Business bankruptcy is a process designed to help a struggling business eliminate or repay its debts under the protection of the bankruptcy court. Depending on the type of bankruptcy filed by a business, business bankruptcies end in either liquidation or reorganization. There are three types of business bankruptcies that exist: chapter 7, chapter 13, or chapter 11.
In chapter 7 bankruptcies case, a company stops all operations and goes completely out of business. A trustee is appointed to liquidate the company's assets (split it among lenders) in order to pay off the business's debt. In essence, chapter 7 bankruptcies mean that the business is over. Only a sole proprietor can be formally discharged at the end of a chapter 7 bankruptcy; corporations and partnerships do not receive a discharge. This form of business bankruptcy is best for businesses that are overwhelmed with debt and is unable to be restructured.
Unlike chapter 7 bankruptcies, chapter 11 bankruptcies allow the business to continue functioning under the eyes of the bankruptcy court. During this period of time, the bankruptcy court must approve all significant business decisions. In this situation, a business is reorganized under a court appointed trustee; in certain cases, the company owner may be the trustee. The business will file a plan of reorganization to detail how it will repay its creditors. This form of business bankruptcy is best for businesses that may have a future and are not overwhelmed by debt.
The last form of business bankruptcy is chapter 13 bankruptcies. Chapter 13 bankruptcies are typically designed for sole proprietorships and is known as the reorganization bankruptcy. A business that files for a chapter 13 bankruptcy will create a payment plan that detail how they will repay their debts. The details of the payment plan often depend upon a business's income, amount of debt, and the value of their assets.
Since sole proprietorships are legal extensions of the owner, the owner is responsible for all assets and liabilities of the firm. Depending on its income, a sole proprietorship may file for a chapter 7, chapter 11, or chapter 13 bankruptcy. In order to file for a business bankruptcy, a sole proprietorship must meet the state's monthly income restrictions, which is often measured by the state's median income. If the sole proprietorship's income is above the state's median income, the owner must then take a means test to determine if their disposable income each month is sufficient for a chapter 7 or a chapter 13. The owner of a sole proprietorship must also attend mandatory credit counseling sessions prior to filing for bankruptcy and before debts are discharged.
Since corporations and partnerships are legal entities separate from their owners, they can only file for bankruptcy under chapter 7 or chapter 11. They are also unable to be discharged from bankruptcy. A partnership lacks the protection between its owners and its debtors; thus, a partnership is often treated as a sole proprietorship. Both creditors are liable for the debt, meaning that a creditor can proceed against any one of the partners for the entire debt.
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