How does a business bankruptcy differ by organizational structure?
For instance, the bankruptcy process is different for each of the following legal structures:
- Sole proprietor
- Partnership
- LLC
- Corporation
Let’s look at these entities and how they handle business debt during a bankruptcy.
Sole Proprietor Files for Bankruptcy
Service-oriented sole proprietors can actually benefit from Chapter 7 bankruptcy; here’s how!
How Chapter 7 Works for Sole Proprietor
A sole proprietorship is owned and operated by one person.
In this case, the individual and their business are considered as one entity in terms of legal liability.
When a sole proprietor files for bankruptcy under Chapter 7, it’s the individual who goes through the process rather than the business itself.
The trustee will still sell off any assets that belong to the sole proprietorship (such as equipment or inventory).
Then, the owner uses the proceeds to pay off any business debts.
If the business’s assets don’t cover the debt the owner owes to creditors, the bank relies on personal liability to cover the charges.
Advantages of Chapter 7 for Sole Proprietors
Many people think that when a business fails and files for bankruptcy, nothing good can come from it.
However, that’s far from the truth! Chapter 7 can be beneficial in some circumstances.
For example, some advantages of Chapter 7 business bankruptcy for sole proprietors include the following:
- Owners can clear personal debts
- Under some personal obligations, you don’t need to meet the income requirements for Chapter 7
- Service-oriented businesses can survive because the bankruptcy trustee can’t take your talents away (meaning you can start another business later)
Disadvantages of Chapter 7 for Sole Proprietors
Although there are some advantages, there are some downsides to know about with this type of bankruptcy.
For instance, some cons of this type of bankruptcy include the following:
- It is a bad option if the business demands equipment or property to run their business
- Not all states protect business property the same way or at the same amount
- The company (usually) ceases to exist once the process is over
Partnership Files for Bankruptcy
Partnerships are another common business legal structure.
Let’s see how a Chapter 7 bankruptcy case can impact partnerships!
How Chapter 7 Works for Partnerships
In a partnership business, more than one person owns and manages the operations.
The partners are usually personally responsible for all debts incurred by the business.
Therefore, when a partnership files for bankruptcy under Chapter 7, each partner must file their own bankruptcy claim.
Like sole proprietors, all of a business’s assets are liquidated and divided between creditors.
These cases involve a trustee responsible for selling the company’s assets and repaying all debts.
Advantages of Chapter 7 for Partnerships
A couple of upsides of filing for business bankruptcy include the following:
- Compared to other bankruptcies, it’s a simple process
- The process is orderly
- You can use assets to sell the business’s debts
- The debts are split between two or more people instead of one person taking on all the burden
Disadvantages of Chapter 7 for Partnerships
Here are the disadvantages of Chapter 7 for partnerships:
- It increases litigation risk
- It increases the likelihood of partnership disputes
- Each partner’s personal assets are at risk
The most significant disadvantage of a Chapter 7 filing for partnerships is that it can severely impact personal relationships in the future.
Therefore, it’s helpful to go into business with someone you trust. Also, discussing what happens in the event of bankruptcy ensures no surprises!
LLC or Corporation Files for Bankruptcy
A corporation or LLC business bankruptcy differs from a personal bankruptcy because the entity is separate from its owners.
How Chapter 7 Works for LLCs & Corporations
Here’s how a Chapter 7 bankruptcy works for LLCs and corporations!
The trustee sells all of the corporation or LLC’s assets and distributes the assets based on priority rules.
Filling for Chapter 7 closes the business and doesn’t allow the entity to receive a debt exchange.
Therefore, a creditor can see payment under a personal guarantee!
Advantages of Chapter 7 for LLCs & Corporations
Some advantages of this type of business bankruptcy include the following:
- Allows for a higher level of transparency (more accessible to prove the closure happened)
- It might prevent a creditor from pursuing litigation
- Many business owners don’t have to sell their personal assets themselves; a trustee does
Disadvantages of Chapter 7 for LLCs & Corporations
Some cons to this process include the following things:
- Trustees may like the debtor’s assets for much less than what they’re worth
- A trustee takes part of the proceeds from the sale
- Owners can’t negotiate their debt for an amount lower than what they owe
