Your Business Credit

Small business bankruptcy: 3 factors to consider

If your business is struggling to survive or you're drowning in debt, Chapter 11 bankruptcy could be a lifeline


If you’ve been forced to shut the doors of a brick-and-mortar business and have run out of cash, or if you’re drowning in debt, you may be thinking about seeking Chapter 11 bankruptcy protection. Here are some factors to consider.

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The COVID-19 crisis has brought many small businesses to the brink of closing.

If you’ve been forced to shut the doors of a brick-and-mortar business and have run out of cash, you may be at that point – especially if you have not been able to get a federal Paycheck Protection Program forgivable loan or an advance from the SBA’s Economic Injury Disaster loan program.

And if you’re drowning in debt, you may be thinking about seeking Chapter 11 bankruptcy protection.

Here are some factors to consider.

See related: How to borrow for your business now while you wait for government help

What are your life’s goals?

If you find the idea of closing your business unthinkable because it’s your life’s passion, then it may be time to go into overdrive to save it by introducing innovative new products or services, finding new ways to deliver what you sell and putting more of your own money into it to keep it afloat.

There are some great, free online seminars being offered to help business owners pivot into new, more fruitful ways of running their operations.

At the same time, every owner needs to think about the future. If you can’t feed your family or keep a roof over your head and can’t find some way to bring in money, then it’s hard to devote yourself to what you’re passionate about.

You need to cover your basic survival needs before anything else, and if your business cannot pay its bills, you are probably already facing a lot of stress in dealing with vendors and suppliers you can’t pay.

If you’re beyond the point where you can tap your personal resources to shore up your business and pay its debts, you may need to think about bankruptcy.

See related: 8 small business grants that can help you stay afloat

How much money do you owe?

Usually, business owners consider bankruptcy when creditors seek judgments against them that are being enforced, says Nat Wasserstein, a restructuring adviser who is managing director of Lindenwood Associates in the Greater New York City area.

When a business doesn’t pay its debts, creditors send demand letters. Eventually, debts that don’t get paid make their way to collection agencies and attorneys.

“Then the law firms file a lawsuit,” Wasserstein says. “If you have no defenses because you do owe that debt, eventually it turns into a judgment. You can wake up one day and try to take money out of your bank account and find there is a freeze on it or your checks start to bounce. Someone slapped a judgment on it.”

If you can’t pay the judgment, it makes sense to talk with a bankruptcy attorney about the options available to you.

How will bankruptcy affect you?

Chapter 11 bankruptcies are usually the first step for businesses that have a shot at surviving.

Chapter 11 is a plan where a company such as a corporation, partnership or sole proprietorship reorganizes under a trustee the court appoints. There are other types of bankruptcy for businesses that are in more dire straits, such as Chapter 7, where the assets of the business may be liquidated to pay off its debts.

Chapter 11 bankruptcies work differently from how they did in the past. The Small Business Reorganization Act (SBRA) of 2019, which took effect in February 2020, eliminates what’s known as the Absolute Priority Rule. That rule said that if the business owner faced unsecured claims, they could not hold onto any equity in the business unless those claims were paid in full.

Now creditors must accept a payment plan from small businesses and can’t just force them to sell all of their assets to pay their debts.

“What this means is that the SBRA allows eligible small business Chapter 11 debtors to work with their creditors and restructure their obligations, without requiring small business owners to essentially forfeit their companies in doing so,” says Wasserstein.

The SBRA allowed small businesses to shield up to $2.726 million in assets. Business owners must apply their disposable income for three to five years to paying them back.

The Coronavirus Aid, Relief and Economic Security (CARES) Act, passed to provide relief for people and businesses suffering economic injury from the COVID-19 crisis, expanded on this, allowing small businesses to shield up to $7.5 million in assets this way. This means you can work your way out of bankruptcy.

See related: Best ways to use your stimulus check

Bottom line

Chapter 11 bankruptcy isn’t something to be taken lightly. It can have a lasting impact on your credit.

However, it may also allow you to save your business.

“It stops everything and gives you time to breathe and ability to negotiate with your creditors,” says Wasserstein. “It gives you the tools to pay off your debts.”

In the meantime, you can gather steam and figure out your next steps. Just because one business didn’t work out it doesn’t mean you can’t start a new one in the future.

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