harassing you and your employees.
• Your business lost a lawsuit and was ordered to pay a judgment that's well beyond your means.
• You racked up a lot of business debt and need to lighten the load so you can pay your mortgage, car loan, or current accounts payable.
• You want to stop (at least temporarily) a vehicle repossession, a garnishment on your spouse's wages, or a foreclosure.
• You want to remove a lien from your home or get out of your mortgage without owing a deficiency.

Will Chapter 7 Bankruptcy Help?

Chapter 7 personal bankruptcy could be the right solution to many of these problems. But it won't be the answer for every small business owner, for two main reasons:

• Chapter 7 personal bankruptcy covers only debts for which you are personally liable. If your business is a sole proprietorship or general partnership, you are personally liable for all of your business's debts, and you can get them wiped out in Chapter 7 personal bankruptcy. If your business is a separate legal entity for example, a corporation or limited liability company (LLC) you are personally liable for the business's debts only if you personally signed for them or guaranteed them. Otherwise, the corporation or LLC is responsible for its own debts and must file its own business bankruptcy case to discharge them. (See Nolo's article Are You Personally Liable for Business Debts? to learn more about figuring out whether you are on the financial hook for what your business owes.)
• You may have to close your business if you file for Chapter 7 personal bankruptcy. If you've already decided that you want out of your business, this won't be an important consideration. If not, realize that as part of the bankruptcy process, the bankruptcy court may want to close your business down, at least temporarily. However, some business owners especially those who own service businesses with few assets may be able to keep their businesses open during Chapter 7. And plenty of business owners have closed down, used Chapter 7 bankruptcy to get out from under their debts, and then started a similar business later. If you do want to continue operating your business, and particularly if you have any valuable business assets (which you are likely to lose in a Chapter 7 personal bankruptcy), Chapter 7 bankruptcy may not be the best option. Instead, you may want to reorganize your business in Chapter 13 bankruptcy, negotiate a workout with your creditors, or consider other options (Nolo's article Handling Business Debts: Your Options explains more).

In addition, there are certain types of debts that Chapter 7 bankruptcy won't discharge (erase). If most of your debts won't be discharged, it's not likely that Chapter 7 bankruptcy will be a good choice for you. For more information, see Nolo's article Which Business Debts Are Discharged in Chapter 7 Bankruptcy?

If your small business finances have reached the point where bankruptcy is a serious consideration, you may feel anxious, isolated, or even like a failure. But you're not alone: The current recession is taking down thousands of businesses, large and small, including many that were well-established stalwarts of our economy. Our bankruptcy system recognizes that financial missteps, overextension, and simple bad luck happens and it provides relief to those who are willing to let the court help them get out from under.

Filing for bankruptcy can even be an important step toward future business success. Chapter 7 personal bankruptcy gives small business debtors the opportunity to wipe out some or all of their debt while protecting their personal assets as much as possible. In fact, many bankruptcy filers go on to start another business and become successful the second or third time around.

More Information on Bankruptcy for Small Business Owners

If you want to use Chapter 7 bankruptcy to get clear of business debts, get step-by-step filing instructions with Bankruptcy for Small Business Owners: How to File Chapter 7, by attorneys Stephen Elias and Bethany K. Laurence (Nolo).