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Facing bankruptcy is always a difficult situation. Although understanding the ins and outs of each type of bankruptcy can prepare you to make the best informed decision that will help your financial future. There are three types of bankruptcies that business owners are able to file for. The type that is best for you to file for will be mainly dependent on your specific situation.

Chapter 7

Chapter 7 bankruptcy is a viable option if your business does not have any substantial assets. Your business must essentially be an extension of you personally. If your business is operated from home and are the only employee, then this could be a good option for you. This is often the best choice when the company is failing and restructuring the business is not worth the cost.

In a Chapter 7 filing, a trustee will be appointed by the bankruptcy court to distribute the company’s assets to the creditors. After this is done and the trustee is paid, you will receive a “discharge” once the details of the case are finalized. A discharge means that you are released from any debt obligations specifically tied to that business. The business will be completely dissolved and liquidated once the case is finalized. Individuals are also able to file for chapter 7 bankruptcy who do not have a business, and are struggling with other types of debt such as credit card debt.  

It is important to note that often when filing a chapter 7 bankruptcy, most cases are “no-asset cases.” This means that you most likely not give up any of your possessions. The law allows you to keep assets that are needed for everyday life. These assets include your house, car, computer equipment or other equipment necessary for work. These are all called exemptions, and beyond those assets it is unlikely that creditors will want any of your other possessions.

Pros

  • It will prevent any lenders from being severely aggressive with collection action
  • You will get to keep any salary you earn and property you acquire after filing
  • Process is completed in 3-4 months

Cons

  • Your credit score will take a serious hit
  • Lose all of your credit cards
  • Lose luxury possessions, such as boat or second home
  • Almost impossible to get a mortgage if you do not already have one
  • Filing will not relieve you of any student loan debt or child support

Chapter 11

Out of the three types of bankruptcies, chapter 11 is the most costly and time consuming. It is often referred to as “reorganization bankruptcy” and involves large sums of money. When filing for chapter 11 bankruptcy, the filing fee is almost $2,000. Unfortunately the cost does not stop there. Legal fees after the original filing can easily cost upwards of $10,000. While it is very uncommon, individuals themselves can also file for chapter 11 bankruptcy. Due to the substantial amount of money needed to meet requirements to file, and the legal fees involved, it is primarily only an option for large businesses or corporations. 

Once filed, you have four months to come up with a business plan that will reorganize the business in hopes to save it. The four month time period can be extended in most cases though. Creditors will vote on this plan, and then the bankruptcy court will approve the plan or not. Any big decisions for the business after this point will have to be approved by the creditors. Reorganization plans are essentially contracts between the business owners and creditors for how the business will be operated moving forward, and for how financial obligations will be paid by the business.

A chapter 11 filing is a last ditch effort to save a business. Sadly, according to debt.org the success rate of a chapter 11 filing is about 10% to 15%. While this is discouraging, with excellent management, a good lawyer, and some luck, it just might work out for your business.

Pros

  • You are not forced to liquidate your business or assets
  • In some cases the owner of the business can be appointed as the trustee

Cons

  • Extremely expensive legal fees
  • Low success rate
  • Could be in financial distress for years to come
  • Oversight from creditors

Chapter 13

A chapter 13 filing is a little different than the other three types of bankruptcies. It is most often used when a business owner’s biggest problem is meeting demands of creditors for immediate payout. You will pay your debt off in 3-5 years while all of your disposable earnings going to debt repayment.

After you file, you will need to create and submit a repayment plan. Creditors can voice their opinions on the plan, but the court will have final say. With a chapter 13 filing it is crucial to stick to your financial plan. You can accelerate your payments, but you can not have any late or missed payments. Late or missed payments can result in your case being dismissed.

To properly take into review your repayment plan you will need to provide the court with some additional documents. The court requires paperwork such as tax filings, all the debt owed and to whom it is owed, and income statements. An individual person with outstanding debt can also file for chapter 13 bankruptcy. The process is exactly the same but the repayment plan applies to you personally. 

Pros

  • No liquidation of assets; unless failing to make payments
  • Only the court has to approve financial plan
  • Cheaper than filing for a chapter 11

Cons

  • Years living under financial supervision of court appointed trustee
  • Lots of paperwork and specific deadlines
  • Must stay on a strict financial plan
  • Obligation to repay debt lasts for years

Should You File?

When learning about the three types of bankruptcies, all of them may seem like a bad option. While having to file for bankruptcy is not anyone’s plan, it does happen often. It can be the light at the end of the tunnel if you are drowning in financial stress and seemingly have no way out. Filing for bankruptcy is a decision that should never be taken lightly though. Consult with a lawyer if you do decide to file. Finally, make sure you understand all of your options before deciding to file for bankruptcy, the last thing you want is to be in the dark.

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