The failures of large corporations in recent years have garnered intense media attention: from the infamous Enron case to the more recent bank collapses, corporate bankruptcy often has negative consequences for a large number of people. Small businesses, on the other hand, usually go unnoticed by the mass media.
Despite the greater number of people affected in cases like Enron, the effects of small business bankruptcy can be much more severe on the owners and any employees. Since they have more limited means than larger companies, small businesses can be more susceptible to fluctuations in local economies. Local restaurants, for example, commonly go out of business during economic downturns, because people are less likely to dine out when the economy is weak.
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If a small business owner does decide to file for bankruptcy, there are certain conditions under which the owner(s) may be able to file under bankruptcy laws used more often for individuals than businesses. Since many small businesses fall somewhere in between these two poles, special stipulations have been enumerated which determine which set of laws to use in these cases.
The US Bankruptcy Code provides several different bankruptcy path, each with different requirements. With the exception of Chapter 12, which is reserved for use by farmers and fishermen, both businesses and individuals can file under any of these chapters. Chapter 7 is the most common type of bankruptcy overall and is used extensively by both individual and businesses. In practice, Chapter 11 is almost always reserved for companies. Likewise Chapter 13 is largely for individuals.
A Chapter 7 bankruptcy case, often called a "straight" bankruptcy, is one in which the debtor liquidates certain assets to repay creditors and establishes a repayment plan. "Liquidating assets" here essentially means turning over saved money and/or selling possessions to pay the creditors back. Fortunately, exceptions are made for "essential" property. In many cases this means individual debtors will not be forced by the court to sell personal possessions, vehicles, etc. Often, however, such steps might be necessary to get funds, or a house (for example) might be repossessed. Chapter 7 cases are the most common.
In addition to Chapter 7 bankruptcy, it is possible for a small business, in particular a single-owner business, to file under Chapter 13. In order for this to happen, however, the owners must have less than approx. $300,000 in unsecured debt or $1,000,000 in secured debt. If the company's debt exceeds these values, the owners must file under Chapter 11.
If a small business files under Chapter 11, there are certain conditions under which a normal Chapter 11 case can become a "small business case." These are distinct from regular Chapter 11 cases in that there is no creditors' committee (a group of creditors) overseeing the process. Such cases are usually filed when the court either does not appoint a creditors' committee, or the committee fails to be sufficiently involved in the process. Additionally, businesses in cases like these must have less than about $2,000,000 in total secured and unsecured debt.
Bankruptcy law is very complex, and to non-lawyers can be very difficult to understand, and even more difficult to use. That's why seeking the help of an experienced bankruptcy attorney is the best way to determine whether you and/or your business should file for bankruptcy, and then prepare a plan if you do.
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