What Are Signs That My Small Business Should Consider Filing For Bankruptcy?
One reason a small business would consider filing for bankruptcy is if it is getting sued. A lawsuit from a vendor or credit card company most often generates a bankruptcy. Many business owners try to finance their operation with a credit card, but it never works. Recently, I helped an electrical contractor with a situation in which one of their former employees, who was actually a 1099 contractor, sued them in federal court under the Fair Labor Standards Act. The employee complained that they were not paying him overtime, which he wasn’t qualified to do anyway. The upshot was that they could either spend $25,000 defending the lawsuit or $7500 to do a bankruptcy and wipe it out. Typically, for an LLC, S corporation, or any kind of business entity, I generally don’t take them into bankruptcy unless they have assets. Or, in the case I just described, the definition of employer in the statute was broad enough to include them individually and not as officers of the corporation.
The decision as to whether or not to file for bankruptcy as an entity or personally is determined on a case by case basis. About 99% of small business owners personally guarantee the obligations of their business. As a result, if a small business owner decides to file for bankruptcy, they’ll most likely file personally. Also, since the debt is business, they wouldn’t have to contend with the means test.
There are all kinds of reasons why a small business would consider filing for bankruptcy. More often than not, it is due to some kind of financial pressure.
Do Small Businesses Typically Make The Mistake Of Waiting Too Long To File For Bankruptcy?
Many small businesses make the mistake of waiting too long to file for bankruptcy. In fact, around August and September, I had a flurry of consults from small businesses seeking advice on bankruptcy. A lot of them were hoping that their situation was going to turn around quickly, which I don’t believe is the case. For instance, one case involves a physical therapy place that received an advance of $130,000 from the government. The advance was granted from a program that Congress passed last summer. And so, their plan is to burn up that cash and then file.
I was also contacted by a person who owns seven Sports Clip franchises. The Sports Clips were purchased in January, and when COVID-19 hit in March, the business fell by 70%. The owner was sitting on $700,000 in personal cash. It came down to either burning up the cash to try to keep the business afloat or file right away. In this case, the trustee would take the cash to pay the creditors.
The decision to file for bankruptcy will depend on a business’s individual circumstances. Many small businesses, however, think they can turn it around, but they’re mostly in denial. The situation with COVID has hit so fast and hard that a lot of people haven’t had the chance to really discern the impact of what this means. Once the lawsuits start coming in, they generally bring someone to my office.
Will I Be Forced To Close My Business If I File A Small Business Bankruptcy?
Filing a small business bankruptcy does not necessarily mean that it will be forced to close. Some businesses continue their operation. For example, I recently helped a person who owns a diesel garage. The business owner’s income is $330,000. He owes creditors and is still running with negative operating costs of about $1000 a month. He had several losses, but continues to operate the business. A lot of times, without the burden of servicing a debt, businesses can actually make it work.
Do I File A Chapter 7 Bankruptcy Or A Chapter 11 Bankruptcy For A Small Business Bankruptcy?
Generally, if you mostly have unsecured debt, such as credit cards, payday loans, and personal loans, you are better off filing a Chapter 7. A Chapter 7 bankruptcy will liquidate all the debt. On the other hand, if you have a business that you want to continue running, but are behind on payments, such as car payments or rent, there are other bankruptcy options. If there is still some equity, and the debt is manageable, you could file for Chapter 11 or Chapter 13. Determining which chapter to file always comes down to numbers. In a typical 11 or even a 13, all your assets and liabilities are put into a 36 to 60-month payment plan. During the repayment period, you also pay a commission to the bankruptcy trustee, which varies from trustee to trustee.
Therefore, if it looks like you can swing it with the payment plan and the regular operating expenses, that’s probably the way to go. As far as I’m concerned, a lot of the businesses will be viable in light of what the payment plan is and the income that is generated. However, if you only have unsecured debt like credit cards, I would never recommend a Chapter 11 or Chapter 13.
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